1991 Won't Be A Pretty Yearby
Like an avalanche gathering speed, the recession of 1991 is threatening to cut a broad swath through the U. S. economy. So far, the service sector is absorbing the most visible damage, with crippling problems hitting such industries as real estate, retail trade, and financial services--all of which added jobs during the past couple of recessions. In this year's downturn, by contrast, office-vacancy rates are hovering around 20%, retailing revenues are expected to fall in real terms, and banks and brokerage houses are still shrinking. Indeed, Citicorp, the country's largest bank, has just announced plans to trim 8,000 jobs, about 8.5% of its total work force.
But even though services have taken the brunt of things until now, companies in the manufacturing sector have no reason to be overconfident. Their fortunes are still hostage to the fate of the overall economy, and signs are appearing that the shock wave from the downturn in services may soon wash over manufacturing. Since last summer, when this recession probably started, industrial production, excluding defense and aerospace, has dropped by 2.8%, just short of the 3.3% plunge in the comparable period at the beginning of the 1981-82 recession. And should the slump continue through the first half of 1991, as economic forecasters such as Lawrence H. Meyer & Associates predict, manufacturing output could keep diving by an additional 2.8%.
True, manufacturing isn't going to be as devastated as it was in the early '80s, when industrial output fell by 12.4%, hundreds of plants were shuttered, financial losses ran into the billions, and nearly 3 million workers were put out of work. Manufacturers who caught pneumonia back then have trimmed down enough to survive this slump with just a bad cold. They have far healthier balance sheets than last time, better control over inventories, and less dependence on the domestic market. And when it comes to profits, manufacturing almost certainly won't be the worst-hit sector of the economy. Food processors, chemical producers, and machinery makers will probably do reasonably well this year. Even steelmakers, who were steamrollered in the early '80s, anticipate that at least they'll break even in 1991, especially if economic growth perks up in the second half.
STRATEGY BACKFIRE? Still, the first half of 1991 is unlikely to be kind to most producers. For one thing, the momentum is going the wrong way. The only part of the economy showing a significant gain in output from August through November was the petroleum industry, which enjoyed a boost from higher oil prices. Makers of consumer durables, such as autos and appliances, have slashed output by 7.3%, according to recent Federal Reserve Board numbers. Even sectors that expect to weather the recession fairly well, such as chemicals, have cut back production. According to projections from DRI/McGraw-Hill, output in almost every manufacturing industry will drop in the first quarter. Even if the recession stays mild, predicts DRI, only food processors and makers of sophisticated technical instruments will show an increase in production in 1991 over 1990 levels.
One problem is that even if interest rates continue to fall, consumer spending won't bounce back soon. In their haste to stay lean and mean, for instance, manufacturers have eliminated nearly 400,000 jobs very quickly. No doubt that's smart business, but it may also worsen the recession by removing demand from the economy just when it is needed most. Now, almost everyone knows someone who is job-hunting. Beyond that, the Mideast crisis, by recalling past oil-shortage recessions, has made consumers cautious. And the drop in real estate values is leaving many homeowners feeling poorer, especially those with big mortgages. Observes Richard B. Hoey, chief economist at Barclays de Zoete Wedd Inc.: "When there's no bid for your labor and no bid for your home, you're supposed to be scared."
More people are likely to be getting that message. Many economists agree that the unemployment rate, now at 5.9%, may pass the 7% mark by the middle of the year. That's low compared with the peak of 10.8% by the end of the 1981-82 recession, but it could be more painful than it looks. In the early '80s, much of the rise in unemployment came from young workers just entering the labor force, which was growing by roughly 2% annually. Now, the labor force is hardly growing at all, thanks to falling birth rates in the late 1960s and early 1970s. That means that most of the newly jobless are people who have been working for some time and, therefore, have more to lose.
To make things worse, state and local governments are facing budget deficits that, as a share of revenues, areunequaled since the end of the 1974-75 recession. Right now, the budget problems are concentrated in the Northeast and a few other states. But fiscal distress is likely to spreadas the economy slows and tax revenues fall. If the economy keeps heading down, states and localities across the country will have to cut spending, lay off workers, and raise taxes in 1991, which will take more bites out of consumer income. "We really don't know how bad things will get," says Steven D. Gold, director of the Center for the Study of the States at the State University of New York at Albany, "but the omens are certainly bleak."
Meanwhile, exports, which have been the mainstay of economic growth over the past couple of years, are faltering. Export-oriented manufacturers such as chemical and machinery makers were counting on foreign sales to keep profits strong as the U. S. economy cooled. But other countries are facing slower growth, too, limiting their demand for U. S. products. For example, about 30% of U. S. merchandise exports go to Britain and Canada, both of which have dipped into recession. Overall, economic growth in the countries that buy U. S. exports may slow from 2.9% in 1990 to 2.2% in 1991--and next year's forecasts are being revised downward every month. This will hold export growth down to 5.4% in 1990 and 3% in 1991, according to DRI/McGraw-Hill, far below the 11% gain recorded in 1989. Moreover, argues Edward Guay, chief economist at CIGNA Corp., European and Japanese companies have built too much capacity at home; that will blunt their willingness to buy U. S.-made capital goods, which account for about half of manufacturing exports.
'COORDINATION FAILURE.' Any slowdown in export growth certainly won't be offset by greater domestic demand, as prudent U. S. companies hold off on capital spending until the economy shows more signs of life. Boise Cascade Corp. is scaling back its capital program from more than $700 million in 1990 to about $300 million in 1991. Other companies are following suit. Overall, manufacturers are planning a 1.3% decrease in real capital spending for 1991, according to an October survey by the Commerce Dept., the first drop in their capital spending since 1986. As the economy's decline has become more pronounced, many more companies that face weak demand have cut or postponed their investment plans for 1991. Indeed, the latest numbers show that new orders for nondefense capital goods plunged by 16.4% in November.
Even companies with strong sales are cutting back in anticipation of a deepening slowdown. The amplifying effect this has on the slump is what economists call a "coordination failure." For example, VLSI Technology Inc., in San Jose, Calif., is still making money in its semicustom-chip business. Even so, CEO Alfred J. Stein has frozen hiring and stretched out buying plans for capital equipment. "I don't see any choice," he says. "But I'm concerned that we may be talking ourselves into a recession."
Intel Corp. is also keeping a tight rein on outlays, even though it has $2.5 billion in cash on hand and expectations of double-digit revenue growth in 1991. Intel plans to shift its spending to the latter half of the year, in hopes that the economy will look better by then. So if a product calls for a $10 million sales-and-marketing budget, Intel will spend less than $2.5 million in the first quarter, more in later quarters. "If you spend first, then try to cut, it's terrible," explains Chief Financial Officer Robert W. Reed.
And when large manufacturers react this way, their suppliers also suffer. Ford Motor Co. has already told suppliers that it wants a 1% reduction in prices by early 1991. The request "is truly not meant to move money from one pocket to another," says Philip E. Benton, the president of Ford Auto Group. "We're putting the screws on them to keep cutting costs"--and help Ford hold its own costs down. But that means razor-thin margins in 1991 for such suppliers as steel companies, who expect their own production costs to rise by 4% over this year. And the longer the economy stays weak, the more likely it is that profits will shrink or disappear.
To be sure, when demand does finally pick up, "manufacturers are going to outperform the rest of the economy," says Mickey Levy, chief economist at CRT Government Securities. They are likely to be carrying lower inventories than in past recessions, and they aren't weighed down by costly debt. Falling interest rates, in turn, are making the dollar cheap, and that should help exports gain market share in Europe even if those economies weaken. And some companies are continuing to invest in new capacity that will let them raise productivity and compete globally. One example is Nucor Corp., the nation's largest steel minimill, which has announced that it will spend $300 million to build a plant in Arkansas using new Japanese technology.
LOWER RATES. Most manufacturers won't see their profits and output really recover, though, until the rest of the economy picks itself off the floor. To a large degree, when that happens will depend on the Federal Reserve Board. For the past couple of years, the Fed has concentrated on containing inflation by managing the economy down to a "soft landing." Since the oil shock of August, though, Fed Chairman Alan Greenspan has pushed down interest rates by a percentage point, and he seems willing to cut them further to head off a deep slump. Eventually, lower interest rates will help many producers, especially if consumers buy more autos and homes. But the Fed may have waited too long before easing monetary policy, argues Northwestern University's Robert Eisner, a former president of the American Economic Assn. "Once you let the boulder go," says Eisner, "it's hard to stop."
Economists such as Jerry J. Jasinowski, president of the National Association of Manufacturers, see "no reason why manufacturing will recover before the second quarter." And even when it comes, the upturn may well be anemic. Troubled banks may still be reluctant to lend, house-poor consumers may not be so eager to spend--and that's if there's no war in the Middle East. Manufacturers may survive all this with much less damage than they suffered a decade ago. But that could be as cheery as the news will get in 1991.