U.S. Industry May Be Mean, But It Also Looks Too Lean

Aided by restructuring and a weak dollar since the mid-1980s, U.S. industry has honed its competitiveness to a fine edge. Now, however, fears are growing that a failure to expand the nation's industrial base could spark an early recurrence of inflation and hamper American manufacturers' future participation in fast-growing world markets.

In a stunning downward revision of earlier estimates, the Federal Reserve has erased some 3.7% of U.S. industrial capacity in one fell swoop--slashing capacity growth from 2.4% a year from 1987 through 1992 to a lackluster 1.7%. As a result, operating rates now look a lot higher than they did only a month ago--81.4% for industry as a whole in April, vs. 79.9%, and 86.1% for mining, compared with 81.8%.

"The new risk," says economist Stephen S. Roach of Morgan Stanley & Co., "is that Smokestack America may have gone too far in hollowing out its industrial base in order to achieve short-term efficiency gains."

Indeed, Roach points out that a number of U.S. industries are already running uncomfortably close to the 85% operating rate that has historically been associated with significant upward pressure on prices. These include primary processing industries such as metals, paper, industrial chemicals, lumber, petroleum, and textiles, as well as producers of machinery and furniture.

The dangers inherent in this situation are twofold. Over the short run, industries that approach their capacity limits are likely to start raising prices significantly, causing the inflation-wary Fed to step hard on the monetary brakes. Over the longer run, the lack of cost-efficient capacity could seriously hurt American manufacturers' ability to maintain market share when the global economy turns up sometime next year.

Such risks would fall, says Roach, if U.S. industry were to start investing in capacity expansion, as well as equipment replacement. But that isn't happening yet. In fact, the annual rate of capacity growth so far in 1993 has been only 1.5%--half that of the early 1980s.

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