The Daily Interview: Light at the End of the Assembly Line

Economists cannot agree on when a rebound will happen. But they do agree that consumers are not at the heart of the problem. In fact, the biggest drag on the economy continues to be a decline in industrial production due to weak capital spending. Daily Interview turned to an expert at the eye of the storm to find out when manufacturers think things could improve.

David Huether Director of economic analysis, National Association of Manufacturers

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David Huether, director of economic analysis at the National Association of Manufacturers, says manufacturers expect their inventories to be picked through by August and for assembly lines to begin humming again by the fourth quarter. A decline in energy prices, interest rates and taxes should help as well, Huether says. Furthermore, he doesn't believe things are as bad as Wall Street would have us believe. Industrial production is down 5% since September, but in other downturns it's declined by as much as 13%. Here's why Huether holds out hope for a recovery by year-end.

TSC: Have you done any member surveys to ask when manufacturers expect capital spending to improve?

Huether: No, we haven't asked that recently, but what we have asked is when they think the inventory cycle will improve. And well over two-thirds expect the inventory overhang to be over by August. We believe this and it's substantiated by the inventory-to-sales ratio. I think right now manufacturing is bottoming out. This is definitely a positive sign.

Firms have seen industrial production fall significantly since last September and one of the reasons is because inventories were built up. Industrial output is most likely to be down again in July, and orders coming in right now are still being filled with current inventory. But because the lull in manufacturing has now lasted nine months, this will put manufacturing back in the black once these inventories have been worked through to a manageable level.

TSC: What caused the slowdown?

Huether: There were about four main components to the slowdown. Output was rising in the manufacturing sector, as well as the economy overall, at a very strong rate in the early part of 2000. GDP was growing close to 5% in the first half of 2000. So, firms misread demand, thinking that growth would continue to be strong. But then when output slowed, they were stuck with excess inventories.

The second problem was high energy costs, and that hit manufacturers more than other sectors because manufacturers are the biggest consumers of energy in the country. Third was high interest rates, which increased the cost of capital. Fourth, there's the strong dollar, which continues. Combined, these are the main culprits of what has been happening.

TSC: Do you see any improvement in any of these areas?

Huether: Yes. Some of these factors have been dealt with. Energy prices have come down. The Fed has worked on lowering interest rates, which has been helpful, and the second-quarter GDP numbers might give them cause to provide more liquidity. And inventories have been shed fairly drastically in the first quarter. But the dollar still remains high. So, most of the ingredients are there for the manufacturing sector to start to rise again, I think, some time in the fourth quarter.

TSC: This certainly is refreshing news, contrary to the pessimism that's plaguing Wall Street, with some economists now saying that the economy may not improve until the second half of next year and a small minority even whispering about 2003.

Huether: I think we should see some improvement in the fourth quarter. I think that by that time the inventory cycle will be over and that the impact of the lower interest rates will start affecting consumer and capital investment spending. In addition to that, you have the impact of the tax cuts. I think the three of those things combined will bring a turnaround.

TSC: Industrial production has been down consistently over each of the past nine months. How much has it fallen and how does this compare to other downturns?

Huether: Since September, manufacturing production has probably fallen 5% over the past nine months. This is a significant drop. By comparison, during the 1990-1991 downturn, industrial output fell 5.2%. So, the reduction in manufacturing in this downturn is comparable to the overall recession of 1991. During the 1981-1982 recession, industrial production fell 10.5%. The downturn of 1980 saw manufacturing production fall 7.6%. In the recession of 1974-1975, output fell 13%.

So, what economists are saying is that the downturn of 1990 was mild compared to the two previous big ones. I would say the current downturn is not catastrophic.

TSC: Are there certain areas of manufacturing that are doing worse than others and are there any areas that are in the positive territory?

Huether: Everything's down. There are some places where output has fallen more significantly than others. Durables have fallen more than non-durables, and within that group the biggest decline in industrial production since September has been primary metals, such as steel and aluminum, which have fallen 13%. Transportation equipment, which includes autos and airplanes, has fallen 8%. Industrial equipment, which includes computers, is down 6.6%. And interestingly enough, stone, clay and glass are down 7.2%. Electronics, which includes semiconductors, is down 5.6%. Those are the big downward movers.

In non-durables, the biggest downward movers are chemicals, down 7.6% and textile mill products, down more than 11%.

TSC: Did you find the second quarter GDP figure of 0.7% as opposed to the 0.9% that economists expected very surprising?

Huether: Very surprising. It was much poorer than the monthly numbers leading up to it were indicating. We were thinking it was going to be around 1.5%. What was surprising is there really wasn't much change in inventories. It was all drastic cuts in fixed investment.

This isn't a good sign, but I still contend that by the fourth quarter we should be accelerating in growth. And I think that what this argues is that the Fed has room to lower interest rates. Inflation is very moderate and lowering interest rates will lower the cost of capital and will aid in putting downward pressure on the dollar.