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Economy Strains Under Weight of Unsold Items

By Annys Shin
Washington Post Staff Writer
Tuesday, February 17, 2009

The unsold cars and trucks piling up at dealerships and assembly lines as consumers cut back and auto companies scramble for federal aid are just one sign of a major problem hurting the economy and only likely to get worse.

The world is suddenly awash in almost everything: flat-panel televisions, bulldozers, Barbie dolls, strip malls, Burberry stores. Japan yesterday said its economy shrank at an 12.7 percent annual pace in the last three months of 2008 as global demand evaporated for Japanese cars and electronics. Business everywhere are scrambling to bring supply in line with demand.

Downsizing can be tricky, though. No one knows how much worse the economy will get, and while everyone waits for the recession to peter out, businesses are grappling with how to cut costs and survive without sabotaging their ability to grow when the economy picks up.

And there is a lot to cut.

"There is over-capacity in everything," from "retail to manufacturing to housing," said Richard Yamarone, chief economist at Argus Research. "If capacity is too large, you don't need that many people employed, which is another reason we're seeing such high job losses."

As long as capacity far outstrips demand, businesses have little reason to expand, buy new equipment or hire workers. Even if the government funds bridge repairs and banks step up lending, many industries still have to go through massive restructuring before growth can resume. But executives say they have to tread carefully. If they put off critical investments in technology or research for too long, they could hobble their recovery and even the economy's.

Few industries have been as stung as severely by excess capacity as the U.S. auto industry, which produces millions more vehicles than it can sell. In 2008, there were enough automotive assembly plants in North America to churn out 18.3 million vehicles a year, according to the Center for Automotive Research. Analysts estimate that consumers this year will buy about 11 million. At current sales levels, it would take 116 days to sell all the cars and trucks clogging lots.

Automakers are scheduled to submit plans today outlining how they hope to restructure their operations to deal with a smaller marketplace, while still developing the new fuel-efficient cars that may be key to their future.

Auto suppliers are also trying to figure out how to survive in the face of massive excess capacity globally.

At its plant in Strasburg, Va., International Automotive Components, a Michigan-based supplier, secured wage and benefit concessions from workers in 2007 in hopes of staying competitive. But when Ford closed a factory in Norfolk, IAC had to lay off more than 200 workers, a third of the workforce in Strasburg. Since then, IAC has been able to line up more work for the plant.

"The unfortunate thing is we know . . . it comes at the cost of other workers whose plants were unable to survive," said Karen Foster, president of United Auto Workers Local 2999, which represents the IAC employees at the affected plant.

There are echoes of the automakers' plight throughout the economy. Sandra Berg, chief executive of Ellis Paint in Los Angeles, an industrial paint and coating manufacturer, recently found herself confronting over-capacity head on. Her company had been growing steadily since 2000 and was able to hand out bonuses for 2008. The downturn started to affect business toward the end of last year. Then came January, and "we just slammed into a brick wall," Berg said.

Since the new year, as sales have plummeted, Ellis Paint has announced two rounds of layoffs, imposed a hiring freeze and cut pay for management by 5 percent. The company has cut everywhere but sales, marketing, and research and development. "Our goal is to keep our expenses at the level of sales. I don't need to make a lot of money. I just need to break even . . . and look for the opportunities," Berg said.

Non-manufacturing sectors are trying to get rid of excess capacity as well. Retail chains such as Ann Taylor and Gap are closing stores after years of expansion, and others, such as Mervyns, are closing for good. "We've tremendously expanded the square feet of stores but not the number of yuppies occupying them," said Standard & Poor's economist David Wyss.

Some analysts say over-capacity is so rampant that it will stymie government efforts to unfreeze credit markets. Banks have little reason to lend not only because they still have bad debt on their books but also because businesses don't have a pressing need to expand, said Mike Shedlock, an investment analyst with Seattle-based Sitka Pacific who writes the popular blog Mish's Global Economic Trend Analysis.

"What is it that we need more of?" Shedlock said. "Do we need more Wal-Marts, more Pizza Huts, more nail salons?"

Strip malls and stores proliferated alongside housing developments, but many of those houses are empty; there were never enough people to fill them in the first place, and there won't be anytime soon.

Harvard economist Edward Glaeser estimates that from 2002 to 2007, the country's housing stock increased by 8.65 million units, outpacing the number of new households, which increased only by 6.7 million over the same period. Taking into account a rise in the number of vacation homes, Glaeser estimates an overhang of about 1.3 million vacant units. Absorbing that excess, he said, could take an additional two years.

Over-capacity in the housing industry has spilled over into countless other peripheral industries -- forcing cuts at chemical companies, home improvement stores and furniture manufacturers. The slump has prompted layoffs at PPG Industries, a leading paint company; Owens Corning, which makes roof shingles; and Therma-Tru, a door-manufacturing company. Therma-Tru recently moved up plans to close its plant in Fredericksburg later this year, citing "weaker-than-expected business forecasts."

Some businesses that were careful to manage inventories during the boom are facing a hard adjustment.

Ben Anderson-Ray, who runs Hubbardton Forge, a small maker of high-end lighting fixtures in Vermont, said he's had to lay off 26 employees after initially cutting hours, even though he expanded the business steadily and his customers aren't stuck with massive quantities of unsold goods.

For now, Anderson-Ray said, he has not scaled back work on new products; he simply cannot afford to do so. As one of the last lighting companies that manufactures its goods in the United States, Hubbardton Forge has survived in part because of its original designs and constant innovation. It cannot compete with overseas producers on price.

"If our order rates improve, we have the capacity in place to come back," Anderson-Ray said. But if order levels fall further over the next few months, he may have to consider further cuts. "We are watching our orders every day," he said.

Some analysts see ending the credit crunch as soon as possible as critical to preventing lasting damage. Harvard economist Diego A. Comin, in his research on Japan's decade-long bout of economic stagnation in the 1990s, found that demand stayed low long enough that businesses didn't make necessary investments. Computer adoption rates, for example, slowed, as did productivity growth. Businesses lost ground to competitors in countries such as South Korea, which made it harder for Japan to emerge from its slump.

Investing in new products and processes matters even more in highly competitive global industries plagued by over-capacity.

"In China, during the boom, there was huge over-capacity in various lines of activity ranging from shoes and clothing, light manufacturing -- all of that stuff. So that is why from the perspective of U.S. companies, we have found it so important to be on the innovative edge," said Harvard business professor Joseph L. Bower. "The only way to create value is to be on the innovative, high-tech, fashion-forward side."

If the credit crunch in the United States persists, "companies will find it difficult to invest in technology for a while, and then once the financial markets are back on track and demand recovers, companies will find themselves in a difficult position," Comin said. "Productivity growth will be declining for a while. They will have a hard time catching up."

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