Factory production continued to fall last month as the share of manufacturing capacity actually in use dropped to 72.9 percent, the lowest level in 20 years, the Federal Reserve reported yesterday.
Several analysts said concerns about the war in Iraq had caused manufacturing firms to be particularly cautious in their production schedules last month, with companies preferring to draw down inventories rather than produce more goods until the war's impact on the economy was clearer. Some suggested that some rebound was likely to occur this month.
The decline in capacity use raised further questions about whether business spending on new plants, equipment and software is likely to increase later this year, since few firms seem to need to expand. Such spending is considered key to giving the nation's sluggish growth rate a boost.
David M. Huether, chief economist for the National Association of Manufacturers, said the failure of production to rebound after the recession makes this "the slowest manufacturing recovery since the Federal Reserve began tracking monthly production back in 1919."
Manufacturing production is up just 1 percent since December 2001, when many analysts think the recession ended. That compares with an average of 10 percent during the first 15 months of the recoveries that followed the six previous recessions, he said.
Capacity use has dropped primarily because of the plunge in production in the 2001 recession. But despite a related drop in business investment, capacity itself has continued to grow modestly as new, more efficient machines and other types of equipment have replaced older versions.
A number of economists said that low use of industrial capacity is not necessarily a good guide to future investment.
Maury N. Harris, chief economist at UBS Warburg, said, "We do not believe that this low capacity use bars a renewed expansion in capital spending over the balance of this year."
In a recent survey of corporate chief information officers by his firm asking what are the key determinants of investment in information technology, only 10 of 131 respondents cited their company's capacity utilization rate, Harris said. The most important factor, according to 75 of the group, was their company's financial results.
And bottom lines are improving. After plummeting in 2001, corporate profits rose substantially last year. According to the Commerce Department, pretax corporate profits were up 16 percent from the end of 2001 to the end of last year, while profits after tax were up 10.3 percent.
Another reason for discounting the importance of capacity use as a guide to total business spending on new plants and equipment is that manufacturing's share of production and investment in the total U.S. economy has been declining. In 2001, when overall business investment had begun to fall during that year's recession, the industrial sector accounted for less than one-third of business investment, Harris noted.
Economist Kevin A. Hassett of the American Enterprise Institute told a recent conference there the same thing. "Capacity utilization is never useful in predicting investment," he said.
Yesterday's Fed report showed factory production falling in numerous industries last month, including motor vehicles, with overall output down 0.2 percent following a 0.3 percent decline in February. Total industrial production, which also includes mining and utility output, declined even more because of a sharp 4.1 percent drop at utilities after a return to normal weather following an exceptionally cold February.
"Today's news, however, is not all gloomy," NAM's Huether said. "Production of high-tech equipment surged 1.6 percent last month following strong gains during the previous two months. This is a good indication that the investment recovery in computers and software is well underway. But the 0.6 percent decline in other machinery production signals that other business investment continues to stagnate."
However, Allen Sinai, chief economist at Decision Economics Inc., said what it will really take to spark significant additional business investment is an increase in spending by consumers.
"Business capital spending almost always follows sales," Sinai said. "We need sustained increases in sales to motivate business investment. Right now we're seeing replacement spending in technology, but spending for expansion purposes is the kind of force the economy needs to lift it."
"In the United States, the management of the bottom line is so great that increases in hiring and expansionary capital spending is going to wait for a belief that increases in sales are going to be permanent. That is going to take some time," he said.
Furthermore, labor productivity continues to rise at a healthy pace even though economic growth has been sluggish. That means that the cost of labor, the largest single cost for most firms, is rising very slowly, if at all. At the same time, other costs, including interest payments, have also been flat, helping firms improve their profits while hardly raising the prices of what they sell.
And this year profits are likely to get a boost from another source, a decline in depreciation charges -- the writing off of the cost of earlier capital investments.
"Unlike some cost reductions, which are largely one-time adjustments, declining depreciation will continue through 2003 and 2004," said L. Douglas Lee of Economics From Washington. "This is the positive side of writing off -- and not replacing -- unnecessary investment."
Last year's gain in profitability is one reason that business spending on equipment and software began to rise last spring after falling for a year and a half. Over the last nine months of last year, such spending increased at an annual rate of more than 5 percent after adjustment for inflation. However, that increase was more than offset by a decline in spending on business structures -- such as new plants, shopping centers and office buildings.
Even economists such as Harris who expect further gains in spending on equipment and software said it likely will be 2004 before investment in structures begins to rise again.