Mind the gap

I felt a stabbing pain when I saw the headline (A Threat to Global Recovery: Too Many Factories), and it got worse when I saw the name of the publication (Time). Call me skeptical, but I think mainstream journalists understand manufacturing as well as politicians do.

I went ahead and read the article anyway, and it turned out to be solid.
The crux of the problem with the anticipated recovery is that the industrialized world's capacity has been built up to such an extent, and the output has fallen so far, that we now have a huge gap. The difference between the manufacturing capacity we have, and the amount we are currently using, is vast.

To quote the article, "In 2010 the output gap among 24 OECD [Organization for Economic Cooperation and Development] member nations is projected to widen to -5.7 percent—the widest gulf by far in the post-World War II era.

OK, fine. That's the word for 24 countries. What does that mean to you? Not much. Let's find some data specific to U.S. industries, shall we?

The Federal Reserve Board, the guys who make the big decisions on the direction of the U.S. economy, track capacity utilization. The data breaks down along the lines of the North American Industry Classification System categories, also known as NAICS codes. I looked at two NAICS categories, metal producers ("primary metals" in NAICS parlance, code 331xxx) and fabricators ("fabricated metal products," code 332xxx).

I did a little statistical work on the data. Nothing complex; I simply found the average capacity utilization for both sectors since 1986, and then I added and subtracted one standard deviation. Simply stated, a standard deviation is an average of all the peaks and all the valleys. If you're not into statistics, you can think of this as smoothing out the peaks and the valleys of a data set. Adding and subtracting one standard deviation provides the average operating range, in a manner of speaking.

Mills are in terrible shape. They tend to use 81.6 percent of their operating capacity. Their operating range is between 72.8 and 90.3 percent. As of August (the latest data available), they were running at 51.5 percent, which is a 43.4 percent drop from the top of the average operating range. Compare the 43.4 percent gap to two previous ones: 21.2 percent (October 2001) and 17.2 percent (May 1991).

Fabricators aren't doing much better. They use their capacity a little less fully, so their average is 85.5 percent, and their standard operating range is 72.8 to 81.7 percent. As of August they were running at 62.4, which is a 23.6 percent drop from the top of their average operating range. The gap was 13.9 percent in October 2001 and 11.1 percent in May 1991.

In other words, in some industries it is much worse that the OECD's calculation of -5.7 percent. For metal producers and metal fabricators, the gap is roughly double as compared to the two previous recessions. Does this mean the recovery will take twice as long?

I apologize if I used too many percentages. If you're interested in seeing the data and an accompanying graph, shoot me an e-mail and I'll send it to you.