Overly Concerned About Overcapacity?

Dec. 21, 2004
As the U.S. economy continues to recover from recession, the answer is both 'yes' and 'no.'

Beauty, it's said, is in the eye of the beholder. The same holds true for industrial overcapacity in the U.S. and around the rest of the globe. Your degree of concern -- particularly about capacity utilization and its effect on the U.S. economic recovery -- depends upon your perspective. On March 5, when President George W. Bush imposed tariffs of up to 30% on steel coming into the U.S., Pascal Lamy, trade commissioner of the 15-nation European Union, was worried. He feared the White House's action would end any hope of finding an international solution to a decades-long excess of global steel-making capacity. Now, nearly six months later, an unusually long period of cyclical overcapacity in chemicals is raising another kind of concern. The worry, says Ken Stern, global executive partner for chemicals at KPMG LLP, is that once inventories of commodity chemicals are restocked, new orders will be slow to rise and, presumably retard the rate of U.S. recovery from last year's recession. Based on historic production cycles, "one would have expected the next peak to be around now," notes Stern. "It's not now. And it's not even close to being now. People are talking about [the years] 2004-2005 as the next peak." During the past several years, the global auto, aerospace, pharmaceutical and semiconductor industries -- as well as chemicals -- have had periods when the capacity to produce has far exceeded demand. A worldwide wave of consolidation has swept through autos and aerospace for example, and some less-efficient production facilities continue to disappear. Significantly, however, not everyone looking at industrial overcapacity focuses on the same things. For example, Richard DeKaser, chief economist and senior vice president of National City Corp., the ninth largest U.S. bank, believes that worry about excess global industrial capacity "generally speaking" is overdone. "The global economy is on a rebound, and rising demand is increasingly utilizing excess capacity," states DeKaser. He notes that capacity utilization in U.S. manufacturing rose a percentage point between December 2001 and May 2002. What's more, in Europe, capacity utilization didn't decline as much during the recession as it did in the U.S., he adds, and it, too, now appears to be rising. The devaluation of the U.S. dollar in recent months against some other major currencies could reduce cyclical overcapacity, notes Herbert Moskowitz, director of the Krannert School's Dauch Center for the Management of Manufacturing Enterprise at Purdue University, West Lafayette, Ind. "U.S. goods should become cheaper and, hence, more competitive, thereby increasing demand," Moskowitz says. But the economic rebound that DeKaser sees and the recent dollar devaluation won't benefit Borden Chemicals & Plastics Ltd., a Geismar, La.-based producer of polyvinyl chloride resins. The company is in Chapter 11 bankruptcy proceedings, selling assets to former competitors and likely to be out of business by the end of the year. "Overcapacity is definitely a factor," states Mark J. Schneider, president and CEO. Specifically, producers in North America have not been able to sustain high operating rates, maintain export levels, and hold on to profit margins as facilities have come on-line elsewhere in the world during the past decade. "Tremendous production capacity" has been added in the developing nations of Asia, including South Korea, China, Thailand, and India, says Schneider. What's more, despite the political turmoil in the region, "you are seeing continuing investments -- major investments -- being made in Saudi Arabia and other Middle Eastern countries," he adds. That scenario, while obviously bad for Borden Chemicals & Plastics, nevertheless seems to sit just fine with David L. Webster, president of the Webster Consulting Group Inc. in Bethlehem, Pa. "We view overcapacity as a very beneficial thing," he says. Overcapacity sends a signal that supply and demand are out of balance and has a Darwin-like effect of rewarding low-cost producers in an industry, Webster contends. "It's a way of rewarding . . . the fittest." Yet Darwin sometimes gets tangled in national security and political concerns, and the economic signal loses some of its strength. The classic -- and continuing -- case is the global steel industry. For example, if you were the U.S. government, and quality was comparable and -- even with transportation costs -- the price of foreign steel was cheaper, "would you care where you got your steel from?" rhetorically asks Kenneth C. Taormina, senior vice president at KPMG Consulting in McLean, Va. But in a time of war -- or even as a matter of general principle -- "would you want all your key raw materials outside the country?" he inquires. "And I think the answer is no." Some U.S. steel executives insist that there is no excess steelmaking capacity in the U.S. And they point to the surge in imports that triggered the Bush Administration's temporary tariff "safeguard" as proof. Steelmakers in other countries dispute that assertion. What's not in dispute is that the U.S. and several other steel-producing nations have been working within the Paris-based Organization for Economic Cooperation & Development (OECD) to halve an estimated 200 million annual tons of excess global capacity by 2005. The OECD's efforts may "help stop governments from subsidizing [producers] to maintain capacity or prolong the life of it," says Brian Moffat, chairman of the Corus Group PLC and chairman of the International Iron & Steel Institute. However, Moffat believes steel management, which he contends is hanging onto a no-longer-viable integrated business model, must take responsible for the overcapacity. "The truth is we created overcapacity, and we will continue to create overcapacity, because we think it gives us an edge."

More Productive Plants -- Capacity Utilization
Dec. 2001 74.4%
Jan. 2002 74.8%
Feb. 2002 75.0%
Mar. 2002 75.3%
Apr. 2002 75.4%
May 2002 75.5%
June 2002 76.1%
Source: U.S. Federal Reserve Board

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