Olav Bradley pulled a tiny plastic part from a bin at his Schaumburg factory. Hold it up to the light, he said, and you can see a hole so small that the buyer will be able to shine the tiniest laser beam through it.
“The Chinese can’t make this,” he boasted.
To beat the Chinese and other foreign competitors threatening his business, the Bradley and his partner invested several million dollars to double the production capacity of their plastic-part plant, PM Mold, with the latest in robotics and automation equipment.
Now, he says he can make twice as many parts–and better ones at that–without adding to his workforce, a feat that is driving up productivity as Bradley’s small factory increases its output of parts with the same number of workers.
“Everybody says I am nuts” for borrowing more money in such a sluggish economy, said Bradley, 63, who makes parts for everything from cellular phones to automobiles. “But as I see it, the only way to beat low-cost wages is with no-cost wages.”
Bradley’s expansion is a classic example of the overcapacity vise squeezing American business during a persistent sluggishness that the U.S. economy can’t seem to shake. As he makes more parts to generate the profits he needs to repay his loans and meet the payroll, he is adding to a glut in the international parts market that has driven down prices and, ironically, put many businesses like his under even more pressure.
As Bradley put it: “We’re making far more parts than we were capable of making before–and getting less money for doing so.” But he says he has no choice but to do what he’s doing to compete with the Chinese and to stay in business.
The ability of companies to make too much has grown into a problem with potentially profound and unpredictable effects on the world economy. The glut of world production is challenging old assumptions about trade relationships and raising questions about whether the United States can continue to be the economic powerhouse it has been for generations while so much of its manufacturing capacity, especially high-tech production, is increasingly shifted overseas.
If the surplus in worldwide industrial capacity persists, it could keep the global economy stuck in a slow-growth pattern for some time and increase the risk that deflation, or a spiral of falling prices, gains a foothold in the U.S. It could also inhibit the investment that is so critical to the revival of the U.S. economy and its technological leadership.
The glut in capacity started during the era of the economic exuberance in the late 1990s, when companies built more factories to satisfy the world’s consumers, especially affluent Americans.
But now that the economic boom of the 1990s is over, the same factories are left with the same capacity to produce the same number of goods as they did when times were good. The excess of supply over demand has led to falling prices for many goods sold around the world and in the U.S.
Shedding workers
In this climate of retrenchment, the U.S. is less able to assume its role as an economic engine and lead the world out of a pronounced slowdown because American factories are shedding workers and shuttering plants that have too much capacity. And those who do invest in their businesses, like Bradley, typically do not add workers.
Nations with low labor costs–such as China, which is rapidly becoming an Asian economic powerhouse–are adding to their economic capacity even in the face of a glut elsewhere. China is counting on America to buy the goods it produces and help generate the wealth it needs to employ a huge nation.
“China has an enormous labor force that’s underemployed,” said Peter Morici, a University of Maryland professor and former chief economist at the International Trade Commission. “They can probably produce a great deal of what they need with many fewer people. And then what do they do with the unemployed?”
The trouble is that America can’t sop up the world’s goods forever, running a huge trade deficit, without consequences. Economist Gary Hufbauer of the Institute for International Economics said something likely has to give. Hufbauer and others hope the U.S. can avoid a financial or economic crisis, such as a plunge in the value of the dollar, or deflation.
Normally, falling prices might seem good for the economy. After all, such a drop makes products cheaper for consumers. But those good deals have a hidden cost. Investment in the U.S. has stalled partly because businesses make a rational choice: Why buy new machines when they might be cheaper tomorrow? But less investment leads to a weaker economy and rising joblessness.
When will it end?
No one is sure when or how the global glut in production capacity will work itself out. To economist Stephen Roach of Morgan Stanley, soaking up all this worldwide surplus would require “three years of aggressive economic growth” in a global economy now rising anemically–only about 2.5 percent a year.
But three straight years of strong growth doesn’t seem likely at this point, Roach said. Japan and Europe are stuck in the doldrums, Japan more so than Europe, and neither appears capable of pulling the world economy out of its slump.
So far, the traditional tools of tax cuts and lower interest rates have failed to lift the U.S. economy. President Bush won approval for a $1.35 trillion, 10-year tax reduction, and the Federal Reserve slashed interest rates 12 times over 13 months, and yet the recovery is just poking along. Now, Bush is promising more tax cuts next year, keeping his fingers crossed that they will work. And the central bank has signaled that there could be more interest rate reductions.
Some industrialists think they have the answer: Let the dollar decline. They argue the U.S. currency is too strong against other currencies, particularly the Japanese yen and the Chinese yuan, and is a major factor in the glut of goods building up around the world and the fact that America every month imports nearly $40 billion more than it exports.
A strong dollar raises the prices of U.S. exports sold abroad and lowers the prices of U.S. imports–good for American consumers looking for bargains but hard on businesses that need exports to hire U.S. workers.
A weak dollar has the opposite effect, lowering the price of exports and making U.S. goods more competitive abroad. But prices of imports go up, reducing the price advantage that foreign companies have in the U.S. market.
“We think some of our competitors, especially Japan, China and to a lesser extent Korea, keep the values of their currencies artificially low so they can sell into our market,” said Thomas Duesterberg, president and chief executive of Manufacturers Alliance/MAPI, a trade organization.
Let the dollar fall by 15 percent, said Morici, and the products of many American companies would immediately become more competitive around the world. But the Bush administration is resistant, fearing that weakening the value of the dollar could roil financial markets.
Also, the world economic system now is not set up for the U.S. to balance out its trade with foreign countries. This is the last thing that U.S. trading partners say they want. Roach said other countries would be hard-pressed to grow at all if they couldn’t export goods to the U.S.
“We are the consumers of last resort,” he said.
America has become the premier consuming nation holding the rest of the global economy together. The U.S. still develops new technological products within its borders. But increasingly manufacturing of these goods is being shifted overseas to take advantage of lower labor costs.
Asia, Latin America and Europe rush to supply the giant and wealthy–and more open–U.S. market. As debt-ridden U.S. consumers snap up foreign goods, the trade deficit is soaring. This year, for every dollar of goods exported, the U.S. is spending $1.43 on imports.
Normally, the value of the dollar would adjust automatically to cure this imbalance of trade. But other countries, eager to continue supplying the U.S. to keep their workers employed, simply invested their profits back into the U.S. market–in government and corporate bonds and in the U.S. stock market–to shore up the dollar’s value.
A nation of consumers
According to Roach, America’s role as a consuming nation is partially the cause of the glut in global capacity. Everyone is rushing to get into the U.S. market, with China rushing toward the head of the line. But he said the flood of cheaper goods is exporting deflation to America’s shores.
China has demonstrated such amazing industrial prowess in recent years, posting double-digit growth rates, that it is rapidly emerging as a major player in world trade. This year, China passed Japan and became America’s third-largest importer, behind Canada and Mexico.
“If exports keep growing in the mid-teens, as some think they will, China could become the world’s largest exporter in five years,” Roach said. “They started with toys and clothes, and now they are going up and down the value chain, making automobiles, consumer electronics, semiconductors, just name it.”
China has made it clear that it does not intend to be a mere assembly center that makes manufactured goods for export by using cookie-cutter blueprints prepared by well-paid engineers and scientists back in the U.S., said Hufbauer and Roach.
George Thomas, chief executive of Contemporary Controls, a Downers Grove manufacturer of industrial electronic controls that opened a plant in China earlier this year, agreed, saying China has intelligent engineers and scientists and the will to challenge the U.S. in technological innovation.
“Not only is our manufacturing at risk, our intellectual property is at risk too,” Thomas said.
To Macy Block, a retired Columbus, Ohio, chief executive of Sun Television & Appliances, a now-defunct electronics firm, the U.S. is making a mistake by manufacturing so much overseas. “Ordinarily countries trade with each other, but there’s nothing that they want from us that they can’t make faster or cheaper themselves,” he said.
But many analysts are not overly concerned about the U.S. losing manufacturing capacity to other countries through companies’ “outsourcing” their operations or moving manufacturing plants altogether.
As long as the U.S. maintains its leadership in developing the products, they say, there is nothing wrong with going abroad to lower-cost manufacturers, especially if so many goods today become virtual commodity items in a short period of time.
“American producers can maintain export-competitiveness, even if they don’t make a product fully within the boundaries of the United States,” Duesterberg said. “We think U.S. manufacturers do best in research and development, new product innovations, and management.”
But Jeff Korman, a Northwestern University professor and a consultant to the Chicago Manufacturing Center, which assists small manufacturers in the region, disagreed.
“We can’t let it slip away,” Korman said. “We cannot. It definitely scares me.” The U.S. not only could lose its manufacturing base but also over time could see its leadership in product development and design begin to erode.
Some think glut could last
Many analysts fear today’s glut in production is not merely a temporary phenomenon that will, over time, be worked off with some painful adjustments–such as more plant closings or consolidations in the U.S.
Some think the glut could last a long time.
Michael Drury, chief economist for McVean Trading Co. in Memphis, a futures trading firm, said the world could face a chronic overcapacity problem as newly industrializing countries like China crank up their export factories. Technology and efficiency of production have advanced to make it easier to set up such plants in every corner of the globe, he said.
According to industry analysts, China has built some of the largest, most advanced semiconductor plants in the world, adding to the supply in an industry already facing an oversupply. In the U.S., some 45 semiconductor fabricating plants have shut down, largely because of the worldwide glut in capacity.
Not all analysts think China is building so much industrial capacity just to sell to the rest of the world. W. Bowman Cutter, managing director of Warburg-Pincus Venture Capital and a former Clinton administration trade official, said that “most of the incremental capacity that China builds is going to serve China.”
Some U.S. companies are crying foul over China’s behavior. In a closely watched case, William Wolf, chief executive of Motion Systems Corp., an Eatontown, N.J., firm, has filed a formal complaint against the Chinese with the Bush administration for copying its technology used in making scooters for the medically impaired. The International Trade Commission ruled in favor of Wolf’s firm, and now the final decision is in Bush’s hands.
Wolf said he has spent several thousand dollars to press his case against the Chinese, and doubted that other small- and medium-size manufacturers would be financially able to challenge the Chinese. “In my opinion, our manufacturing expertise is going away,” he said.
After Contemporary Controls opened a plant in China, Thomas said he had cut costs by one-third to a half by selling Chinese-made goods in the U.S.
He thinks China is well on its way to becoming the premier world manufacturing center. “They’re ingrained capitalists,” he said. “That goes all the way back to the Ming Dynasty. Every one of them is an entrepreneur.”
Thomas said that for the $11,000 a year he pays for a single family health-care plan for his employees in Downers Grove, he can put four or five semi-skilled workers on the payroll in China.
Pinched by slowdown
Fierce international competition has hurt many U.S. manufacturers in several industries, including the tool-and-die industry where Bradley is trying to keep his business afloat.
Overcapacity has been a perennial problem in his industry, Bradley said. About 25 percent of plastic mold shops like his have closed, he said, “and of the shops that have survived so far, employment is down at least 20 percent.”
Larry Waltz, president of Waltz Brothers, a Wheeling manufacturer of machined parts, said his family-owned operation is being pinched by the economic slowdown but still surviving by becoming more efficient and adopting lean-manufacturing techniques, which call for eliminating all waste possible from the production process.
But Waltz said he has found a way to tap lower wage costs in China without opening an operation there. Through an alliance with a group of firms that do business with the Chinese, he has a Chinese company do most of the machining on a pump shaft that is used in 7-Eleven Slurpee machines.
But the part is then brought back to his shop in Wheeling, where his workers put the finishing touches on it with precision grinding.
On this part, which sells for $11, Waltz said he increased his margin by 30 percent by working out a special arrangement with the Chinese. Now he’s ready to expand his global presence through such contacts with other countries too, he said.
But Bradley said that, at least for the present, he wants to fight rather than partner with foreign competitors. The son of Norwegian immigrants, he started his business in 1963 and has gone through booms and busts.
“When you devote your whole life to something, you hate to see it destroyed,” he said. “If the tool-and-die and industrial mold industry goes down, we’re going to lose manufacturing totally.”
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The series
SUNDAY: The economic challenge of overproduction
MONDAY: The global threat of overproduction
TUESDAY: Government’s weak hand
WEDNESDAY: The new new economy
