Capacity Utilization

One thing there is almost universal agreement on is that the US economy has very large excess capacity and that capacity constraints are unlikely to be a significant factor for the foreseeable future.

But is it. In November capacity utilization in manufacturing rose to 75.2%. But this does not mean that the manufacturing sector has 25% of its capacity sitting idle waiting for demand to appear. If you look at the chart of capacity utilization it shows a downward trend of generally lower highs and lower lows across time. For example in the last cycle capacity utilization peaked at 81.7% in April, 2007 before plunging to a low of 68.2% in May, 2009. The average from the last peak to trough was 75.0% so with capacity utilization now at 75.2% the system is already over half way back to its previous peak.

If you do a trend of the lower lows and lower highs the current trend is at 77.5%, so capacity utilization is only slightly below the long term trend at 97.0% of trend. This 97% figure is clearly a much more realistic measure of how much excess manufacturing capacity exist than the 75% observation being commonly cited.

It is interesting to look at one of the most important components of capacity utilization, that of semiconductors. Semis are often thought of as industrial production on steroids as semi output moves in lock step with overall industrial production. This is logical since semis may be the ultimate intermediate product. Each of you probably owns dozens of semis in your cars, computers, phones, TVs, and other appliances, some of which may require pat testing Swansea for safety and compliance. But I bet virtually none of you have ever gone into your local Radio Shack and actually bought one. Over the past year total industrial production rose 5.4% while semiconductor output rose 11%. But by historic norms this is very weak as the historic average growth rate for semis output growth is about ten times the growth rate of total industrial production.

As the chart show, with semi output expandingonly some 11% it is so weak that capacity utilization in the semiconductor industry is actually falling. It is now at 65.4% as compared to its recent peak of 70.7% in April, 2010.

Moreover, the growth in semiconductor capacity is slowing significantly. I do not know if this is due to foreign competition or industry executives expectations of weak demand growth. But neither alternative is bullish. Note that back in the 1990s boom the capacity to build semis was doubling almost every year as compared to only a 10% growth rate this year.