Manufacturing capacity utilization has been falling; has anyone noticed? Economics Spotlight, May 2018
Manufacturing capacity utilization has been on a broad downward trend, cutting across many manufacturing industries. A continued decline in manufacturing capacity utilization could possibly mean subdued business investment in the future.
Many of us know that fewer and fewer people work in manufacturing in the United States these days. But not many people know that US manufacturers aren’t using their factories and machines as intensively as they used to. Over the past 40 years, actual manufacturing output as a percentage of maximum manufacturing capacity—what economists call “capacity utilization”—has fallen almost 10 percentage points. Indeed, capacity utilization falls and recovers with each business cycle; however, each recovery has peaked lower than the previous one (see figure 1). This downward trend has been more pronounced over the last two decades, with some industries likely more affected than others. The steeper drop over the last two decades might also be one of the reasons why US investment spending has been relatively weak during the same period.
Manufacturing capacity has outgrown manufacturing production
The dip in manufacturing capacity utilization is not due to a fall in manufacturing production. From January 1972 to December 2017, manufacturing production increased 166 percent.1 During the same period, manufacturing capacity increased 187 percent—substantially more than production. Therefore, over the long term, it seems like US businesses might have invested too much, raising capacity by more than what the demand required.
For comparison, we have broken January 1972 to December 2017 into two periods—January 1972 to December 1999 and January 2000 to December 2017. In December 1999, manufacturing capacity utilization was roughly 81 percent, almost the same as it was in January 1972. During this period, manufacturing production and manufacturing capacity increased by approximately the same degree. However, from January 2000 to December 2017, capacity utilization declined from 81 percent to 75 percent. This is because manufacturing production increased just 6 percent during this period, while manufacturing capacity grew 13 percent (see figure 2).
Many manufacturing industries have witnessed decline in capacity utilization
Average capacity utilization was lower during 2000–2017 than during 1972–1999 across many manufacturing industries (see figure 3). Over the last two decades, many different factors have contributed to the steeper fall in capacity utilization in each of these industries. For instance, the shift to digital technologies might be responsible for the relatively large drop in capacity utilization in other manufacturing industries (mostly comprising newspaper, periodical, book, and directory publishing) as well as in certain parts of printing and support activities such as book printing. Some industries such as textiles and apparel are likely showing the impact of international trade.
The dip in capacity utilization across industries such as motor vehicles, electronics, apparel, and textiles may be partially explained by capacity-boosting technological improvements. Another reason could be the offshoring of manufacturing production and the rise of global value chains.
Lower capacity utilization could mean lower investment in the future
Falling manufacturing capacity utilization across several industries might be an important cause of weak investment. During 1972–1999, when the decline in manufacturing capacity utilization was gradual, the average annual growth in investment in manufacturing equipment was 8 percent. From 2000 to 2016, as capacity utilization fell at a sharper tilt, making more and more spare capacity available, average annual investment in equipment dropped to just 2 percent (see figure 4). Interestingly, even though investment in equipment was relatively weak during this period, it was still enough to boost capacity. And since capacity grew by a greater degree than production, capacity utilization fell more sharply than before.
A continued decline in manufacturing capacity utilization could possibly mean subdued business investment in the future. Why should businesses invest in additional plant and equipment while current demand is met by current levels of production? And businesses can ramp up production if required without incurring fresh investment when there is existing spare capacity. In any event, business decisions about investment spending are much more likely to be related to real physical constraints such as production capacity than purely financial transactions such as share buybacks. (See Decoding corporate share buybacks: Is it at the cost of investment? for more.)