Big Wheels Turning

By Barbara Rudolph

Just a few years ago, pundits were proclaiming the decline of American industry and heralding the conversion of the U.S. to a service economy. Overwhelmed by a tide of imports, U.S. manufacturing firms were accounting for a dwindling portion of the gross national product and generating a shrinking share of total employment. At the same time, service businesses ranging from fast-food outlets to financial conglomerates seemed to be where the action was. Soon, the seers said, Americans would all be flipping burgers, selling software or shining one another's Italian shoes.

But lo and behold: the Rust Bowl is resurgent. Thanks largely to a weakened dollar, which makes imports more expensive and American goods cheaper overseas, the output of U.S. factories rose 4.2% last year, twice the 1986 increase. Marching proudly under the MADE IN THE U.S.A. banner, companies are boosting their exports and winning back domestic sales lost to imports. Says Peter Jordan, an economist at Data Resources, a consulting firm: "American manufacturing is undergoing a major renaissance." In fact, business is so strong that some firms may soon face a shortage of capacity to handle the soaring demand.

Of course, the comeback remains vulnerable to a downturn of the U.S. economy. After 64 months of growth in the gross national product, the longest peacetime expansion in U.S. history has reached old age, and economists are checking its vital signs. Last week the Government reported that the index of leading economic indicators, a barometer of future economic performance, fell .6% in January. But economists were encouraged by the Government's revision of the December index, which changed from a .2% drop to a .3% increase. Moreover, the unemployment rate fell from 5.8% in January to 5.7% in February, the lowest level since July 1979. While retail sales were sluggish in February, most economists expect rising exports to keep the economy going through the rest of the year at least.

The revival of manufacturing is not quite so remarkable as it may seem. U.S. industry was beleaguered in the early 1980s, but not so close to the brink of doom as many observers believed. Between 1970 and 1984, manufacturing output rose 53%, almost as strong an increase as the 62% in services. While many companies laid off factory workers, new industrial firms sprang up and others expanded, so that the total number of manufacturing jobs remained fairly constant. Meanwhile, employment in service businesses shot up 47% between 1970 and 1984, but that was partly because productivity growth was much lower in those areas than in manufacturing.

Nonetheless, there was no denying that U.S. manufacturers faced some profound hardships, most notably the strong dollar. Between 1981 and 1985, the greenback's value climbed more than 50% when measured against the currencies of major trading partners. That made U.S. products prohibitively expensive for foreigners, while imports became dramatically cheaper for American consumers.

When the dollar started its steep decline in February 1985, the outlook for U.S. manufacturing began to improve. Some two years later, the dollar lost all the gains it had made during the previous five years. The first industries to benefit from the dollar's drop produced goods that are sold mostly on the basis of price. Among them: paper, plastics and metals. As the dollar fell, sales of such manufactured goods as office equipment and machine tools picked up sharply as well.

By 1987 the turnaround was unmistakable. Exports surged 11.4%, compared with a 3.7% increase in 1986. And while the trade deficit hit a record $171.2 billion in 1987, it was at last showing signs of falling in the final months of the year. December's trade gap of $12.2 billion was down 31% from October's $17.6 billion. Many economists believe the persistent trade deficit will cause a further sharp decline in the dollar, which will give an extra lift to U.S. manufacturers. John Paulus, chief economist of the Morgan Stanley investment firm, predicts that by 1991 the U.S. will be the low-cost manufacturer of most traded products. Says he: "The world will be turned upside down. Japan and Europe will be clamoring for protection against U.S.-made goods."

Already, the export boom is boosting revenues for all sorts of manufacturers. Shipments of lumber and wood products last year increased 31%, to almost $4 billion. Apparel exports rose 26%, to $1.5 billion. High-tech firms are flourishing as well. The Los Angeles-based Meridian Group, which exports electronics products, scientific instruments and equipment for some 20 industrial companies, reports that its shipments were up 15% last year, to $25 million. Says Charles Nevil, Meridian's owner: "I just got back from Europe and Asia, and old customers were coming up to me and sheepishly asking if I would sell to them again."

Even U.S. automakers, who for years had only minimal success in exporting cars, are sharing in the surge. Chrysler expects to export some $800 million worth of vehicles in 1988, up from $200 million just three years ago. General Motors plans to send 4,000 cars to Japan this year, up from 2,875 in 1987.

When the dollar was strong, many American firms set up factories overseas to take advantage of relatively low costs. But the dollar's dive has inspired some of them to bring their production back home. Last November, Tandy decided to shift assembly of its Color Computer 3 from South Korea to Fort Worth. The move will cut production costs by some 7%. Similarly, the Otis Elevator division of United Technologies recently began producing escalators in its Bloomington, Ind., plant. Since 1983 its escalators for the U.S. market had been made in a plant in West Germany.

American manufacturers have not depended solely on the falling dollar to bolster their business. They have also slashed costs and boosted productivity. While output per worker-hour grew at a 2.4% annual rate in U.S. manufacturing between 1960 and 1982, it doubled to a 4.8% pace over the past five years. Productivity gains have been particularly dramatic for machine-tool makers, which had been savaged by foreign competition. Michigan-based Cross & Trecker shortened the length of time it takes to produce a critical machine-tool part called an air bearing from five months to five days. Such productivity improvements have helped companies hold down prices and raise sales. January machine-tool orders were twice what they were for the same month of 1987.

Profitable and prosperous once again, many firms have recaptured market share that had been won by foreign rivals. In 1986 Japan's Komatsu Construction held 11% of the U.S. market for earthmoving equipment. Today its share is down to 9%. That is good news for Komatsu's archrival, Caterpillar Tractor, based in Peoria, Ill., which claims 45% of the market. U.S. firms have staged a comeback in the specialty-steel market as well. In 1986 domestic producers claimed 50% of the market for steel used in making machine tools; now that figure is up to 70%.

In response to the dollar's plunge and the rejuvenation of their American rivals, more and more Japanese companies are opening factories in the U.S. In July Mitsubishi will begin constructing a forklift-manufacturing plant in Houston. Within the past three months, nine Japanese machine-tool makers have announced plans to build factories in the U.S. They will service the four Japanese auto plants already operating in the heartland.

Though large companies still account for the bulk of U.S. exports, small firms are playing an increasingly important role. Nowhere is the boom in small-scale industry more apparent than in Southern California. The thousands of companies in and around Los Angeles make it the leading metropolitan area in the U.S. for manufacturing output (value of 1987 shipments: $75 billion). The profit margin of Zero Corp., which makes electronic equipment as well as Halliburton camera cases and luggage, amounts to an unusually high 9% of sales. Zero attributes much of its success to Japanese-style cooperation between workers and managers. Nearby Point 4 Data is a thriving manufacturer of expensive ($50,000 to $100,000) computer systems. Its secret: designing programs to meet the needs of individual customers instead of going for the mass market. Point 4's sales last year reached $22 million, up 15% from 1986.

For all its current strength, the manufacturing comeback could falter. Economists are worried that many of the productivity improvements achieved by industrial firms are one-time gains that cannot be repeated. Some companies simply shuttered old plants and shifted production to newer, more efficient factories. Robert Lawrence, a senior fellow at Washington's Brookings Institution, likens this process to raising a baseball team's batting average by cutting the five worst batters. The remaining hitters will post a higher batting average, but in extra innings the manager could find himself with an empty bench.

In some industries the bench is almost empty already. Paper mills are producing at 97% of total capacity, while primary metal and chemical manufacturers are operating at more than 90%. Overall, U.S. factories were running at an average of 82% capacity at the end of last year, the highest level since 1980.

Yet executives remain wary of making capital investments. A common nightmare is that the dollar will regain its strength. Reports Lynn Michaelis, chief economist at Weyerhaeuser, a leading lumber and paper producer: "The strong dollar of 1985 is having a haunting effect when it comes to investing large chunks of capital." It takes about three years to build a large factory, and companies have no idea what economic conditions will be like when the plant is finished.

Fear of a recession, almost endemic in corporate boardrooms, is also restraining new plant construction. Says Edward Irving, senior vice president of United Technologies, an automotive supplier: "Back in 1980 and 1981, we had to shut down 25 plants because of excess capacity in the auto industry. We said to ourselves, 'We're not going to face this again.' " That attitude is to be expected, says Fred Bergsten, director of the Institute for International Economics: "A reluctance to invest in new capacity is a natural reaction to years of meager profits."

But the hesitation to build new factories could cause trouble. Companies may be forced to turn away customers, missing an unusual chance to wrest market share away from foreign competitors. Says David Hale, chief economist for Kemper Financial Services: "We have had five years of underinvestment in manufacturing. This may simply represent a form of corporate anorexia."

U.S. companies might want to take a cue from the Japanese, who invest in the future without being overly concerned about the impact of temporary recessions on short-term profits. They want to make sure they have enough capacity when demand surges. And with U.S. manufacturing in the midst of a renaissance, it is certainly no time for American managers to be timid.

With reporting by Richard Hornik/Washington and Frederick Ungeheuer/New York