BUSINESS
Economist Charles Reeder Bullish on Chemical Industry Retired Du Pont economist sees resurgence of trade, increased operating rates leading to higher profits for U.S. industry William J. Storck, C&EN New York
a 25% decline in the value of the dollar, trade must be a factor in any economic forecast, he says. With that decline, it has to follow that there will be an expansion of exports and a restraint of imports. "And so I would expect all manufacturing, agriculture, and so on, and the chemicals within those areas, that have been hard hit by the flood of imports and an inability to compete in certain markets abroad, to be benefited relative to the rest of the economy as you get a weaker dollar," he says. "That's point number one. You're going to get some more volume growth and you're not going to have the same pressure from imports. And, if some import prices are raised, this will give a little pricing flexibility." Reeder thus sees the trade picture as a boost to operating rates. "An improved trade balance could mean a significant improvement in operating rates once it takes hold,"
Charles Reeder, former chief economist for Du Pont, is bullish on the chemical industry—and, indeed, on the entire manufacturing sector of U.S. industry. In an exclusive interview with C&EN, Reeder forecast only modest growth in gross national product in the next year, but soaring profits. Reeder retired from Du Pont last year after 15 years as the company's principal economic forecaster. Now he heads his own economic consulting firm, Charles Reeder Associates, in Wilmington, Del. The new venture currently serves government and industrial clients—especially industrial companies that are too small to have a full-time economist or that want economic help on only a part-time basis. In addition, he publishes Reeder's Economic Digest, a monthly newsletter of economic analysis and forecast. Reeder expects GNP to grow about 3% this year, only a slight pickup from last year's 2.2%. "I don't think there is a lot of zip out there," he says. "The consumer has kind of laid back because of the high debt ratio. The instability in the oil industry is holding business investment back. In the first quarter, government purchases were way off. So we won't get too much in the way of GNP growth this year." But, within that 3% GNP growth, a lot of things are going to be taking place, according to Reeder. With Reeder: tremendous moves to cut costs
he says. And the improved operating rates seem to be the key to a tremendous earnings improvement. "We know that the leverage can flow through to the bottom line from operating rates," he says. "But on top of that we have had these tremendous moves to trim costs—wage rates, improved processing, and everything else. So the industry is in a very favorable cost position." So, if you put it all together, it is going to make a big difference in performance, Reeder says. "With tight cost control and probably lower unit costs and then, of course, with the lower energy price and feedstock costs, lower nonunit production costs, and an accruement in volume linked in part to the dollar situation, the leverage on profits could be very, very substantial— clear out of proportion to a 3% growth in GNP." This fits with the prevalent theory in the chemical industry that whereas sales will be essentially unchanged in 1986 from 1985, earnings will be up significantly. Although sales volumes may well be up in 1986, the value of those sales probably will not follow because of possibly declining prices of chemical products tied much too closely to a weak oil price. Then, too, certain segments of the economy are not going to show more than a modest increase in chemical demand. According to Reeder, the automobile industry has topped out, for example. Consumers are spending less and may even begin to increase their savings rate, and thus their spending may not be up nearly so much as real income would suggest. But balancing that is a continuing strong housing market that will be a plus for chemicals. Once again it comes back to trade as the balancing factor. May 26, 1986 C&EN
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Business However, if trade gives even a slight boost to volume, that will be enough to spur earnings. Reeder says it is not like the old days when, to get larger earnings increases, the industry would have to have larger volumes. "It's just a reversal. It's as though we've been disproportionately hard hit by the strong dollar. Then when the dollar falls, the industries that have been disproportionately hard hit are going to be disproportionately benefited. The chemical industry is one of t h e m / ' Much of the apparent cost-cutting in the industry has come at the expense of employees, and although the chemical industry has not traditionally been labor intensive, Reeder sees this as having a positive impact on earnings. "The employment curve for individual companies has been coming down for two or three years running, so the industry is going to have fewer people. And many of those let go are higherpaid managers. Then when you get some modest improvement in output, the industry's output per worker [output divided by manhours put in] increases very substantially. At the same time, there is a deceleration of the wage increase. Therefore, the gain in output per worker is going to outstrip any gain in wages, and the unit labor costs drop." Reeder says that even if labor may be only 25 to 30% of total costs, any decline in unit labor costs will help. The industry probably will see a decline in prices because of the passthrough of competition, but costs will drop faster than prices. Thus, profit margins widen and if the industry makes higher margins on greater volume, matters get dramatically better. Further, Reeder believes that forecasts are going to be conservative. "All forecasters are timid," he says. "Nobody is going to forecast the kind of spike that you will get if this all works out." Just how long the current recovery is going to last is of vital interest to everyone. Reeder says the recovery is good for at least two more years, or through 1987, which would make it the longest postwar recovery. "And I really think that it will last beyond that," he says. In his c u r r e n t n e w s l e t t e r he addresses the prospect of slower 16
May 26, 1986 C&EN
growth and the recovery. "There are several reasons why the prospect of growth in the 3 to 4% range over the next 18 months should be applauded rather than viewed with concern. Growth in the 3 to 4% range is sustainable indefinitely based on trend rates of labor force and productivity growth. Anything too much faster would be likely to create rising inflation and interest rates—distortions that typically cause recessions. Another recession would wipe out most of the gains from a prior period of rapid growth." And, he says, "growth of only 3% in GNP does not put a lid on the amount of profit an individual businessman can make, particularly when the 3% growth in GNP is accompanied by lower interest rates, growing export opportunities, and reduced energy costs." When the recovery does end, Reeder told C&EN, it probably will end in the classic fashion in some kind of boom that will be destabilizing to the economy. Manufacturing will overbuild as people discover they are short of capacity in some areas. "They will think that we'll be in a period of slow growth forever and suddenly they'll be scrambling to build new plants. Then, of course, the inventories will build and create excesses in the system. Prices and interest rates will rise and markets will tighten. However, I don't see that on the horizon right now." The idea that businessmen think the current trend will last forever is strong in Reeder's thinking. "They will never learn their lesson," he says. "The high cost of money probably did more to restrain inventories in the late 1970s than any experience that came out of the 1975 recession. "You always think that history is permanent. So whatever has been happening is always thought to be here forever. If growth is slow, it's always going to be slow. If there is a boom, there will always be a boom. Rising oil prices are always going up. High interest rates are never coming down. Pretty soon, people start talking to themselves. For instance, they think if the dollar is strong, it's always going to be strong and they had better build their
plants abroad because they can't afford to source them here." It is here that Reeder sees the place for the corporate economist. "He or she can sit back, take an objective look, and point out that this is not going to last forever. He or she can tell business clients that they should be thinking ahead or they are going to be out of fashion. The trouble is that the executives may hear and agree with the economist, but the day-to-day pressures will still often blind the business executives to the long-range change. It's human nature." For the long term, Reeder does not see the industry getting back to the old days when it was growing at about twice the rate of GNP. "But," he says, "it should grow faster than GNP." He points out that the chemical industry has had its highest growth during periods of stable energy and feedstock costs. At that time chemical prices relative to prices in the rest of the economy were declining and "it's simple Economics 101 that your industry is going to grow faster, if your prices are declining, than some other industry where prices are rising." Reeder believes there is still ample opportunity for substitution of chemical products for others. If this can occur in enough applications, then there will be above-average growth. "The industry is still putting a lot of money into research for products and developments in biomedical sciences, life sciences, electronic chemicals, and others. If there is some payoff on these, then the potential for continued faster growth, whether one and one half times or two times GNP, certainly exists. "People have always said that at some point, the industry has to taper off, become completely mature and grow no faster than GNP. That has been true from 1979 on, but it was due to the dollar, the drop in exports, and high prices depressing the industry. And chemical prices rose relative to other prices. Now, chemical relative prices are declining so you can look at time spans and to the extent that price and volume are linked, and ask, 'Why can't we grow now like we grew then?'" •
