Capacity of both manufacturing and distribution facilities is set to rise strongly over the next three years after a lengthy stagnation. The added capacity in distribution centers/warehouses will come in the form of more space that needs to be equipped with materials handling equipment. In manufacturing, the added capacity will be the result of an expansion of equipment, especially upgrades, rather than more space.

This is happening right on schedule, one year after the economic recovery restarted last May. Surplus capacity is being rapidly absorbed. Manufacturing capacity utilization, excluding electronics, rose two percentage points in the last few months to 76.3% in February. It will be near 78% when the May data is reported.

This quick rise is because production is expanding now at about an 8% annual pace while capacity additions are minimal, if any at all, through May. Capacity has been nearly constant for almost three years. A 78% utilization rate is the threshold of a several year period of rapid increases in manufacturing investment.

How much capacity will be added? Capacity expanded 11% in a similar period in the late 1990s in spite of a rising dollar that made U.S. exports less price competitive.

There is no parallel measure of warehouse utilization but the consensus of commercial real estate market research firms is that both capacity and utilization began to rise slowly at the end of 2003. The rebound in distribution is several months ahead of manufacturing because of surging imports. Non-oil goods imports have been rising at a 15% pace since last summer, overcoming the negative impact on imports of a declining dollar. While imports fell slightly in January, early February export and production data from Canada and Asia suggest that import growth will continue strong into the summer.

Recent jumps in equipment orders confirm the beginning of a surge in factory investment. At the front end, construction equipment orders are up 29% in the last three months. To equip factories and warehouses, orders over the last three months have risen 14% for heating/ventilating/air conditioning equipment, and 9% for heavy electrical equipment.

Expansion projects will appear first in construction spending for factories and warehouses. There is tentative evidence of more warehouse building activity early in 2004 with spending on new construction at a 19-month high. Factory construction spending remains stagnant early in 2004. Spending in both sectors is projected to jump more than 30% in 2004–05.