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November 8, 1988
"Lean Years After the Fat - Chip Industry's Prosperity Causes a Slowdown"
San Jose Mercury News
By Timothy Taylor
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THE pundits-that-be are expecting an economic slowdown for Silicon Valley in 1989. You can see it in the depressed stock prices of high technology companies. Even the Semiconductor Industry Association, a group never bashful about predicting a boom, says that semiconductor sales will grow only slightly next year.

I'm no silicon guru, but if high technology industries slow down during 1989, it shouldn't be a big surprise to anyone. A slowdown would follow an industry tradition of boom and bust.

For a prime example, take the historical pattern of the semiconductor industry. Mark Scott Sieling, an economist with the Division of Industry Productivity at the federal government's Bureau of Labor Resources, described the industry cycle in a recent article:

"When the demand for electronic equipment and products declines, manufacturers reduce their purchases of semiconductor devices to a much larger extent than they reduce production of finished electronic goods, resulting in inventory depletion. As demand recovers, they often double or triple their orders for semiconductors to ensure delivery and rebuild inventories."

In short, companies that use semiconductors tend to buy more than they can use in good times and use more than they buy in bad times. As a result, the semiconductor manufacturers ricochet between extremes. The creation of hot new products and the decay of old cold ones can make these cycles even more pronounced.

Here's the paradoxical conclusion: The very fact that 1987 and 1988 have been so good for high technology industry may be the reason for a decline in 1989. As James J. Mitchell, business editor of the Mercury News, pointed out in a column Oct. 30, pessimism about the future of high technology industry -- even if that pessimism is misguided! -- can cause investors to be less willing to plunk down their money. Thus, worries about a slump can help to bring it on.

The way to short-circuit this cycle of gloom would seem evident. Tell the truth, so investors are not misled into thinking that a cyclical dip is a long-term decline. But if the last cyclical trough of the high-tech industry is any guide, it's not easy for people to remember obvious truths in bad times.

The most recent cycle of boom and bust for the high- technology industry was in 1984 and 1985. In the semiconductor industry, for example, the value of output in the United States rose by 27 percent in 1984, according to figures from the Bureau of Labor Statistics. It was an extraordinary boom year.

In 1985, though, semiconductor output fell 9 percent, and stayed at that level through 1986. Essentially, semiconductor users spent a lot of 1985 and 1986 using up what they had purchased in 1984. A classic counterreaction.

But although everyone around Silicon Valley knew these figures, not many were willing to view the bad times as a price to be paid for the good times. The businessmen of the semiconductor industry set off to Washington to try their hand at political entrepreneurship, and they were successful in pushing for an agreement which attempts to restrain competition from Japanese and other foreign semiconductor manufacturers.

The calls for protectionism against the Japanese are muted now, with high-technology industry doing well, but I predict that the volume of complaints will shoot back up to high if industry enters a down cycle.

It was common around Santa Clara County in 1985 and 1986 to hear predictions of long-term economic decline for this area. Remember how layoffs at local companies led to predictions that the high-technology industry would move out of state or overseas? Remember the wailing that high housing costs and traffic gridlock had stifled growth in the valley? Remember the glut of office space that was never going to end? Remember the desperate need for the federal government to put hundreds of millions of dollars into the semiconductor industry?

Of course, the high-technology industry rebounded and has grown rapidly for the past two years. But if 1989 brings another cyclical downturn, the doomsday fears are likely to return in full force. This sort of unwarranted pessimism can injure the local economy in two ways.

The first problem is the one Mitchell warns of, that outside investors may believe this area to be washed up and decline to put their money here. The second problem is that local executives and government officials may decide that problems like international competitiveness, high housing prices and traffic congestion are insoluble problems, and begin to ease up in the search for solutions.

If a cyclical downturn does arrive next year, it may ease everyone's blood pressure to remember that perfect stability is not a blessing often granted to real world economies. If one can look beyond the cycles of boom and bust, this area continues to have excellent prospects for long-term economic growth.

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