Special Report
August 21, 2024 | 13:53
Manufacturing’s Down but Not for Long
Economics
Economics
What’s the current state of American manufacturing? The data are displaying mixed results. For example, the ISM Manufacturing PMI was 46.8 in July, having been below the expansion-contraction (50) mark for 20 of the past 21 months (Chart 1). This is the longest such run since the 1989-1992 period, but the latest episode has been registering far higher (sub-50) readings than all the major manufacturing downturns in the past (that often slip below 40). If the factory sector is truly stuck in a lengthy recession, it’s a very shallow one by historical standards. |
However, the S&P Global Manufacturing PMI dipped just below the critical 50 mark in July (49.6), having spent the first six months of this year in expansion territory and casting doubt on the sector currently contracting. (Both PMIs concur about recession-like conditions from the autumn of 2022 to the end of last year.) Elsewhere, real manufacturing output (part of the Fed’s industrial production data) decreased 0.3% in July after a flat June and a strong 0.8% increase in May (Chart 2). While the short-term trend is slowing, the trend over the past year is essentially flat (+0.1% y/y). If measured from the post-pandemic peak in October 2022, real factory output is still down a net 1.0%, but this is entirely due to the drop off during the immediate months after peaking. Manufacturing employment inched up by 1k in July after falling 9k in June and rising a combined 10k in April and May (Chart 2 again). The short-term trend here is a sideways pattern, with the trend over the past year also looking the same (+0.1% y/y or +14k). Importantly, factory jobs posted their cyclical peak in January, which was also the highest net hiring (12.97 million) in more than 15 years (it’s hard to argue lengthy recession when jobs are expanding). Taking the above data together, it appears that America’s factories are more in a holding pattern than in descent, still reeling from Fed tightening. After it began raising policy rates in March 2022 and doing so much more rapidly as the year unfolded (and broader financial conditions tightened alongside), manufacturing activity ground to a halt by October as consumer and business demand for goods was dampened. And among consumers, goods demand was further dampened by the post-pandemic shift back to services and basic satiation. As noted above, October 2022 was when the ISM PMI last hit 50 before its multi-month slide and also when real manufacturing output peaked. The good news is that, with the Fed poised to cut rates (as early as September), goods demand and manufacturing activity should both get a boost. In the meantime, there has been another important development brightening the prospects for American manufacturing. Although the amount spent on building new factories (or expanding/refurbishing existing ones) inched up only 0.1% in June, it’s grown 19.1% over the past year (Chart 3). And the annual pace hit a record 74% in April 2023, with the growth of the past two years prodded by the Biden Administration’s two prongs of industrial policy [1]. |
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The Creating Helpful Incentives to Produce Semiconductors (CHIPS) and Science Act along with the Inflation Reduction Act (IRA), both signed in August 2022, provided a bevy of tax incentives, subsidies and other financial support to expand America’s manufacturing capabilities in select industries. These include semiconductors and (related) electronics, electric vehicles (EVs) and batteries, clean power (e.g., products for solar and wind energy), clean energy manufacturing including heavy industries (i.e., ‘greenifying’ production inputs and producing cleaner outputs), and biomanufacturing (e.g., producing energy and other products from biomass). |
The CHIPS and Science Act packed $280 billion worth of support for related R&D, regional high-tech hubs and (STEM) workforce development along with semiconductor manufacturing. There was $53 billion earmarked for the latter with at least half already distributed. The IRA originally packed just over $390 billion of support, but the latest estimates have more than doubled the cost. While the various tax credits have sunsets (most are in 2032), they didn’t have caps, which boosted the cost as take-up is turning out to be much greater than anticipated. Combined, these are providing more than $800 billion of (direct) multiyear support to the manufacturing sector, mostly on the investment side. And it’s working. The White House is tracking publicly announced investments that have ties to these two pieces of legislation [2]. The latest tally is about $900 billion (Chart 4). These are multiyear investment plans, but there’s no guarantee they will be put in place or that they will eventually garner government support. Since August 2022, the value of construction spending in manufacturing has surged by a cumulative $120 billion. As such, the bulk of these announced investments are still to come, holding out the potential for a manufacturing ‘renaissance’, in terms of the secular trends for production and employment. The manufacturing share of payroll employment has been steadily declining since World War II (Chart 5). On an annual average basis, it went from highs of 37.9% in 1944-45 (peak war production) to under 9% in 2010. Since then, however, the slippage has slowed meaningfully, raising the prospect that this trend could potentially stabilize or even turn up a tad. In 2023, the average was 8.3%, and it has been 8.2% so far this year. Alongside employment, the manufacturing share of GDP has also been steadily declining during the past seven decades. In nominal terms, the annual share has fallen from a high of 28.1% in 1953 to a low of 10.0% in 2021 (the pandemic) before rebounding a bit to 10.3% (Chart 6). However, most of this nominal slide is due to relative prices; over time, the price level in the broader economy has increased faster than the price level in the manufacturing sector (Chart 7). The latter has been increasingly exposed to international trade and globalization, which has kept a tighter lid on prices. Since 1953, the ‘inflation gap’ has run at a 1.2% annualized rate (total economy 3.2%, manufacturing sector 2.0%). Meanwhile, these two ebbing secular trends also mirror the steady expansion of the services sector. In real terms, the manufacturing share of GDP has remained in a relatively narrow range, from 10.0% (1982) to 12.3% (1973). The 2023 figure was 10.2%, close to the bottom of the range. Contrary to the protectionist narrative, America’s factories have been keeping pace (in terms of real output) with the growth in the broader economy. Meantime, the juxtaposition of a falling employment share but a relatively stable production share points to gains in the sector’s productivity over time, supported by automation and other technological advances. As the federal government’s financial support for increased productive capacity in the above-mentioned industries continues to unfold and begins being noticeably reflected in (increased) production and employment, we reckon factories’ share of real GDP along with their employment share could potentially start improving. |
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However, there are offsets. A key one concerns EVs. Last year, sales increased 54% to 1.4 million units or 9.3% of total sales (Chart 8). This share has held firm so far this year. Strong demand growth is expected to continue, with production increasingly supplanting that of internal combustion engine (ICE) vehicles. The Biden administration has mandated that two-thirds of U.S. new vehicle sales must be EVs by 2032. Another offset concerns the regional economy. The traditional manufacturing heartland of the Midwest-Great Lakes states has seen factories shifting to the Southeast states for years, particularly in the automotive space. A look at where the policy-induced manufacturing investments are being announced suggests this shift is going to continue (Chart 9). Although Indiana (the state most exposed to manufacturing) is still garnering a good amount, at $32 billion or 6.4% of Gross State Product (GSP), along with Ohio ($43 billion, 4.9%) and Michigan ($28 billion, 4.2%), most other heartland states are not. In their place, Texas and Arizona, for example, are topping the standings. Texas’ announced investments total $153 billion (5.9% of GSP). This is followed by Arizona at $122 billion, which is a whopping 23.6% of GSP (most among any state). Meanwhile, geopolitical and supply chain resiliency issues, which were major impetuses for the two industrial policies, are supplying another support for the manufacturing sector. The consequent behavioral shifts toward re-shoring, near-shoring and friend-shoring, and away from unbridled globalization, should be another tide lifting factory activity across the country. On balance, the odds of manufacturing’s secular production and employment trends not just stabilizing but improving, perhaps even breaching the range of recent readings, are mounting. One can call this a renaissance of sorts, even acknowledging the industry and regional redistribution themes that will also be playing. |
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[1] Although the initial run-up in construction spending both in the manufacturing sector and economy-wide also reflected escalating construction costs that peaked well in the 20% y/y range during the summer of 2022, these cost increases later cooled. They were up 1.4% y/y as of July 2024. [^][2] The White House is also tracking all announcements of public and private investments in infrastructure, tied to the Infrastructure Investment and Jobs Act (signed November 2021), along with the infrastructure funding provided by the American Rescue Plan Act (signed March 2021). The total here is $565 billion. [^] |