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January 12, 2024 | 12:58
U.S. Manufacturing’s Sort-of Renaissance
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U.S. Manufacturing’s Sort-of Renaissance |
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Is U.S. manufacturing in boom or bust? Recent data revealed a stark contrast. On the one hand, the ISM Manufacturing PMI was 47.4 in December, the 14th consecutive month below the expansion-contraction (50) mark, which is the longest such run since the early 2000s (Chart 1). Elsewhere, factory output is down 1.5% from its October 2022 post-pandemic peak. And although payroll employment in the sector rose 6,000 in December, there has been a 2,000 net job loss over the past 10 months. But, on the other hand, the amount spent on building new factories (or expanding/refurbishing existing ones) increased 0.5% in November, a 63% annual change (Chart 2). Although the latter pace had hit 80% earlier in the year, this is still the strongest pre-2023 clip in three decades of data [1]. The combination of steadily contracting factory activity and sharply expanding manufacturing capacity appears at odds, particularly since recessions tend to subdue investment. After the Fed 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, assisted by the post-pandemic shift back to services and basic satiation). The PMI hit 50.0 and factory output (via industrial production) hit its cyclical peak. That same month, construction spending on manufacturing slipped 1.6%, but it’s been on a near-75% annualized tear since, prodded by the Biden Administration’s two prongs of industrial policy. |
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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 is packing $280 billion of support, with $53 billion earmarked for subsidizing increased microchip manufacturing (over the next decade). The IRA originally packed just over $390 billion of support, but the Joint Committee on Taxation’s original estimate of the cost of tax incentives was $270 billion. It has now raised that estimate to $663 billion. While the various tax credits have sunsets (most are in 2032), they didn’t have caps, which inflated the cost as take-up is turning out to be much greater than anticipated. Combined, these are providing more than $940 billion of 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 $640 billion (Chart 3). These are multiyear investment plans, but there’s no guarantee they will be put in place. Since August 2022, construction spending in manufacturing has surged by a net $90 billion (to November 2023), while non-defense capital goods shipments (ex-aircraft) have gained a net $20 billion (at annual rates). As such, the bulk of these announced investments are still to come, holding out the prospects of a manufacturing ‘renaissance’, in terms of the secular trends for production and employment currently in place. The manufacturing share of payroll employment has been steadily declining since World War II (Chart 4). 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% which is also where it ended the 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 10.6% in 2020 (the pandemic) before rebounding to 11.0% (Chart 5). 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 6). 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 1.3% 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 11.2% (1982) to 13.5% (1973). The 2022 figure was 11.4%, close to the bottom of the range [3]. 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. Given the relative stability of factories’ aggregate share of real GDP and the recent signs of more stability in their employment share, the eventual death of America’s manufacturing sector has been greatly exaggerated. This makes any talk of a renaissance, or ‘re-birth’, appear a bit out of place. Nevertheless, 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 these secular trends could stabilize if not start improving. However, there are offsets. A key one concerns EVs. Last year, sales increased 53% to 1.4 million units or 9.1% of total sales (Chart 7). 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 8). Although Indiana (the state most exposed to manufacturing) is still garnering slightly more than its fair share, most other heartland states are not. In their place, Texas and Arizona, for example, are topping the standings. Indeed, Texas is in a league of its own, with announced investments amounting to $122 billion or 5.1% of gross state product (GSP). This is followed well behind by Arizona at $77 billion, which is still a whopping 16.2% 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 behavioural 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 subsequently cooled. They were up less than 1% y/y as of December 2023. [^][2] The White House is also tracking all announcements of public and private investments in infrastructure, tied to the Infrastructure Investment and Jobs Act (worth $1.2 trillion with $550 billion of net new money, signed November 2021), along with the infrastructure funding provided by the American Rescue Plan Act (signed March 2021). The total here is $425 billion. [^][3] In the latest GDP data release (2023Q3), there were comprehensive revisions and the base year was shifted to 2017 from 2012. However, industry data before 2017 have not yet been released. These changes lowered the manufacturing share of nominal GDP by around 0.5 ppts per year (+/-0.2 ppts) over the six periods, and the share of real GDP by around 1.0 ppts (+/-0.2 ppts). These are essentially level shifts that presumably will be mirrored among more of the historical revisions. The 2022 nominal share is now 10.3%, still drifting up from pandemic-era lows with 2023, so far, averaging 10.2%. Last year’s real share is now 10.4% with this year averaging 10.3% to date. [^] |