Friday, April 15, 2011

Fed President Lockhardt on the Manufacturing Sector

This is a very good overview of the current state of the US manufacturing sector. What I find really interesting is that despite all the complaints about the decline of US manufacturing, very few pundits are latching onto this success story.

The recovery is proceeding in part because of a relatively strong rebound in manufacturing production and employment from the depth of the recession. In 2010, both production and employment in manufacturing industries outpaced growth in the rest of the economy. Strong foreign demand for U.S.-made goods boosted manufacturing exports, which last year made the largest contribution to gross domestic product (GDP) growth since the Second World War.

The latest data show that the manufacturing sector has sustained the strong production gains recorded in 2010. Manufacturing output expanded at an annualized rate of approximately 9 percent in January and February. The manufacturing purchasing managers index (a timely and important indicator) remained at strong levels through March. This index encompasses information on production, factory orders, shipments, and inventory data. The rebound of this index in this recovery has been the strongest since the rebound following the deep recession of the early 1980s.

So now let me walk you through a discussion of the status of and outlook for the manufacturing sector. I will cover the following topics:

  • A definition of manufacturing—what industries are included in measures of production, for instance.
  • The current profile of manufacturing in America. Here I will comment on the evolution of the sector over recent decades.
  • Manufacturing as a source of employment.
  • And, finally, how manufacturing costs factor into inflation outcomes in the greater economy.

Manufacturing sector defined
For level-setting purposes, I'll define what manufacturing encompasses in the U.S. economy. The sector encompasses a great number of industries and activities, from raw steel production to motor vehicle assembly to water bottling and oyster shucking. Yes, even light processing of products of nature like water and oysters is considered manufacturing. The Department of Commerce has 473 classifications under manufacturing.

The manufacturing sector includes establishments such as factories, plants, and mills. Think of establishments as individual sites where manufacturing activity occurs. A company may have multiple sites. There are approximately 340,000 manufacturing establishments in the United States. These establishments produce goods through mechanical, physical, or chemical transformation of various materials, both raw materials and already-manufactured goods. These are transformed into both semi-finished and finished goods.

A number of industries—a good example is the auto industry—employ the supply-chain model, whereby lead companies do final assembly as well as product design, brand management, and distribution. Feeding the assembly line are tiers of suppliers who manufacture components. Manufacturers of components, in turn, rely on their producers and suppliers of raw materials.

Profile of U.S. manufacturing
Manufacturing output represents about 11 percent of the U.S. economy in real GDP terms. It may surprise you that this percentage has been relatively constant for several decades.

A lot has been written about the growing demand for Chinese-made goods, and China's manufacturing sector is expanding rapidly. Despite China's rapid growth, the United States remains the world's largest manufacturer. According to U.N. data, the United States accounts for one-fifth of global manufacturing output in real terms. That share has held largely constant for the past 20 years.

The United States' high share of global manufacturing output reflects to a significant extent the size of the U.S. economy and domestic demand. Although U.S. exports have grown rapidly, the United States is not the world's largest goods exporter. China and Germany export more manufactured goods than the United States.

In the current recovery, manufacturing production has grown faster than total GDP. But while GDP has already reached prerecession levels, manufacturing output is still about 10 percent lower than three years ago because of its outsized decline during the recession.

Performance within the manufacturing sector has varied widely across industries during the recession and afterwards. Some industries, such as apparel, were in secular decline for many years. Domestic apparel manufacturing was hit hard by the recession and has benefited little from the recovery. Other industries have experienced cyclical swings. Metals production, for example, contracted and then expanded largely in sync with the economy. And a few industries, notably the computer and electronic products industry, rose strongly for many years and slowed only briefly during the recession. Computer and electronic products output is already 20 percent higher than before the recession.

Manufacturing as source of employment
Coming back to the long view, while manufacturing output through the years maintained its share of total GDP, manufacturing's share of jobs has steadily declined. In the 1950s, almost one in three payroll jobs was in manufacturing. Today that number is less than one in 10.

In terms of absolute employment levels, the number of manufacturing jobs fell by almost five million over the last decade and currently stands at around 11.6 million after remaining relatively stable during the 1980s and 1990s. In contrast, manufacturing output over this period has grown at about the same pace as the overall economy. Obviously, increasing production combined with stable or falling employment is only possible if productivity is rising.

Output per worker has increased faster on average in manufacturing than in the overall economy. In many cases, productivity gains in manufacturing have been the result of automation and robotization. In other cases, productivity gains have been realized by reconfiguring production processes, including the offshoring of more labor-intensive, early-stage component production to locations where labor is cheaper.

Higher productivity has translated into higher wages. Although employment in the manufacturing sector is much lower than 20 years ago, manufacturing wages remain higher than average wages and have been growing faster. Currently, the average weekly wage in the manufacturing sector is nearly $200 dollars higher than the average for all private industries—double the premium of 20 years earlier. This increased wage premium reflects the changed mix of jobs and relatively higher skill requirements in the manufacturing sector today.

I want to summarize manufacturing in very basic terms: its output level is up; output share is steady; employment is down; productivity is up and, therefore, wages are up. That's the manufacturing story in a few words.

I am aware there is a lot of angst about the manufacturing sector. In part this is driven by the fact that the sector is no longer the generator of jobs it once was. Realistically, the future of the manufacturing sector depends on its ability to change and reinvent itself in response to global competitive pressures. So far, the sector has done this pretty successfully. In my view, to paraphrase Mark Twain, reports of the demise of U.S. manufacturing have been greatly exaggerated.