Manufacturing Keeps Growing

There are two points to make about manufacturing. First is today’s Institute of Supply Management report on manufacturing activity. The second is my take on an ongoing discussion at fivethirtyeight.com where a great post on the decline in US manufacturing has generated a great deal of discussion.

First the ISM report.

The index of manufacturing activity dropped from 58.4% in January to 56.5% in February. While the decline is disappointing, I don’t think it signals a new cyclical downturn because there were a number of extenuating circumstances last month, not least bad weather causing a few slow days of production. If the decline continues into March and beyond as the weather improves, then we should be concerned. In any case, any reading on the ISM index above 50% indicates overall growth, so we have now experienced a few months of steady expansion in activity in our factories. Late last year I was a little skeptical about this pick up: the much ballyhooed inventory adjustment could be sufficient to have spurred it. Now that the adjustment is over – or appears to be – we will start to get a good look at whether there is sustainable growth developing in the manufacturing sector.

One bright spot in the ISM news stands out: the sub-index for employment rose to 56.1% from 53.3%, indicating that factory hiring is starting to increase. As long as this index stays above the magic 50% mark, jobs will steadily become more available.

Now for that Fivethirtyeight.com discussion.

The thrust of the discussion is that there is a misunderstanding about the state of US manufacturing. It is commonly stated in the media and politics that the American manufacturing sector is in decline. This sometimes shows up as statements such as ‘we don’t make anything in America anymore’.

This is simply not true. US manufacturing production has risen steadily for decades. So has industrial capacity. Setting aside the normal downturns during recessions, this increase in output has gone on throughout the post-World War II era.

The problem is not production so much as employment: the pace of productivity growth in manufacturing has been so strong that it has outpaced output by a mile. That means the US produces much more using far fewer workers than ever before. So there has been a steady loss of jobs, a loss made particularly stark by the current crisis, even though our factories have been busily making more stuff. The result is that industrial areas of the country have lost jobs throughout the last few decades, and that older less efficient factories have been closed. This elimination of the older less productive factories has caught the attention of pundits, but the establishment of the newer factories, often with much smaller workforces, has gone less noted.

The auto industry is a case in point. The loss of jobs in and around Detroit is well documented, and is the constant cause of political and media based commentary. Meanwhile many states in the South are now littered with new auto factories churning out cars for companies like Nissan, Honda, and Toyota.

So why the angst?

The lost jobs tended to be high wage blue collar jobs that a less educated worker could perform well in and support a decent lower middle class lifestyle on. The abundance of factory jobs combined with the safety net of the New Deal provided the major underpinnings for the rapid rise of the American middle class in the 1950’s and 60′. As those jobs diminished a section of society found itself incapable of maintaining that lifestyle: the replacement jobs that were available, and sufficient to make ends meet, tended to require more formal education; while other jobs, those more fitted to the displaced worker’s educational levels were insufficient – wages were too low. So even when an ex-factory worker could find a new job in the same locale as the factory, it often failed to provide a good enough income. Hence the steady decline of Detroit and other older industrial areas.

This story is actually one of success for our manufacturers, who have been able to keep their businesses humming despite intense global competition. We all benefit from this in the form of lower prices for the things being produced in the better factories, which leaves us with cash to spend on other things. Obviously the workers who produce those other things now have jobs that were not there before, so the benefit ripples out well beyond the immediate impact.

The down side to this is that the displaced factory workers have to be re-absorbed into the economy somehow. And that is where much of the angst emerges. We have no been very effective at re-training large enough numbers of these people. The result is that there has been a steady attrition from the working population: the number of people at work as a percentage of the adult population has drifted down in recent years, and one major cause of this drift is the decision of many ex-factory workers not to seek full time employment any more. The impact has been felt particularly on the adult white male population, whose workforce participation rate has dropped away strongly over the last decade or so, and is now at historically low levels.

In many ways this is a long term adjustment process intractable to short term measures. As the factory workforce continues to shrink, other employment opportunities dominate for the next generation of workers, and the problems of the older generation simply disappear.

Then there is the problem of wages. One reason why wages have been practically stagnant in America for the last decade is that the number of high wage factory jobs is steadily declining, and that the newer, replacement, jobs carry lower wages. This produces a squeeze on family earnings and, since the cost of living has not declined, the standard of living has tended to drop along with the wage stagnation. It is this squeeze on disposable incomes that has spurred all most of the angst, and the constant references to the decline in manufacturing. The lower middle class has been subject to a long term vicious squeeze that will not abate any time soon. I attribute much of the rise of extreme politics to this trend: people are working hard and yet are unable to maintain growth in living standards. This, naturally, translates into a feeling of alienation from society or government, and hostility towards other groups who become the targets of envy or suspicion. Illegal immigrants are an obvious such group.

The productivity spurt was associated with the growth of, and industrial application of, new technology, especially information technology. The advent of robotics on production lines is a good example of this. This is not an unprecedented process. American agriculture has gone through similar waves of change, with exactly the same results. At the turn of the twentieth century American agriculture was in crisis: yields were declining and profits were being severely reduced. Innovations in production, largely promulgated by the newly created Agricultural Department in Washington, arrested and reversed the decline with such success that agricultural production rose rapidly at the same time the employment on farms dropped – an exact analog to the manufacturing situation today.

The analogy breaks down, however, in one crucial respect: the wage differential between the lost jobs and the gained jobs. When agriculture went through its technological revolution the displaced workers were able, eventually, to find work in unskilled factory jobs that often carried a higher wage than they had been earning before. This coupled with the burst of agricultural productivity gave a significant shot in the arm to the economy as a whole: the newly growing mass of factory supported households not only had better wages, but those wages were able to buy more produce because the cost of farm goods dropped. Today we see a different and more difficult transition taking place: the new jobs do not offer wage increases, so the standard of living increase brought about by the abundance of cheaper manufactured products is offset by the lower wages – there is no kick to growth in our standard of living.

This is, of course, not universally true. Some parts of the workforce, those with a higher level of education, have seen strong growth in their standard of living. They have been able to take advantage of the lower cost of manufactured goods and thus they have been able to allocate more spending on peripheral services. The problem is that the provision of those services is not a high wage activity.

The productivity revolution in manufacturing has, thus, not had the same impact as it agricultural analog. It has been much more specific in its benefits and has tended to undermine rather than encourage a general growth in our standard of living – the enormous separation in incomes and wealth in modern America is, in part, attributable to this problem,.

The solution is both difficult and long term. We need to encourage the creation of new high wage manufacturing jobs in industries that have lasting potential: energy conservation and ‘green’ technologies are examples as is biotechnology. Plus we need to provide a better transition for displaced workers. What we need to avoid is protection, which only absorbs money and prevents us from reaping the benefits of productivity advancement.

In a nutshell: our manufacturing ‘problem’ is not one of decline, but of success. We are producing more and using less to do it. Unfortunately that means a lot fewer jobs. So, our issue is not industrial, it is post-industrial. We have failed to adjust adequately to our own success and, especially, we have failed to create the kind of jobs we need to prevent a decline in the lower middle class. Until we do it will remain commonplace to see a problem in manufacturing where, in fact, there is none. And the likelihood of a drift towards extreme, and volatile, politics will continue.

That’s something worth trying to avoid.