Tuesday, February 08, 2011

What's Driving US Manufacturing Growth?

The other day I noted the surprisingly good performance of the US manufacturing sector. (As another recent example of such evidence, see last week’s strong report on the ISM Manufacturing Index.) I’ve been sifting through some data trying to get a better sense of what sort of manufacturing activities are driving this unexpected strength, and why.

Is it Autos?
Part of the story is the recovery of the US auto industry, of course. But really, that’s just a small part of the story. The picture below shows US manufacturing production in the motor vehicle & parts industry, compared to the rest of the US manufacturing sector. While the motor vehicle industry has recovered substantially from its nadir in 2009, output remains about 25% below its peak in 2007. The rest of the US manufacturing sector, on the other hand, is only about 5% below its 2007 peak. Note as well that the motor vehicle industry accounts for only about 20% of US manufacturing output.

Making Stuff that Businesses Want
So what else accounts for the relatively good performance of US manufacturing? The following picture shows that its growth has been driven largely by production of business equipment, and more generally, by durable goods production.

The reason for this strong growth in the production of business equipment is something that I think has largely been overlooked: business did actually begin spending on investment goods in 2010. Much of this was simply catching up from the extreme slowdown in spending on equipment in 2008 and 2009, but nevertheless, in 2010 it was definitely true that business spending on equipment and software grew at a very healthy rate.

Note that this matches my personal (i.e. anectdotal) experience over the past 12 months; senior management of the companies I meet with almost universally tell me that the purse strings have finally loosened, and their companies are beginning to make major purchases and investments that had been put off.

The next picture shows the growth in demand in the US economy. Business purchases of equipment and software (capital machinery, furniture, IT equipment, etc.) grew extremely rapidly in 2010. Yes, it was growing from the very low base of 2008 and 2009 levels, but still, such growth is signficant. And this picture also makes clear that demand from consumers is not the primary driver of growing US manufacturing output.

What about International Trade?
The other obvious feature of the picture above, of course, is that US exports of merchandise also grew at a very healthy clip in 2010. This is another important explanation for the relatively strong performance of the US manufacturing sector.

But international trade - or in a sense, the lack of it - is also responsible for growing US manufacturing output in another way: during this recovery (unlike the last two), increased demand by US businesses for equipment and machinery has been satisfied by US production of those items, rather than imports, to a greater degree than many of us (or at least me, speaking for myself) would have expected.

The picture below shows the growth in purchases by businesses of equipment and software over the past 25 years, and compares it with the growth in US manufacturing of business equipment. Following the recessions of 1990 and 2001, businesses did not ramp up their purchases of equipment nearly as rapidly as they have done in this recovery. Furthermore, in the 1990s and 2000s much of the increase in US demand for those types of products must have been met by imports, since US production of those types of goods did not grow by nearly the rates we’ve seen over the last year (at least not until right at the peak of the business cycle).

The Bottom Line
I don’t want to overstate things here. US manufacturing is doing surprisingly well, but in part it’s simply making up for the enormous downturn in 2008 and 2009. And the simple fact that the manufacturing sector is relatively small in the US means that there’s only so much that it can do to pull the rest of the US economy into high gear.

However – and this is a pretty big however – this is the first time in 25 years that the manufacturing sector of the US economy is not underperforming the economy as a whole. And it’s being driven in large part by solid growth in domestic demand for durable goods and business equipment. The last piece of the puzzle – the role of international trade in the relatively strong performance of US manufacturing – is also an extremely important one, and suggests that some fairly profound shifts in the US’s international competitiveness may be happening. I’ll take a look at that later this week.


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