Also see our Economic Commentary which supplements the Laufenberg Economic Quarterly and primarily focuses on more recent economic developments.

Perspectives

This page is designed to offer you my perspective on economic fundamentals, ranging from business cycles to yield curves. It will provide more detailed economic analysis than is generally available in the Quarterly. For the most part, the essays provided here will attempt to discuss timely fundamental issues related to the forecast but are expected to have a longer shelf life than the content on either the Quarterly or Commentary pages. I hope that over time you will consider the information on this page as a source of reference when debating economic issues in the future.

Daniel E. Laufenberg, Ph.D.
LaufenbergQuarterly.com

bar

Made in the U.S.
(January 29, 2013)

Numerous times during my career I have heard people complain that we do not make anything in the U.S. anymore. They contend that everything sold in the U.S. now is made overseas, typically in China. It is true that a lot of the goods available to consumers are not made here. Nevertheless, we still make a lot of stuff domestically, it just is not found on retail shelves, which creates the perception that U.S. manufacturing is dead.

Many are annoyed by this. They worry that without manufacturing, we are no longer the economic powerhouse of the past. A few economic commentators have gone so far as to suggest that the overall performance of the U.S. economy should be tied solely to goods output and that services should be excluded entirely. They contend that the only real value added in the economy is through the production of goods. I suspect that they are confusing value with physical assets—such as precious metals or land.

I believe that sound economic analysis provides a somewhat different perspective about the value of goods and services. To begin with, goods are seldom purchased for their own sake. Typically they are purchased to provide a service to the consumer. For example, very few people purchase an automobile simply to park it in their garage. Most people buy a vehicle for the transportation services it provides. The alternative is to ride the bus, fly, or take a train, all of which are considered transportation services. And even a physical asset, such as gold or land, is not purchased for its own sake but for the services it can be used to acquire. But even this is possible only if someone else is willing to buy the asset or accept the asset in exchange for services rendered. The point is that generally goods are purchased for the services they provide.

That has always been the case. One important difference today is that if a consumer wants to fully utilize the services provided by a good purchased, he or she may need to purchase the service separately. That is especially true with regard to electronics and communication devices. In particular, the cable or satellite service that goes with the new flat screen television, the carrier service that goes with the new smart phone, or the internet provider that goes with the new computer. In addition, with the purchase of any new product, you may decide to purchase a service contract that will cover the cost of repair. Service features are not new, just broader than they were in the past. After all, a television, even without cable or satellite, still requires electricity to operate, which is a service. Since it is the service provided by the good that has value, it makes sense to think of all services provided as value added. Of course, there is always the debate about whether the price paid for a particular service or good truly reflects its value to the user.

Some surprising aspects of manufacturing output

The debate about the value of goods versus services may be misplaced given that manufacturing in the U.S. is far from dead. Using annual real gross domestic product (GDP) data by industry as reported by the Bureau of Economic Analysis, it is possible to estimate the relative importance, or change in importance, of manufacturing in the U.S. over time. As shown in Chart 1, real manufactured output (after adjusting for inflation) actually has increased over the two decades ending in 2011 (the solid line). In addition, despite concern to the contrary, manufacturing output’s share of total private real output actually has remained relatively steady over the same period (the dashed line), although very volatile. For the most part, the performance of manufacturing output since 1990 is at odds with the general perception about the condition of U.S. manufacturing.

That being said, in 2011 (the most recent data available), the level of real manufactured output was still below its recent peak in 2007. The same could be said for real manufactured output as a percent of total private output. Notwithstanding this recent shortfall, manufacturing output was 13.7 percent of private output in 2011, compared with 13.6 percent in 1990. For the 22 years ending in 2011, manufacturing’s share of private output averaged 13.9 percent. As such, the share of total output from manufacturing currently is not that different from the average of the last two decades. Nevertheless, the manufacturing sector’s share of total private output clearly has been very sensitive to the business cycle, generally gaining share during expansions but losing share during recessions.

chart 1

Recessions in general take a toll on manufacturing, but this was especially true in the last recession. Real factory output in 2011—even after nearly three years of recovery—was still below its previous peak in 2007. Moreover, manufacturing output as a percent of private output in 2011 was still below its recent peak in 2007. This makes sense given that purchases of goods are often postponed before services in recessions. For example, during a recession consumers may delay or cancel the purchase of a new phone but continue to subscribe to the phone service for their old phone or they may decide to drive their old automobile longer but they still have to service their old car and insure it. The consequence of these decisions is that consumer goods consumption, especially durable goods consumption, takes a larger hit during a recession than consumer services consumption. Recall that consumer durable goods are more likely to be manufactured in the U.S. than nondurable goods. Businesses often will make similar decisions about their equipment and software purchases (that is, keep the old equipment and software that still must be serviced and maintained). And goods production, in particular manufacturing, has to adjust accordingly.

On the other hand, once jobs begin to return and incomes improve, pent up demand for goods typically is released. The U.S. economy seems to be in just such a period, which may explain why manufacturing has rebounded in recent years. This can be seen more clearly in Chart 2, which plots the annual growth rates of services, goods, and manufacturing output from 1991 to 2011. At the moment, the manufacturing sector seems to be doing better than it was but still not great. One interesting aspect of the three growth rates plotted in Chart 2 is that manufacturing output tends to do better than the overall goods component during expansions, but takes more of a hit in recessions. Although this difference is very similar to the one between manufacturing and services, goods output growth more closely tracks manufacturing output growth over the business cycle. A second interesting feature is that the gap between the growth rates for goods output and for manufacturing output seemed to be even more pronounced since the 1990-91 recession.

chart 2

Of course, goods production is a much broader measure of output than manufacturing alone. It also includes agriculture, mining, and construction. Indeed, two reasons why goods output has not kept pace with total private output since 1990, even though manufacturing output on average has, are agriculture and construction. Construction output, which contributed substantially to goods output from 1990 to 2004, was a drag on goods output growth more recently. Also, agricultural output has lagged in recent years and probably continued to be an issue in 2012 owing to the drought.

While manufacturing output has maintained its share of total private output over the last 21 years through 2011, this share remains very low. As shown in Chart 3, services output continues to dominate private GDP. The upward trend in services output since 1990 is broadly based across all services industries, with particular attention to health care and educational services. Based on changes in technology, living standards and demographics, this should be no surprise. Output from the health care services industry was the only major component of output that continued to track higher during the 2007- 2009 recession. Educational services output also held up well during the last recession, but not as well as health care. One other thing to remember is that the bulk of the profit margin on a particular product may come from the services provided rather than the tool manufactured to apply those services. This most likely explains why telecommunication companies are more than happy to give you the cell phone if you sign an extended service contract.

chart 3

At the moment, the U.S. manufacturing sector seems to be holding its own against services, but at a relatively low level. However, this is more a services growth story than a manufacturing growth problem. With the onset of the next recession, whenever that may be, my clients once again will express concern about the dearth of manufacturing, and manufacturing jobs, in the U.S. economy. And once again, it will be the business cycle that drives that outcome.

Factory jobs versus all jobs

Although manufacturing output has increased on average since 1990, manufacturing jobs have not. As shown in Chart 4, the manufacturing sector has lost nearly 6 million payroll jobs since 1990, reflecting the loss of 3.5 million jobs in nondurable goods manufacturing and 2.5 million in durable goods manufacturing. In other words, the decline in jobs over the last few decades has been relatively broad based in manufacturing. As a percent of all private nonfarm payroll jobs, manufacturing employment has lost even more ground, dropping to less than 11 percent in recent years from 19.5 percent at the start of 1990. Indeed, the loss of factory jobs may be the reason people assume that factory output has been lost as well.

chart 4

The question often asked is why factory jobs have disappeared in the U.S. The truth be told, manufacturing jobs have disappeared nearly everywhere in the world, in large part because of technology advances that have made manufacturing more efficient. Stuff is made differently now than it was because of automation through robotics and computers. In other words, automation has eliminated the need for some manufacturing jobs but not all. Clearly, the factory job of today in many cases is far different than the factory job of yesterday. And when they are not much different, they cannot survive the high-cost labor environment in the U.S. The result was that factory jobs were lost owing to automation, outsourcing or offshoring.

Automation not only reduced the number of factory jobs, as well as the composition of those jobs, but it also may have improved the quality of the goods produced. After all, the precision of machines reduces the risk of human error in mass production. This adds to the efficiency and productivity of manufacturing because there is less time and production lost to “do-overs.” That does not mean that quality is perfect. There still may be quality issues with new or redesigned products. The Boeing Dreamliner jumps to mind in this regard. The point is that there still will be design issues; that is, if it is designed properly, quality is less likely to be an issue than it was twenty years ago.

In addition, outsourcing has been another way firms have reduced head count on their payrolls. This process is more obvious at manufacturing firms because the jobs that are outsourced are often service jobs. In particular, legal matters, accounting activities or even human resources, (part of the back room operations of manufacturers) can be farmed out to specialty firms. Typically they can outsource these activities at a lower cost to the manufacturer than if they tried to duplicate this expertise in house. To the extent that these jobs are no longer on the payrolls of manufacturers, then they show up in the data as a net decline in manufacturing jobs and a net gain in service jobs, but not necessarily one for one.

Finally, offshoring has depleted manufacturing jobs over the last two decades as well but probably not to the extent many suggest. My favorite example of this is the 3M Company, which I was told develops roughly 300 new products a year. Most of those new products are manufactured in the U.S. for the first three to five years to iron out any bugs in the products or in the production line. Once the product has matured and the production process has been fine-tuned, its production for efficiency reasons will be moved someplace else. In other words, so long as we continue to come up with new products and the labor force is sufficiently flexible, there will be a place for manufacturing in the U.S. In fact, that will continue to be our advantage in a more economically competitive world. That being said, many U.S. manufacturers have tried to send production overseas but usually it is the production of goods to be sold in that country rather than imported back to the U.S. Obviously, there has been some jobs shipped offshore to produce goods that are imported back to the U.S., but many of those low-skilled, high-paying jobs could not survive in the U.S. economy anyway. Also, in some cases, the jobs have been moved to another region in the U.S. rather than to another country. This is not offshoring or outsourcing, but rather relocating. Businesses relocate all the time. It is just more obvious when a manufacturing firm does it because of the infrastructure involved. Relocation may result in a net loss of payroll jobs, but not always. Generally the purpose for such an interstate move is a more flexible workforce, a more receptive tax system or a less restrictive regulatory environment.

Interestingly, manufacturing jobs have turned up a bit more recently. Since late 2009, manufacturing jobs actually have increased 500 thousand and the percent of factory jobs to total private sector jobs has held surprisingly steady. The last time manufacturing jobs registered a cyclical increase was in the 1990s but their share of all private sector jobs continued to decline. Is this the start of a new trend or is it just a cyclical anomaly? I do not know the answer to that question, but I do know that the opportunities to reduce manufacturing jobs owing to automation, outsourcing and offshoring have not been eliminated. However, that being said, they may not be as prevalent as they were. For example, we may have to wait a bit for the next major technological innovation (which in this case is probably the application of information technology to another major sector of development). At the moment, we are gathering and automating information, which is a prerequisite to developing new applications of this data.

Also, the low cost alternatives to manufactured goods and business services, such as China and India, are not as readily available now as they were in the last expansion. The implication is that much of the future increases in the demand for goods are more likely to be satisfied with domestic production than foreign production. I am not suggesting that the obsolete manufacturing capacity that was removed over the last several decades will be replaced, but rather that new products, technology and jobs necessary to produce them increasingly will be stay here.

In addition, there are fewer opportunities to outsource manufacturing jobs as there were in the past. In fact, in some cases, firms have found a need to rebuild some parts of their back room operations rather than continue to outsource to others. U.S. manufacturers also have increasingly turned to domestic suppliers for parts in an effort to have more influence over pricing and quality.

Of course, the stability of manufacturing jobs as a percent of total private jobs over the last few years may reflect the sluggishness of job growth in the nonmanufacturing private sector more so than the gain in manufacturing jobs. One disappointing aspect of the jobs data in the current recovery has been the growth of private nonfarm payroll jobs. I contend that this perceived weakness in payroll employment is more a result of changing demographics than anything else. Other economists would disagree with my assessment. They contend that it is because businesses are reluctant to add employees in the current environment of mistrust, uncertainty, and concern about the future course of fiscal, monetary and regulatory policies. I understand the frustration that employers have with the current state of macroeconomic policies, but I still think the major issue confronting the jobs data is the aging population.

Productivity gains have already slowed

Regardless of why manufacturing jobs have trended lower over the last several decades, real output from the manufacturing sector has not. In other words, the manufacturing sector truly has learned to do more with fewer workers. This is shown rather clearly in Chart 5, which plots the annual indexes of real manufacturing output (solid line) and manufacturing jobs (dashed line) from 1990 to 2011, with 1990 equal to 100 in both cases. Over this period, output has increased roughly 72 percent, while jobs have fallen about 33 percent. Continuing a trend that apparently began about five decades ago, the decline in jobs from 1990 to 2011 appeared to be secular in nature, with recessions simply accelerating the decline. In contrast, real manufacturing output trended higher on average over this period, but it too was hampered by recessions. This was especially true during the last recession.

The result has been that the manufacturing sector has been very productive since 1990. Indeed, productivity in manufacturing has increased far more than productivity in the overall private economy. According to the BLS, labor productivity in the manufacturing sector increased 3.4 percent annually from the first quarter of 1990 to the third quarter of 2012, while labor productivity in the business sector increased annually at 2.2 percent over the same period.

The concern is whether this pace of productivity improvement can be sustained. After all, from the first quarter of 1990 to the fourth quarter of 2007, labor productivity in manufacturing increased a whopping 4.0 percent annually, well above the pace for the overall business sector. However, since 2007, labor productivity in manufacturing has slowed to an annual rate of only 1.8 percent, in large part because of the severity of the recession in 2008-2009. Some market participants suggest that the last recession was so severe that it marked the death knell for U.S. manufacturing. Given the rebound in manufacturing output, as well as factory jobs, so far during the current recovery, it seems premature to declare U.S. manufacturing dead. Nevertheless, the structural changes over the last several decades, such as outsourcing and offshoring, which have added to labor productivity in U.S. manufacturing during this period, will not aid cost cutting as dramatically as they did. In fact, there may be a temporary swing in the other direction, where businesses have discovered that they have gone too far for quality reasons and now need to restore some of the activities they had previously outsourced.

chart 5

The bottom line is that I expect U.S. manufacturing output to continue to grow roughly in line with the overall economy, but follow a far more volatile trajectory than total private output owing to the influence of the business cycle. However, this output growth may require that factory jobs keep pace with overall employment as well, given that there is less opportunity for manufacturing to outsource or offshore operations. That does not preclude manufacturing firms from restructuring, which is another way to reduce payrolls and increase productivity. But with the advance of new products and increased global demand, I contend that U.S. manufacturing will need to add more jobs over the next few years, not eliminate them. In this regard, with fewer jobs being outsourced by manufacturing, it may be the business services industries that find it more difficult to add jobs than in the prior two expansions.

______________________________

bar

red tri

For the current economic forecast, as well as other analysis and commentary, please visit the Stonebridge Capital Advisors website.

Dlaufenberg@stonebridgecap.com

red triGo Here for more information about Dan Laufenberg

The views expressed here reflect the views of Daniel Laufenberg as of the date referenced. These views may change as economic fundamentals and market conditions change. This commentary is provided as a general source of information only and is not intended to provide investment advice for individual investor circumstances. Past performance does not guarantee future results.


Current Perspective

2013 Economic Perspectives

Made in the U.S.
-- January 29, 2013

2012 Economic Perspectives

Going over the "fiscal cliff"
-- November 2, 2012

Factors that drive consumer spending -- August 13 , 2012

House prices: the bottoming process continues
--
March 8 , 2012

Equities and the political calendar
-- February 7, 2012

2011 Economic Perspectives

Is the great American job machine finally broken?
-- December 6, 2011

Recession fear, not fact
-- September 4, 2011

Core inflation: a policy guide more than a policy target
-- May, 2011

Help not wanted?
-- Feb, 2011

Special Report: Health Care Legislation:
Essay No.1 - Costs
Essay No.2 - Revenue
Essay No.3 - Budget Deficits

2010 Economic Perspectives

Causes of the financial crisis revisited
--November, 2010

A less robust U.S. Economy longer term
--August, 2010

Greece: A test of Europe's resolve to remain united
--May, 2010

The U.S. jobs machine restarting at a slower pace
--February, 2010

~ ~ ~ ~ ~

HOMEABOUTCOMMENTARY FORECASTspacerPERSPECTIVESLINKS