from Follow the Money

A manufacturing boom?

July 19, 2005

Blog Post
Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

Tim Duy highlighted a Wall Street Journal story on Monday that puts forward the case that the US manufacturing sector is booming.

I did not find Journal's argument entirely convincing. After all, the chart that accompanied the Journal's story shows the US industrial production index to be barely above its 2000 peak.

But there is no doubt that US manufacturing production has been increasing recently, driven by the production of business equipment and exports. As the Journal (Vascellaro and Hilsenrath) notes:

"In the past year, the growth in output of high-tech equipment, machinery and aerospace products has outpaced overall economic growth."

That should not be much of a surprise though. US domestic demand remains pretty strong. The dollar fell a lot v. the Euro from 2002 to 2004. World economic growth was very strong in 2004. China, India and the oil exporting countries are all flush with cash. There is plenty of global demand for capital equipment. Ask Boeing. Ask GE. Or look at the 13% y/y growth in US goods exports in 2004 (10% or so this year, ytd).

US manufacturing should be doing well.

The surprise, to me, is that it is not doing better.

At the end of 2004, the Fed's index of industrial production was only 1.5% higher than at the end of 2000. It is now about 3.8% above its previous "peak" levels.

Let's compare that increase to the increase in several other key variables since the fourth quarter of 2000:

In the first quarter of 2005:

Real GDP was 12% higher than in q4 2000 -- a far bigger increase than the increase in manufacturing production.

Real consumption was up 14.5%

Real imports were up 19.4% ($1802 billion v. $1509.5 billion)

Real goods imports were up 21.2% -- far more than the increase in US industrial production. They are up 31.7% from their q4 2001 trough. US industrial production is only up 9.6% from its trough.

No wonder Societe Generale (the French bank) calculates that 40-45% of the incremental US consumption dollar ends up buying imports of various kinds.

Real non-residential investment is 4.25% higher than in q4 2000 (it has fallen as a share of GDP, since real GDP grew faster); residential investment is 32.6% higher now than then (it has risen as a share of GDP). That just confirms what we all more or less knew.

(Data comes from the BEA)

Manufacturing accounted for 12.7% of 2004 US GDP. Real goods imports are 13.9% of 2004 GDP, or 13.4% of nominal GDP. That includes things like oil. But in broad terms, US imports of manufactured goods are not much smaller than overall US manufacturing production.

For the trade deficit to fall, I suspect that will have to change.

Manufacturing remains important. US service exports show no sign of being dynamic enough to generate the kind of service surplus needed for the US to run a large deficit in both petroleum products and manufactured goods.

Let's compare the increase in the industrial production index between the end of 2000 and the end of 2004 (1.5%) to the increase between the end of 96 and the end 2000 (20.7%), or from the end of 1992 to the end of 1996 (19.9%), or even the end of 88 to the end of 92 (3.7%).

If industrial production had continued to increase at its Clinton era pace, the index would have been 139 -- not 116 or so -- at the end of 2004.

OK, that is a bit unfair, since there was a recession in 2001. But the increase from 96 to 00 came in the face of a major global slump (the Asian crisis of 1997) and a very strong appreciation of the dollar. Conversely, after early 2002, the dollar depreciated strongly, at least against some key countries.

88-92 was a recession period as well, and industrial production was rather weak then too. One big difference though. During the 88 to 92 period, the US trade deficit fell substantially, as US domestic demand growth slowed. Obviously, the trade deficit did not fall from the end of 00 to the end of 2004, in part because the US consumer kept on spending from 2000 on, even as investment slumped.

Still, the 88-92 data supports Truman's caution about what happens to the overall economy during a period of external adjustment. Increased foreign demand for US goods -- whether from further falls in the dollar, faster growth abroad or a combination of the two -- may well be offset by slower growth in US demand for all goods, foreign as well as domestic.

Another, more immediate, concern. At some point the lagged impact of a weak dollar will wear off. Right now US exports to the OPEC countries and South America are growing particularly strongly, in part because these countries have plenty of cash to spend and in part -- I suspect -- because a weaker dollar is helping the US regain some of the market share it lost in at least some of these markets from 2000 on.

Look at the data on p. 13 of this ECB publication. It seems like the sclerotic Euro area took market share from the dynamic US in Russia and the Middle East from 2001 to 2004. Politics may some something to do with it. But the fact that the euro was kind of weak until early 2002 probably helped. Capital goods ordered in 2001 or 2002 might not be delivered until 2003 or 2004.

Right now, the US is benefiting from the lagged impact of 2003 and 2004 dollar weakness -- something that the Wall Street Journal story might have emphasized more. US exports to Europe did quite well in 2004 despite slow European growth because of the weak dollar. But unless current trends change, at some point the US will start to feel the lagged impact of recent dollar strength.