US Manufacturing Resurgence is Broad-Based

By Jeff Ferry, CPA Research Director

Manufacturing employment in the US has now shown year-on-year growth of more than 250,000 employees for six consecutive months, the largest and most sustained manufacturing job growth we’ve seen since 1998.

Manufacturing employment may finally be on the path to a real recovery from the severe downturn that began in 2001, when we lost 1.47 million manufacturing jobs in a single year.

Figure 1 shows that as of October, the US added 296,000 manufacturing jobs compared with the previous October. That’s equivalent to a 2.4% increase in manufacturing jobs over the year, with total manufacturing employment standing at 12.785 million in October, per Bureau of Labor Statistics data. That’s of course far below the 17 million manufacturing job count the US enjoyed in the early 1990s. Nevertheless, solid 2%-3% year-on-year growth as we have seen for the past eight months is a big step forward.

Figure 1. Compared with year-earlier totals, US manufacturing employment was up by 296,000 jobs in October 2018 to 12.785 million.

Furthermore, a CPA analysis of the 19 sectors within manufacturing shows that the job growth is broad-based. Figure 2 shows that 14 of those sectors showed positive job growth on a year-on-year basis. Only five sectors showed declines, most of them related to apparel and textiles, and they accounted for about 10% of the manufacturing workforce.  Sub-sectors accounting for 90% of manufacturing industry saw job growth. The fastest-growing sub-sector was electrical equipment, appliances and components, which added 18,000 jobs for 4.8% growth. The two largest sectors, transportation equipment and computer/electronics grew at 2.3% and 2.4% respectively.

Figure 2: US manufacturing employment fell by over 5M between 1999 and 2010. Growth rate began to accelerate last year, with year-on-year growth of 2.4% in October.

It’s noteworthy that two large metal-using sub-sectors, fabricated metal products and machinery manufacturing, each grew at more than 4% and showed stronger job growth than the primary metal manufacturing sector. The latter sector includes the steel and aluminum industries, which have publicly announced new investment and more jobs in response to the Section 232 metals tariffs the Trump administration imposed earlier this year.  Since then, critics of tariffs including politicians of both parties and many mainstream economists have loudly and relentlessly declared to anyone who will listen that higher prices for steel and aluminum will hurt the downstream industries.

Figure 3: Year-on-Year Manufacturing Job Growth by Sub-Sector.

Yet two major downstream industries are doing so well that they are hiring more people than metal-makers! What gives?

To get some insight, we spoke to Zach Mottl, who runs the family-owned Atlas Tool Works in suburban Chicago. Mottl is a member of the Coalition for a Prosperous America and is a past chairman of the board of Illinois’s Technology and Manufacturing Association (TMA). Atlas has 72 employees and revenue just under $10 million a year. Mottl reports that business is booming, and has been booming since last year. “I have unlimited demand from my customers,” Mottl told us. “I could double my sales right now. I’m in a pickle because I’m at capacity.” Mottl told us many of his peers are seeing the same strong demand. “Demand has changed. Perceptions have changed.  It all accelerated after Trump took office.”

Atlas’ customer markets where Mottl has seen increased demand include: aerospace (both military and civilian); medical device; machine tool manufacture; oil and gas exploration equipment; and food manufacturing equipment. Mottl, who expects revenue growth this calendar year of 9%, told us he has 4 job opportunities for machinists and programmers, and if he could fill those, he would be ready to hire a dozen more. He said he and his peers find it very hard to fill those positions because 20 years of manufacturing decline have dissuaded many young men and women from pursuing careers in manufacturing.

Mottl describes the impact of tariffs on his business as “insignificant.” He says his steel and aluminum costs are up some 10%-15% for most varieties, while some hard-to-get specialized varieties can go higher, as stockholders take advantage of short-term scarcity. But those price increases are lost in the noise of a market where strong demand has led to rising prices for most of his products. “We’ve raised prices on hundreds of jobs this year. Shops like mine are feeling pricing power again. Sometimes the customers refuse to pay but I know they won’t find it cheaper anywhere else. In one quote for a power generation customer, we raised our price 40% and the customer walked away. A few weeks later, he came back and accepted our offer.” Tariffs, he said, don’t matter, partly because metal is a small part of his costs, and also because this is a hot market. “I just pass them [metal price increases] along.”

Mottl’s experience is borne out by the job growth numbers in Figure 2.  After all, manufacturers don’t take on more employees unless they are seeing real demand growth and are confident about incoming orders. The booming manufacturing economy is also borne out by the latest Purchasing Managers Index(PMI) from the Institute for Supply Management.  The September PMI index came in at 59.8% (a figure above 50 denotes growth) with New Orders at 61.8 and Production at 63.9. ISM Chairman Fiore said those indicators showed “strong growth in manufacturing for the 25^thconsecutive month, led by strong production output, continued strength in new orders, improvements in supply chain delivery performance, and better utilization of existing inventory.”

Optimism on the economy extends to the consumer sector too, as shown by the Conference Board’s consumer confidence index, which reached an 18-year high of 137.9 in October.

What explains such a powerful economic boom in this, the ninth year of economic recovery? Part of the explanation lies in the Trump administration’s actions in 2017, including deregulation to stimulate specific sectors such as energy, and the tax cut which cut corporate income tax and put an additional $71 billion into corporate bank accounts, a cut of 30% in the federal corporate tax take. Another part of the explanation is good old-fashioned Keynesian stimulus. According to a Treasury press release on Sept. 13^th, the federal budget deficit leapt 33% in the 11 months to August to $898 billion.

Part of the explanation also appears to be that US businesses are now shying away from buying Chinese, because of tariffs on Chinese imports and growing recognition that those tariffs will persist for a long time, and tariff rates may even rise. China’s version of the PMIfellin October to 50.2, its weakest level in two years, while the new export orders sub-index fell to 46.9, below the key 50 level and its fifth consecutive monthly fall, suggesting Trump’s antagonistic approach to China is having an impact on US business’s import decisions.

Of course, the current economic boom cannot run forever. The plunge in the stock market suggests investors see an impending recession, and much will depend on the Fed’s management of interest rates too. The overvalued dollar also poses a dangerous threat to continued US economic growth.

Tariffs and Economic Theory

Why have so many mainstream economists been wrong about the tariffs’ impact on metal-using industries? Instead of suffering, the downstream industries are thriving. One reason is simple political prejudice. Raised as internationalists and convinced that the US must not modify the international world order it created in the post-World War II period, they allow their sentiment to cloud their economic judgment.

But an equally important reason is technical. Economists’ models put a large emphasis on the relationship between price and demand. If a product’s price goes up, its demand is supposed to fall. This demand curve relationship is a longstanding principle in economics. And it is true if all else is equal. But all else is rarely equal. For example, it is also true that if incomes rise, demand rises, and the income-driven rise in demand can outweigh the price-driven fall in demand. That is what appears to be happening in the US economy in 2018.

There is a second technical reason why price increases have not led to falls in demand. The economists’ principle that a price increase leads to a fall in demand operates only if there are alternatives to the good whose price has risen. A rise in the price of Coke reduces Coke sales as long as Pepsi is available. What happens if both Coke and Pepsi prices rise in tandem? This appears to be what is happening in the US economy. The prices of many industrial goods are rising together, and in an optimistic environment, customers are willing to pay those prices.

In economists’ lingo, this means that the elasticity of demand is close to zero, in other words a price increase of 10% or even more leads to a demand decrease of close to zero (and a rise in total spending). Interestingly enough, Whirlpool CEO Marc Bitzer gave financial analysts a lesson in real-world economics in his October 25th investor conference call. Back in July, investors got worried when Whirlpool said it was going to be hit by higher costs for the steel it uses in its washing machines and other appliances and the stock fell. But on October 24^th, Whirlpool announced strong Q3 results. Despite a stagnant market in the US, the company was able to raise prices and deliver 5% revenue growth in North America.  Bitzer said that he expects tariffs (including steel and certain China imports such as motors) to add $300 million to Whirlpool’s full-year costs. Yet its Q3 earnings figure of $4.55 was 19% up on the year-ago figure, and Whirlpool stock has since gained some 7% in a down market.

On the next day’s conference call, analysts probed Bitzer on how he was able to raise prices in Q3 without losing market share. He replied: “I would always argue on a full year basis there is limited overall category price elasticity on the consumer side, i.e., I would say on a full year basis, consumer prices do not necessarily impact consumer demand in a strong way.”

This comment from a man who has been immersed in the home appliance business since 1999 illustrates a key fact about much of US (and global) business: many markets are oligopolistic, i.e. dominated by a small group of producers who tend to raise and cut prices at similar times by similar amounts. Economists’ models, which assume so-called “perfect competition” miss this effect, and therefore overestimate the impact of price.

The conclusion is that tariffs, if levied broadly, can be a highly effective means of steering demand from foreign suppliers to domestic suppliers. Given a choice between adapting their models to the real world, or continuing to issue predictions based on obsolete models that meet their own and their colleagues’ prejudices, most mainstream economists choose the latter course.