(What’s Left of) Our Economy: So Much Manufacturing Data…So Few Trade War Answers

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Census Bureau, core capex, Federal Reserve, Jerome Powell, manufacturing, Markit.com, Philadelphia Fed, tariffs, Trade, trade war, Trump, {What's Left of) Our Economy

What a day for U.S. manufacturing data! It no doubt raises major questions over whether President Trump’s tariff-centric trade policies are finally showing signs of damaging American domestic manufacturing (as has been widely claimed for months, despite an almost total lack of statistical evidence). Unfortunately, it’s a mixed and pretty muddy verdict that’s delivered by the separate reports from the Census Bureau (on national spending on the kinds of “core” capital goods made by U.S. manufacturers), the Philadelphia Federal Reserve Bank (on manufacturing in the mid-Atlantic states), and private sector consultancy Markit.com (on the overall state of domestic industry).

To be sure, the headline figures collectively were worrisome. The Census reading was both worse than expected, and strengthens the case that there’s been a softening on business expenditures on machinery and equipment not meant to build defense-related products (which, after all, reflect government decisions, not economic fundamentals) or aircraft (where demand is thought to be unusually volatile, and therefore likely to produce results that distort the figures for industries as a whole).

The Philadelphia Fed reading was the first such monthly reading since May, 2016 showing regional industry to be contracting rather than expanding. And the Markit report – something of a national version of the Philadelphia survey – signaled “the slowest improvement in business conditions since September, 2017.”

But the obstacles to drawing any broad conclusions, much less trade- and tariff-related conclusions – are formidable to say the least.

In the first place, it’s always dangerous to place major emphasis on a single month’s worth of results. In addition, the three surveys cover different time periods. The Philly Fed and Markit results purport to show conditions for February. The Census capital spending release only brings the story up to December. Not to mention that it came 35 days late due to the partial federal government shutdown.

Moreover, the Markit and Census results are preliminary. Revisions are rarely game-changers, but can sometimes turn contractionary readings expansionary – and vice versa.

It’s also crucial to distinguish between absolute drops in activity and relative drops. The Philly Fed report – which provides the most recent data – and the Census results describe absolute contractions in their indicators. But the Markit headline figure remains in expansion territory – it’s just not quite so expansionary.

As RealityChek regulars are used to reading, “Don’t ignore the internals.” And all three releases were filled with intriguing details. On the positive side, for example, the February Philly Fed report found that hiring by regional manufacturers not only kept increasing – it increased at a faster pace. That’s unusual for a manufacturing sector that’s supposedly contracting. And in fact, respondents professed to be slightly more optimistic about their future prospects in February than they were in January. Markit also reported strong February manufacturing employment along with other signs that “manufacturers remain firmly in expansion mode.” 

On the negative side, the Philly Fed reported big drops (both into absolute contraction) in both new orders and shipments. The former in particular seems like bad news for future business. And the Census capital spending results also are viewed as a forward-looking indicator – although they’re two months old.

Most challenging of all is figuring out what role the Trump tariffs have been playing, since they’re hardly the only development influencing manufacturing’s health. The economist who writes the Markit reports sums up the situation aptly, in my opinion:

“Businesses that experienced a soft patch for production cited a range of factors holding back growth, including adverse weather, worries about the global economic outlook and ongoing international supply chain uncertainty.” That last phrase refers to trade conflicts and their possible impacts. But of course, even assuming that such uncertainty was indeed a major cause of the soft patch, let’s not forget that soft patches often firm up quickly.

And don’t forget the Federal Reserve! Last October, Chairman Jerome Powell spooked investors by suggesting that the central bank would keep raising interest rates well into this year. Such “tightening” usually slows down growth by increasing the cost of borrowing for consumers and businesses. But in mid-November, Powell indicated he was having second thoughts and, after financial markets suffered through a terrible December, in early January convinced investors that he was serious about continuing easy money with an early January statement.

So as I see it, there’s still no significant evidence that the Trump tariffs themselves have already been hurting American manufacturing, and no compelling evidence yet that they will. But since no one has a whizbang crystal ball, and the stakes are so big, the intellectually honest course to take is to keep monitoring the data and report on them as accurately and as dispassionately as possible.

(What’s Left of) Our Economy: Why Tariff-Induced Gloom Looks Sillier than Ever

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inflation, Institute for Supply Management, ISM, manufacturing, Markit.com, PMI, Purchasing Managers' Index, survivorship bias, tariffs, Trade, trade war, {What's Left of) Our Economy

Look – I’m hardly the world’s biggest fan of the monthly private sector national manufacturing surveys that purport to reveal the state of American industry. I’ve reported on their consistent failure to track the actual performance of domestic manufacturers compared with the results of the official (and much more comprehensive) data, and explained that a main reason is that the surveys suffer from “survivorship bias.”

Still, since they’re both so widely followed, it’s crucial to note that both the October report released by the Institute for Supply Management this morning, and its counterpart from Markit.com, show that the sector is doing just fine. More specifically, since these results track well with the latest government figures on manufacturing, they represent even more evidence that claims of tariff-induced manufacturing devastation are Fake News.

The headline number for the October ISM (57.7) was indeed lower than its September edition (59.8). It’s also lower than the average for the last twelve months (59.2). But it’s not much lower. Even more important – any reading above 50 signals expansion. And although the comments from various industries contained were full of tariff-related concerns, according to Timothy R. Fiore, who oversees the reports, they “reflect continued expanding business strength.”

Many of the internals also showed American manufacturing remains firmly in growth mode. In particular, new orders and employment both continued increasing. Yes, they were increasing at slower paces than in September. But businesses believing that big trouble lies ahead usually don’t keep ordering more stuff (and manufacturers’ customers generally include other manufacturers as well as companies in other parts of the economy) and adding more workers. They start pulling back.

The Markit.com October U.S. manufacturing Purchasing Managers’ Index (PMI) revealed even stronger reasons for optimism about domestic manufacturing’s foreseeable future, and for its ability to thrive despite any near-term hits delivered by Trump-ian trade policies.

Markit.com also uses 50 as its dividing line between expansion and contraction, and it emphasized that is 55.7 score for October was a five-month high. In addition, it “signalled a further pick up in growth momentum and a strong improvement in the health of the manufacturing sector.”

And the internals? If anything, they were even better. Markit.com did describe the price pressures faced by American manufacturers as “intense” and blamed them “largely” on “higher raw material and metal prices stemming from the ongoing effects of tariffs.”

Nonetheless, the October survey also reported that “Driving the latest development in the health of the sector was a sharp increase in new business. The upturn in total new work reached a five-month high….” Additionally, “Greater production requirements and efforts to clear backlogs meanwhile led to a quicker monthly rise in hiring, the fastest for ten months.”

Pessimists can point to Markit’s observation that “firms registered a strong rise in buying activity amid reports of greater efforts to stockpile….” That’s evidence that manufacturers were drawing purchases forward in hopes of escaping the costs of future tariffs. At the same time, companies rarely build inventories unless they’re confident they can sell the stockpiled stuff further down the line. And indeed, according to Markit, “output expectations towards the coming 12 months improved, with firms suggesting that anticipations of further new order growth drove optimism.”

The only significant fly in this ointment concerned inflation. Markit.com’s Chris Williamson wrote that “In a clear sign that inflationary pressures are continuing to build, strong customer demand meant firms were often able to push cost increases through to selling prices. Average prices charged for goods leaving the factory gate consequently jumped to one of the greatest extents seen since mid-2011.”

So far, these price increases haven’t shown up in the official data (see here and here), but certainly they could. In fact, the entire sunny picture painted by these surveys, and the government figures, could darken all of a sudden, and tariffs might be to blame. But for the time being, nothing of the kind has happened. So when you see news reports or other statement to the contrary, predicting a future of trade war-produced future of gloom and doom, you can be surer than ever that the sources don’t believe that Facts Matter.

(What’s Left of) Our Economy: New Reasons to Ignore Those Manufacturing Surveys

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consolidation, emerging markets, Federal Reserve, industrial production index, Industry Week, innovation, Institute for Supply Management, investment, ISM, manufacturing, Markit.com, mergers and acquisitions, Michael Collins, monopoly, offshoring, oligopoly, survivorship bias, Trade, {What's Left of) Our Economy

The newest editions of the two big private sector American manufacturing gauges – from Markit.com and the Institute for Supply Management (ISM) came out this morning, which should be a complete non-event given all the data I’ve presented on what a terrible job the ISM in particular does at tracking industry’s real health. (I haven’t closely analyzed Markit’s results, but since they roughly match the ISM’s, they seem about as bad.)

Of course, the Markit and ISM releases are in fact big deals to policy-makers, economists, and investors, so let’s try to turn a sow’s ear into a silk purse and show how the big structural weakness of these surveys can be used as a window into a big reason for domestic manufacturing’s ongoing collective troubles. That weakness, as loyal RealityChek readers know, is survivorship bias. And recently, an important new explanation for this bias, for its resulting distortions, and for manufacturing’s continuing struggles despite all the renaissance claims, has come to light.  

A quick refresher on survivorship bias: Unlike the Federal Reserve’s index of industrial production, the Markit and ISM surveys don’t try to measure how the American manufacturing sector as a whole has grown or shrunk. (Both companies look at other measures of manufacturing performance, too, and this discussion applies to them as well.) Instead, they choose a sample of manufacturing companies and ask key executives to assess their firms’ circumstances. If Markit and ISM asked these businessmen for their actual growth or other figures, for example, this wouldn’t be a big problem. But since they ask instead whether they’ve been growing (or contracting) at all, it’s a huge problem.

With the former methodology, it would be at least reasonable to extrapolate the sample data and draw conclusions about the entire domestic manufacturing complex. But the technique used by these two companies simply tells us how that sample (which is also much smaller than the Fed’s) has been faring in its own judgment. And because so many U.S.-based manufacturing firms have fallen by the wayside in recent decades, the Markit and ISM surveys wind up reporting only on the remaining companies – the survivors.

Individual companies, of course, can often prosper even as their overall sector isn’t (grabbing a larger share of stagnant or even shrinking pies). But that’s exactly why the Markit and ISM results have lost whatever ability they may have once had to describe domestic manufacturing’s overall health when overall industry was much larger.

At the same time, it shouldn’t be forgotten that because of greater efficiencies, a national manufacturing sector with fewer companies can still keep generating more production and employment. That’s why I’m always hesitant to use as evidence of U.S.-based industry’s troubles data on the (significantly) declining number of American manufacturing “establishments” over time. There’s no doubt that these figures reflect many company failures, and resulting factory shutdowns. But there’s also no doubt that they reflect lots of that aforementioned efficiency-enhancing consolidation – and these statistics don’t contain any breakdowns.

Recently, though, some new data have emerged that reveal another angle of the survivorship bias issue – the surge of mergers and acquisitions in manufacturing. These transactions are fundamentally different from the two forms of consolidation described above. Rather than stemming from individual companies deciding that they can do better with, say, one factory rather than two, or from individual companies prospering because rivals have gone bust, this form of consolidation stems from companies acquiring one another.

An important June post from IndustryWeek makes clear how dramatic this increase has been, especially since the early 1980s. As a result, in 200 manufacturing sectors monitored by the Census Bureau, 16 percent were characterized by their four largest companies accounting for at least half the value of shipments. By 2007 (the latest statistics available), this share had jumped to 37 percent.

The post’s author, consultant Michael Collins, notes that “Under [such] oligopoly and monopoly conditions, investment slows down. Because competition is weaker, corporations are better able to raise prices and profits without investing in new technologies and products—and declining investment can lead to declining innovation and economic stagnation.”

He doesn’t say this explicitly, but it shouldn’t be overly difficult to see how such consolidation can undermine production as well. This could be especially important given the huge share of domestic manufacturing that’s engaged in the production of parts, components, and other industrial inputs. They’re the source of considerable innovation in industry, and if manufacturers overall become less interested in better products and processes, then demand for their output is bound to suffer.

Collins also hints at another way that consolidation could depress output – by using oligopoly and monopoly power to reduce wages and increase prices for American consumers. In recent decades, the argument could reasonably be made that new demand in emerging market countries like China, Mexico, and Brazil would compensate – and then some – for lower consumer and industrial purchases in the United States.

But nowadays it should be obvious that this promise has not been realized and remains a distant prospect. Three big reasons: Emerging market growth has slowed dramatically and even shifted into reverse in some instances; the incomes of their consumers have remained so low; and they have made dramatic progress in supplying their own industrial innovation needs themselves. And largely because these emerging markets (enabled by offshoring-friendly investments and trade policies) sapped the growth potential of high income countries like the United States without adequately replacing it, the world has been stuck in low-growth mode ever since recovery from the last recession began – six long years ago.

It’s completely unreasonable to expect Markit or ISM to shed much light on these wide-ranging developments in their monthly reports. But by the same token, it should be clearer than ever that what they don’t show about domestic manufacturing is far more important than what they claim to reveal.