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.