The Mismeasure of Manufacturing

This post is part of our series, Is Manufacturing Making It? [1]

Using statistics primarily sourced from the Federal Reserve, we are repeatedly told that manufacturing isn't dead, just manufacturing employment [2], due to all our productivity gains. I must disagree that it's all about productivity, as did a group of economists who met last November to discuss government productivity measures [3], Louis Uchitelle of the New York Times reporting (via Curious Cat [4]:

... The fundamental shortcoming is in the way imports are accounted for. A carburetor bought for $50 in China as a component of an American-made car, for example, more often than not shows up in the statistics as if it were the American-made version valued at, say, $100. The failure to distinguish adequately between what is made in America and what is made abroad falsely inflates the gross domestic product, which sums up all value added within the country.

American workers lose their jobs when carburetors they once made are imported instead. The federal data notices the decline in employment but fails to revalue the carburetors or even pinpoint that they are foreign-made. Because it seems as if $100 carburetors are being produced but fewer workers are needed to do so, productivity falsely rises — in the national statistics. ...

This is a problem that even extends, as the article goes on to explain, to the service industry. If your accountant is outsourcing some of their tax processing work to India on the cheap, this also boosts US productivity statistics. Tracking the real impact of that imported carburetor, or any other imported intermediate input (say that three times fast,) in the productivity statistics is presumed to require years of work and congressional funding.

Imported Intermediate Inputs

Courtesy also of the Curious Cat blog [4], some of the economists who realize that manufacturing productivity measurements are distorted do work at the Federal Reserve and wrote about it in a paper entitled, "Offshoring Bias: The Effect of Import Price Mismeasurement on Manufacturing Productivity" (pdf) [5], by Susan Houseman (Upjohn Institute), Christopher Kurz (Federal Reserve Board), Paul Lengermann (Federal Reserve Board), and Benjamin Mandel (Federal Reserve Board). Emphasis mine:

... [We document] the rapid rise in both the levels and share of materials used by U.S. manufactures that are sourced from abroad. Over the ten year period from 1997 to 2007, the import share of total materials jumped roughly 50 percent, as the fraction of materials used climbed from 17 to 25 percent.

... In addition, [the Bureau of Economic Analysis] uses import and producer price indexes from [the Bureau of Labor Statistics] to construct industry-level intermediate input price indexes. BEA and BLS, in turn, use intermediate price indexes to compute industry and sector-level value added and productivity measures. If import price growth is overstated, it follows that the real growth of imported inputs is understated and industry value-added and productivity measures are overstated. Real GDP, computed as the sum of real value added across all sectors of the economy, also will be upward-biased.

... Although preliminary, our analysis presents evidence that offshoring bias has been substantial in recent years. We find that the growth rate of imported intermediate input prices may have been biased upwards by between 16 to 35 percentage points, which in turn has led the average annual growth rate in manufacturing productivity to be overstated by 0.1 to 0.3 percentage point or by between 9 and 20 percent over the entire period from 1997 - 2007. These numbers are significant, as 0.1 percent average annual growth rate for multifactor productivity is roughly equal to the average annual contribution of capital to manufacturing growth from 1997 to 2007. ...

The paper explains that because the share of imports from developing countries has been going up, and the prices of those imported manufacturing inputs has been dropping relative to equivalent inputs from developed nations, the cost of inputs to manufacturers has also been underestimated.

What this means, the authors detail, is that because rapidly falling input prices aren't measured properly in the import price index, much of the effective value add is counted after an imported product enters the US market. In other words, the US is taking China's productivity gains and adding them to its own productivity balance sheet, falsely inflating both manufacturing productivity and GDP.

Not Just Employment

So are the employment statistics the only place this mismeasured offshoring shows up? I don't believe so.

Consider the export:import ratio [6], which has been going down in the US, but up in Germany over most of the last 30 years. Are German workers likely to be less productive, or work in less automated environments, than US workers? Is that question too silly to even be typed?

Indeed, as Mark Zandi, chief economist and co-founder at Moody's Economy.com, noted in testimony before the Senate Banking Committee [7] last July, the opposite is likely the case. Emphasis mine:

... The unprecedented decline in manufacturing during this downturn is the result of the collapse of the vehicle and housing industries, a deep recession throughout the global economy, and draconian cuts by U.S. businesses in their investment in technology and other equipment. The longer-running decline in U.S. manufacturing is largely due to the loss of market share to global competitors; since the turn of this decade, most of the decline in market share has been to Chinese manufacturers. ...

If automation-mediated productivity increases are a prime factor in manufacturing job losses, how have employers managed to increase automation while making "draconian cuts" in equipment and technology spending? Particularly while noting that output has gone down in the last decade [8]. And again, we're losing market share in what are evidently wholly viable industries, whose end products are still very much in demand by consumers. This leaves tons of money and millions of jobs on the table every year, as noted previously [9].

Richard McCormack from "The Plight of American Manufacturing," once again:

... U.S. demand for manufactured goods has increased by 400 percent since 1980, says Revere Copper CEO Brian O'Shaughnessy. But U.S. production of those goods increased by 40 percent. ...

This is the living definition of losing market share.

US manufacturing is losing its footing in consumer markets both at home and abroad, and while the losses aren't total, they're serious. This has been ignored because the financial sector that's been funding the offshoring craze was doing well, and because many observers don't consider job losses to be that big a deal. Now that the finance industry isn't doing well and job losses have been revealed to be a very big deal, now that free trade has been revealed as a unilateral disarmament [10], can we start caring about this again, please?

The Vicious Cycle

As my colleague Dave Johnson recently pointed out, workers who make $70/week can't buy Whirlpool refrigerators [11]. Nor, for that matter, can they buy new Ford cars [12]. They can't afford mortgages or unsecured lines of credit at the mass consumer levels that would support a robust financial services industry [13]. They can't go out to eat at sit-down restaurants, or afford to patronize other businesses that comprise a strong service sector economy.

Who, in other words, are $70/week workers in Mexico going to be making those refrigerators for? Sure as blazes, it isn't going to be for laid off manufacturing workers in the US who've been pushed into bankruptcy and defaulting on their mortgages in the wake of yet another [14] jobless [15] 'recovery' [16].

Because the big problem with the declining fortunes of US manufacturing employment is that Wall Street profits [17] become the only thing that recovers [18] after recessions, which seem to be coming thick and fast these days. If that's the kind of future we want, we should keep our eyes fixed firmly on outdated productivity statistics. If it isn't, we should start looking at having a sensible industrial strategy that creates a lot of jobs.