U.S. manufacturing: challenges and recommendations; How to best ensure the continued strength of U.S. manufacturing

Business Economics, July, 2004 by Kristin Forbes

The U.S. manufacturing sector was hard hit in the recent recession, particularly with respect to employment. This paper examines the recent challenges for U.S. manufacturers, discussing short-term factors related to the characteristics of the recession as well as longer-term structural issues, such as strong productivity growth. It also discusses the role of increased trade with China. Based on this analysis, the paper then evaluates what should, and should not, be done to help U.S. manufacturing. Some proposals could significantly damage the competitiveness of U.S. manufacturers. Instead, the Administration has enacted and proposed a number of policies to ensure the continued strength of the U.S. manufacturing sector, as well as a broader recovery in the U.S. economy.

**********

The U.S. economy has experienced a challenging few years--from the terrorist attacks of September 11 and series of corporate governance scandals, to the wars in Afghanistan and Iraq. During this period, the manufacturing sector has been particularly hard hit. Although the recession was fairly mild (as measured by the contraction in GDP from its peak), it was not mild for manufacturers. Manufacturers felt the economic slowdown earlier, longer, and harder than the rest of the economy. Figure 1 shows the much sharper decline in manufacturing output than for the economy as a whole.

The manufacturing sector was particularly hard hit, not only in terms of declining output, but also in terms of declining employment. Manufacturing employment fell by nearly 2.8 million over the three years from January 2001 to January 2004--at which point it reached its lowest level since 1950. The recent drop in manufacturing employment was the biggest cyclical decline since 1960. Although the recession ended in November 2001 and growth surged in the third quarter of 2003, employment in the manufacturing sector has been much slower to recover. Only in February 2004 did manufacturing employment finally turn the corner and start to increase. Figure 2 shows this unusually slow recovery in manufacturing employment compared to during past recessions.

Many of the challenges facing U.S. manufacturers, however, are not unique to the United States. Other large economies have also experienced substantial job losses in manufacturing over the past few years. For example, manufacturing employment has fallen by about one-sixth in Japan since 1995. Even China--which is frequently cited as replacing developed economies as a major source of manufacturing production--has lost fifteen percent of its manufacturing jobs since 1995 (equivalent to about 15 million workers).

This sharp decline in manufacturing employment in the United States and other leading economies leads to the critical question: what can and should be done to help the U.S. manufacturing sector? To answer this question, however, it is first necessary to understand the challenges facing U.S. manufacturing, and especially the forces driving the recent decline in employment. After discussing these points, my comments will then evaluate some of the different proposals to help U.S. manufacturing. Some of these proposals would have little benefit and could actually hinder the recovery of U.S. manufacturing, while others could help ensure that U.S. manufacturing continues to be one of the most productive and competitive in the world.

Causes Behind the Employment Decline in Manufacturing

The recent job losses in manufacturing result from short-term effects from the most recent recession and longer-term trends related to structural shifts in the U.S. economy, especially relatively strong productivity growth.

Short-Term Factors

First, the disproportionately large impact of the recent recession on the U.S. manufacturing sector largely stems from the nature of the recession. Over this most recent business cycle, the U.S. experienced an unusual weakness in business investment and exports--two components of GDP that are closely tied to manufacturing. Nearly all business investment goods and most nonagricultural exports are manufactured products.

Investment growth was unusually rapid prior to the recession, and the overhang from this rapid investment delayed new investment when growth slowed. The pace of new business investment was further delayed by the series of corporate governance scandals, and possibly the uncertainties following the 9/11 terrorist attacks. All of these factors caused investment to decline much more than during past recessions, as shown in Figure 3, as well as to recover more slowly after the recession ended.

Similarly, exports were unusually weak during the most recent recession. Figure 4 shows that exports usually increase about one year after the start of a recession, while in the most recent recession exports fell by over ten percent. Exports declined largely due to slower growth among our major trading partners, such as Japan and continental Europe.

Longer-Term Trends

Lower investment and export growth during the most recent recession are not the only factors responsible for the employment decline in the U.S. manufacturing sector. Amplifying these short-term factors was the longer-term trend of strong productivity growth in the U.S. economy, and especially the manufacturing sector.