Tuesday, May 9, 2017

Is US Manufacturing Really Great Again?

One chart, more than any other, has influenced people's beliefs about the US manufacturing sector, as can be see by this debate here, and here (the latter a link to the Autor/Harrison/DeLong/Krugman debate, all of whom I am enormous fans of). This graph (below) apparently exposes the lie that trade has played a significant roll in hollowing out manufacturing jobs. It shows that manufacturing employment as a share of total non-farm employment has been declining on a fairly steady trend. In fact, in recent years, it has even outperformed this long-run trend. Thus, it seems we can forget the idea that US manufacturing is in any kind of a slump, judging by this. On the contrary, since we are now above trend, it seems that manufacturing is great again!

However, there are several problems with this thesis. The first is that, if we extend this trend far out into the future, it will imply that manufacturing employment should soon comprise a negative share of employment. Obviously, that can't happen. It would be more natural to assume that the decline would flatten out over time, as it eventually heads toward zero at a slower rate. Additionally, in terms of output growth, as Noah Smith notes, the period from 2008 hardly looks like any sort of a renaissance. And if rising above the trend after 2008 in terms of employment share is not evidence of good performance, than staying on the trend can hardly be conclusive evidence that everything was OK before it.

An additional problem is that, imagine for a second that you have a city -- let's call it Detroit -- that loses 80% of its tradable-sector employment. What could theoretically happen is that the city might soon lose 80% of its non-tradable sector employment as well. Thus, one might infer from its unchanging tradable sector employment share that the decline in tradables was not the cause of the overall decline in jobs. (And, yes, as I pointed out in my job-market paper, other tradable sectors beside manufacturing do seem to have been hit in the early 2000s.)

One example that those who imagine themselves to be sophisticated often use is the decline of agricultural employment. Obviously, one major reason for this is dramatic productivity growth in agriculture over time. We're told then, that the linear decline of manufacturing as a share of total employment is just like agriculture. However, agricultural employment did not continue a linear decline all the way to negative territory. That would be impossible! after all. What happened is that in recent decades the decline as a share of total employment has slowed tremendously. Thus, the question could be why this didn't happen earlier for manufacturing -- why manufacturing was not like agriculture.

(Note: I believe the steep dropoff in agricultural employment around 2000 was related to a change in the classification system.)

However, I do think it is true that while trade is a major driver of the decline in manufacturing employment (see my own research here and here), and was dominant up until the Great Recession, since then slow overall GDP growth is now likely to be the dominant factor holding back manufacturing. And thus, those who care about the US economy should be more focused on monetary policy than trade. Incidentally, a focus on monetary policy will also weaken the dollar and help solve that problem as well.

In any case, let me plot real manufacturing output relative to trend to make the case that not all is well in this sector. (Frequent readers of this blog or my twitter feed @TradeandMoney are no doubt already familiar.)

And, here is Real GDP relative to the long-run trend.

Lastly, haven't we heard that manufacturing is declining "everywhere" as a share of GDP? Let's do an international comparison of employment, exports, and value-added in that case (see below). Indeed, one sees problems here as well.

The idea that everything is OK in US manufacturing is a cockroach idea that, no matter how much it is at odds with basic facts, can't seem to die. In a future post, I'll write a bit more about my thesis on what went wrong. Spoiler alert: it has to do with real exchange rates. If true, then a massive tax cut from Trump would be the worst thing to happen to the US manufacturing sector since, well, the last two massive tax cuts.