Trade tensions are strangling American manufacturing

Slowing industrial production could portend a wider economic contraction

Megan Greene


Workers at a Ford plant in Chicago. US manufacturing output grew in May and June, driven by the auto sector, which is forecast to slow later this year © AFP


The US manufacturing sector has now contracted for two consecutive quarters, according to the Federal Reserve, raising concerns a general recession is drawing near. But those fears remind me of a triathlon I recently completed. With burning lungs and a pounding heart, I’d really flagged during the swimming section. Then I recovered and finished fine. So does a limping manufacturing sector really mean the American expansion will end?

A recession is a bit like the death of a star — you can only see it clearly after it happens. We can’t be certain manufacturing is leading the US to contraction. But it could be a portent: industrial production was down 1.9 per cent annually in the first three months of the year and 1.2 per cent annually in the second quarter. Manufacturing production was down 1.9 per cent and 2.2 per cent, respectively. The definition of a technical recession is two quarters of contraction. And while manufacturing output grew relative to the previous month in May and June, it appears to have been largely driven by auto and auto part production, widely forecast to slow later this year. Automakers such as Ford and Nissan are cutting jobs and earnings forecasts.

President Donald Trump’s trade policies are receiving much of the blame. Not only have trade tensions contributed to weaker demand from China for US goods, they have disrupted supply chains and inventory management for US manufacturers. Operating a business when you don’t know what the rules will be is like trying to complete a triathlon with a weight around your neck.

Now, a manufacturing recession need not necessarily result in an economic one. Fifty years ago, manufacturing represented almost 25 per cent of US gross domestic product. Today it accounts for only 11 per cent of GDP and 8 per cent of employment. America has become a services-based economy, and service industry data have remained buoyant in the US and abroad.

Furthermore, the nature of investment has changed drastically over the past few decades. In 1998, nearly 50 per cent of non-residential fixed investment went into new structures and industrial equipment to boost manufacturing capacity, while about 30 per cent went into informational processing equipment and intellectual property. In the first half of this year the percentages were reversed, with roughly 30 per cent going into structures and equipment and 50 per cent into technology.

Optimists will highlight the potential for these tech investments to result in higher productivity growth and potential growth. However, the impact will be felt only in the medium term, once workers have learnt to use the new technologies to improve their productivity. In the short term, this shift from tangible to intangible investment tends to be bad for workers: factories create more jobs than the likes of WhatsApp.

Some analysts see parallels with the manufacturing recession of 2015-16 and worry this time it will lead to an overall contraction. In both cases, weakness was driven by an economic slowdown in China and a strong US dollar. In 2015-16 as now, the dollar appreciated in part because of stronger perceived economic fundamentals in the US than abroad.

The Fed’s decision to pause rate rises as financial conditions tightened sharply in late 2015 helped weaken the dollar and arguably kept the slowdown in manufacturing from dragging the overall economy into recession. Today, however, financial conditions are already easy. The Fed’s rapid shift in tone from rate rises to rate cuts since the end of last year has done little to affect the currency.

Meanwhile, factory orders and purchasing managers’ indices for the eurozone, the UK, Japan and China all show manufacturing contracting. That puts pressure on their currencies and makes American exporters less competitive.

But there are other important differences from four years ago. In 2015-16, consumer spending rose at an average 2.8 per cent annual rate. In the most recent quarter, it grew by a brisk 4.3 per cent. Then, a collapse in oil prices crimped investment in energy; today, oil prices are much higher than in 2015. China’s slowdown then was driven by a deliberate campaign to deleverage. Today, Chinese authorities are trying to reflate growth that has foundered amid a trade war with the US.

Given its impact on Chinese demand and American factories, the trade war is the key to whether the US slips into recession. If Mr Trump were to call it off, it would remove the weight around manufacturers’ necks — and allow the US economy to power through swimmingly.


The writer is a senior fellow at the Harvard Kennedy School

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