On The Economy -- Shift To Services Continues

When the U.S. Commerce Department's Bureau of Economic Analysis releases its first look at first-quarter 2004 corporate profit figures on May 27, they are expected to show that the ratio of after-tax profits to GDP rose to the highest rate since the end of the Korean War, some 50 years ago. That may come as a shock to many manufacturing firms that are still struggling to make ends meet -- especially those in the durable goods sector. Since as I write this column we don't yet have the corporate profit data for the first quarter of 2004, I am looking at a table summarizing figures for the final quarter of 2003. The numbers tell me that the "core" durable sector of the economy -- a sector that includes machinery, computers and electronics, and transportation equipment -- is the only sector that does not show profit. It logically stands to reason that if these core industries cannot make a profit during times when the economy is booming and profit margins in other sectors of the economy are at record rates, they won't stick around much longer. The movement to foreign locations will intensify. The motor vehicle industry is Exhibit A. Virtually every major car company in the world is building plants in far-flung locations and will be able to shift production facilities from one country to another on almost a moment's notice. And there's no good reason why other core durable goods industries won't follow this pattern. It's true that profits in these industries also turned negative in the 1990/91 recession. But by 1993 they had recovered sharply. What is unique about the current situation is that a fairly sharp recovery has still left profits in the red. At least historically, profit margins peak early in the business cycle, when labor costs are at their trough because wage gains have been moderate, and productivity growth has risen to a cyclical peak. That is precisely what happened last year, too, but in the case of the core manufacturing industries, it wasn't enough. What, then, remains for American manufacturing? I'm not predicting that 5 million jobs will disappear overnight, or even during the rest of the decade. However, the lack of profits in the foreseeable future does strongly suggest that when new plants are built, they will not be in the U.S., and these firms will continue to reduce employment whenever possible. They will continue to shrink in absolute terms, not only relative to the rest of the economy. Meanwhile, job creation will remain robust in the other sectors of the economy -- trade, financial, and other services. There has been a great wringing of hands and gnashing of teeth about high-paid manufacturing jobs being replaced by minimum-wage jobs at McDonald's and Wal-Mart. To a certain extent this is true, but it is easy to exaggerate. According to Bureau of Labor Statistics figures, average hourly earnings for production workers in manufacturing last year were $15.74. Average earnings for all other hourly-paid workers (i.e., excluding high-paid salaried workers) were $15.28, or 3% less. That is not negligible, but it is hardly the 50% to 75% drop claimed by some commentators who compare the $15.74 figure with the $5.15 statutory federal minimum wage. Less than 1% of the full-time jobs in this country actually pay only the minimum wage. The U.S. will increasingly become a service-based economy. This trend has been apparent for many years, but if there were any remaining doubt, it has been erased by the inability of core manufacturing industries to generate a profit even as margins rise to record levels in the rest of the economy. Michael K. Evans is chief economist for American Economics Group, Washington, D.C., and president of the Evans Group, an economics consulting firm in Boca Raton, Fla.