In September, the Institute for Supply Management index of manufacturing activity fell to 47.8, its lowest level since June 2009. This is all the more troubling because, based on the Federal Reserve’s measurement of manufacturing output, manufacturing production was down in the first two quarters of the year, signaling a sectoral-wide recession in the first half of the year.
Most economists, of course, don’t worry too much about manufacturing, since government data suggests the sector only accounts for about one-tenth of the U.S. economy.
But the government doesn’t measure manufacturing’s impact accurately. Using analysis of national input/output tables by Interindustry Forecasting (Inforum) at the University of Maryland, economists from the Manufacturers Alliance for Productivity and Innovation (MAPI) showed manufacturing’s total value chain actually accounts for about one-third of U.S. GDP, or three times the impact that the official data suggest.
This means the risk of a manufacturing downturn is much greater to the rest of the economy. How could the government estimate be so unintentionally misleading?
For starters, official manufacturing statistics are based narrowly on information collected at the “establishment”—or plant—level, as opposed to the “firm” level. That means numerous manufacturing-related activities, from corporate management to R&D to logistics operations, are not included within the NAICS codes for manufacturing (31-33). For example, the Commerce Department classifies the work of senior executives in Briggs & Stratton’s headquarters as “management of companies and enterprises” (NAICS 55), Caterpillar’s R&D centers as “professional, scientific and technical services” (NAICS 54), and Stanley, Black & Decker’s warehouses as “wholesale trade” (NAICS 42).
Another reason the government measurement is misrepresentative: it only includes the creation of upstream value, from the processing of raw materials and intermediate inputs through the production process. The manufacturing value stream is much broader, encompassing the associated activities in both the upstream supply chain and the downstream sales chain of manufacturing goods sold to final demand.
Start with the upstream activities associated with manufactured goods for “final demand” (that is, designed for end-users such as households, businesses, or government): to measure these you have to include the value of all the intermediate inputs purchased for use in production, such as raw materials, process inputs, and services. Not only do car manufacturers need steel to make cars, but steel manufacturers need coal and iron ore to make steel, and all the raw materials need to be transported from place to place. In recent years the value added of all intermediate inputs upstream of the factory, bound for final demand, has hovered around $3.1 trillion.
Then as the goods move downstream from the factory loading dock through the sales chain, you need to add in the value derived in the transportation, wholesaling, and retailing of the goods. Additional value is generated in related services such as rental, leasing, insurance, professional services, maintenance, and repair. Combine the value of all these downstream activities with the producers’ value, and you get the manufactured goods downstream sales chain. MAPI estimates that downstream added value on manufacturing goods for final demand totals more than $3.6 trillion.
Combined, the (up and down) value stream of manufactured goods for final demand equals $6.7 trillion, or about 29% of the roughly $20 trillion of final demand for goods and services in today’s U.S. economy.
But even this definition of manufacturing’s value stream is incomplete. As noted above, goods designed for “final demand” are those destined for an end-user. This does not include intermediate inputs made for non-manufacturing supply chains, such as gypsum and cement bound for the construction supply chain, or chemical fertilizer used in the agriculture supply chain. (The government credits the value of these inputs to those other sectors, even though they are clearly part of the U.S. manufacturing process.) Adding this value back into the manufacturing sector provides a more holistic and accurate perspective. Goods designated for non-manufacturing supply chains provide an additional $500 billion in value added to manufacturing’s total value chain. That represents an additional 3% of GDP – which raises manufacturing’s total impact on the economy to 32% of GDP.
In other words, the manufacturing footprint is about a third of the economy, not a tenth. This means when manufacturing sneezes—and it appears to be catching a cold right now—economists and policymakers need to sit up and take notice.