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Matthew Cowie
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Independent financial analyst currently living in Beijing, China. Articles written for Fidelity Independent Adviser have appeared on CNBC.com, Yahoo Finance, theStreet.com and Seeking Alpha.
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  • The Real U.S. Economy: Manufacturing Is Still King 0 comments
    Apr 25, 2013 12:19 PM

    If you've heard that the consumer is 70% of the economy, you heard wrong. The 70% figure comes from GDP, which measures not gross product, but the final expenditure. Since everyone in the economy is a consumer and consumption is the final stage of the economic cycle, consumption makes up a lot of final goods. However, the economic activity taking place behind the scenes is far more complex.

    Instead of looking at final products, we can look at the total amount of intermediate goods in addition to final goods. A car sale, for example, is recorded in GDP. In gross output, the mining of metals, the refining of steel, and the production of auto parts suppliers are all included.

    One way to look at the economy is the Hayekian triangle. At the top are higher order stages of production, such as mining and farming. At the bottom is the lowest stage, consumption. As you can see, the last stage is the largest, but in terms of area the triangle is far larger than the last stage. GDP tells us the final slice, but gross output tells us the total picture.

    (click to enlarge)

    Imagine consumers decide to save more and the money is invest in capital goods. Media headlines would blast the drop in GDP as a sign of economic weakness, but in fact the total amount of economic activity may be increasing as higher order stages of production expand. Similarly, GDP fails to tell us if higher order stages of production are contracting and thus signaling a future recession when the numbers finally work their way down to the GDP. (Manufacturing data is a leading indicator, retail sales a lagging one.)

    Luckily, The BEA does calculate total economic activity with a gross output figure. In the chart below, I show gross output as a percentage of the total private economy output for some of the important sectors in the economy. The data is annual.

    (click to enlarge)

    Manufacturing is the largest sector of the U.S. economy. (The production of everything from cars and computers to Coca-Cola and cardboard are included in manufacturing.) Check out what happened to manufacturing in 2008-it started to decline and fell all the way into 2009, what we know as the recession. In terms of raw data, only in 2011 did manufacturing exceed its pre-crisis output levels (along with gross output). Increased spending in retail, healthcare and government failed to spur a recovery, only as manufacturing gross output climbed to a new high at the end of 2011 did it even make sense to talk of a recovery.

    Unfortunately, the gross output numbers are reported with a large time lag; 2011 data was released in November 2012. Still, we can look at data such as the Manufacturing PMI and Census data on new orders, among others, to monitor the sector.

    (click to enlarge)

    (click to enlarge)

    Neither chart indicates a recession is coming, but both indicate deceleration in the manufacturing sector with an increased risk of recession.

    Manufacturing is the engine of economic growth. Consumption is the caboose.

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