Manufacturing’s Role in World Economy is Evolving

https://www.iise.org/iemagazine/2019-05/html/baudin/baudin.html

ISE Magazine May 2019 Volume: 51 Number: 5

By Michel Baudin

What does manufacturing as a whole look like as a worldwide economic activity? When a company starts up or shuts down a plant, or relocates production from one country to another, it is a data point. It may be a compelling story but it doesn’t tell you the aggregate effect of all manufacturing on a country or on the world.

Beyond anecdotes about particular companies or locations, the global data collected by the World Bank and the International Labor Organization confirm that the size of the manufacturing sector is positively correlated with that of the rest of the economy and the share of manufacturing in advanced economies is holding its own in terms of value added but declining in terms of share of the labor force.

We can apply our own analytics to datasets from publicly available sources. Globally, you cannot describe manufacturing by pictures or videos. You have to use numbers, and money is the only language available to compare activities as different as making frozen lasagna and oil tankers. It’s tricky because currencies change in value over time and with respect to each other.

Economists at institutions like the World Bank, however, have been dealing with these issues for decades. They use currency-independent ratios when-ever possible, converting all values into U.S. dollars based on bank exchange rates, and they adjust for inflation to have numbers in constant dollars.

National economic statistics are not equally trustworthy in every country. In democracies, they are usually compiled by agencies structured to be immune from political pressure and staffed by professional statisticians; in authoritarian regimes, they are tasked with producing the numbers the rulers want to see. We use these data not be-cause they are perfect but because they are all we have, understanding the need for cautious inferences.

The most common measure of a country’s economy is its gross domes-tic product (GDP), the sum of the value added of all its businesses, defined as:  Value added = sales – external inputs where external inputs = materials + energy + outsourced services.

These external inputs are massive in manufacturing. The aggregate value-added of the manufacturing sector is its contribution to the GDP. This concept of value-added has nothing to do with customers’ willingness to pay but is widely used by governments not only for GDP calculations but also as the basis for value-added taxes (VAT).

When a company outsources a process, it reduces its value-added by the corresponding amount spent. When it outsources to another country, it reduces its contribution to the GDP by the same amount. A company’s value-added per employee is usable as a mea-sure of productivity across multiple activities, unlike the pieces/operator metrics that are specific to a production line or a product.

A caveat, however, is that it can be increased without any improvement in work methods or equipment if there is an opportunity to switch to a product with a higher value added.

Throughout the world, communities vie to attract factories, create jobs and stimulate the local economy. Conversely, factory closings dislocate com-munities and may even destroy them. Worldwide employment statistics reflect the aggregate effect of such events, and are available from the International Labor Organization (ILO), an arm of the U.N.

First, let’s consider the 10 largest economies in the world by their GDPs and by the contributions of their manufacturing sectors. The point is to establish whether the rankings match. The top four are the same in both rankings, with the U.S. ranking No. 1 overall and China No. 1 in manufacturing. Among the next six, Brazil and Canada have lost their spots in manufacturing, replaced by Korea and Indonesia.

This raises the question of whether a country can be rich without a strong manufacturing sector or poor with one. To check this out, we plot the contributions to per-capita GDP of manufacturing versus all other sectors for the 171 countries in the World Bank database for 2016. With a few, small exceptions, a strong manufacturing sector goes hand-in-hand with a strong over-all economy.

World rankings By GDP and manufacturing sectors

For the economy as a whole, WawamuStats posted a video on YouTube that shows the evolution of the top 10 countries. It shows, in particular, the dramatic rise of China to No. 2 since 2010, primarily due to manufacturing.

The correlation coefficient is 0.97, indicating that strength in manufacturing and other sectors tend to go together. The outliers with a high per capita GDP and an undersized manufacturing sector both have populations of about 600,000; Macao, with revenues centered on gambling, and Luxembourg, a tax haven. The outliers with an oversized manufacturing sector and a low GDP are Ireland and Puerto Rico, respectively, with populations of 5 million and 3.3 million.

In advanced economies, journalists and politicians bemoan the “hollowing of manufacturing.” As manufacturing migrates to emerging economies with cheap labor, the sector is described as withering, with plenty of anecdotal evidence from plants and cities devastated by plant closures.

But what do the numbers say? It has started to decline in China but is still substantially higher than for the other countries in the group, reflecting the fact that China is still an emerging economy. Except for a dip during the financial crisis, the share of manufacturing in the GDPs of Japan and Germany has been steady around 22 percent since 2002.

By this measure at least, these countries have seen no hollowing of their manufacturing sectors. This share is lower for the U.S., France and the United Kingdom, between 13 percent and 9 percent, and shows no decline since 2008.

If you go back further in time, you see a decline in manufacturing’s share of GDP in Japan, Germany, the U.S., France and the U.K., but not in the past 16 years for Japan and Germany, and not in the past 10 years for the U.S., France and the U.K.

In fact, Japan and Germany on one side and the U.S., France and the U.K. on the other visually form two clusters, but what does it mean? Is the strength of manufacturing compared to other sectors in Japan and Germany a sign of economic health? Or is it a sign that they are lagging behind the other three in converting to a service economy? It is possible to make an argument for both.

The horror stories about the hollowing of manufacturing in advanced economies, however, are not about GDP but about employment. This is a different story. Historical data on manufacturing employment is avail-able for all of the top six GDP countries except China.

This is unfortunate, given that China’s manufacturing sector is the largest in the world. We plot what we have for the other countries and treat the special case of China separately.

Among the six countries with the top GDP in 2016, China needs a separate treatment. Neither the World Bank nor the ILO provide data on manufacturing employment in China but only on industrial employment. Partial data can be retrieved from other sources, like the U.S. Bureau of Labor Statistics (www.bls.gov/) or the National Bureau of Statistics of China (NBSC), but we have no way to be sure it is computed the same way as the World Bank data. In particular, there is no consensus on the difference be-tween industry and manufacturing.

In Europe, the two terms are synonymous. Germany’s “Industry 4.0,” for example, is entirely about manufacturing. Americans, on the other hand, call any business an “industry,” even when it has nothing to do with manufacturing, as in “the entertainment industry” or “the insurance industry.”

To the World Bank, manufacturing is “the making of goods or wares by manual labor or by machinery,” and it does not include mining, oil and gas or construction. The NBSC, on the other hand, does not have a separate category for manufacturing. It is lumped under industry along with mining, logging, salt processing and the repair of industrial products.

In 2016, according to the NBSC, China had 807 million “economically active” people; 776 million of them were employed, 223.5 million of those in industry. The latest data cited by the BLS for manufacturing is of 99 million employees in 2009, exceeding all the five other top GDP countries combined. For this reason, we cannot ignore it.

For 2009, the NBSC reports 211 million in industry, more than twice as many as the BLS estimates for manufacturing. Clearly, numbers based on industry and manufacturing do not belong on the same chart.

Manufacturing in advanced economies has been focusing on high value-added products. This is where they have a comparative and sometimes an absolute advantage over emerging economies. This is not only luxury goods; there are other products selling for prices that are high with respect to their external inputs. This includes leading-edge semiconductors and pharmaceuticals, aircraft and agricultural machinery.

Methods improvements in Japan, the U.S. and Europe have paid off for some companies. What they learned enabled them to make savvy investments in equipment and technology that use less labor.

Overall, however, we have no way to determine how much of the in-crease is due to the flight to higher-value added products and how much is due to methods improvements for the same products.

Manufacturing won’t be main source of jobs in future

We are working with incomplete and not perfectly clean data, but we can still draw the following conclusions:

1. The size of the manufacturing sec-tor in an economy correlates positively to the sizes of the other sec-tors.
2. The share of manufacturing in the GDP of advanced economies is holding steady.
3. Manufacturing’s share of the labor force in advanced economies is slowly declining.

In the best possible future, today’s emerging economies all become advanced, while today’s advanced economies remain so. Manufacturing will not be the massive source of jobs that, up to now, people have taken primarily out of necessity. Employment in manufacturing will instead be the chosen profession of a minority. Others will work in services, attending to the needs and wants of other people. This future is by no means guaranteed. It may be a utopia but the alter-natives are dystopias.