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Manufacturing's woes may be just beginning

The good news: manufacturing is still growing, although at the slowest pace in two years. The rest is all pretty much bad news.
/ Source: contributor

The good news: Manufacturing is still growing, although at the slowest pace in two years. The rest is all pretty much bad news.

New factory orders are down, manufacturing inventories have been slashed, order backlogs are shrinking and employment is flat. That is the news from the latest batch of reports on the manufacturing sector.

The outlook isn’t much better. The prospect of deep cuts in government spending because of the debt ceiling bill wending its way through Congress will likely mean reduced consumer spending. Government employment, already trending down, will accelerate as federal spending cuts prompt layoffs. That will slow manufacturing demand and employment even more and perhaps lead to losses in factory jobs for the rest of the decade, analysts say.

"The brief manufacturing recovery has stalled. This report gives us little reason to believe that the coming months will be any better," Scott Paul, Executive Director of the Alliance for American Manufacturing said in a statement, referring to the Institute for Supply Management's survey of manufacturing activity in July, which came it at 50.9.

That is just barely above the 50 level which is the difference between growth and contraction, and well below the 54.9 reading that had been expected. The ISM report is the first major indicator of how the economy performed last month, and the disappointing number took the wind out of an early-morning stock market rally.

"This is the slowest growth we've seen in this manufacturing index since summer of 2009," said Gary Burtless, an economist at the Brookings Institution.

The report was one of a number of pieces of data, including last Friday’s GDP report, to show the U.S. economy at growing risk of slipping back into recession — a so-called “double-dip.”

"I think we're going into reverse," Burtless said.

Manufacturing accounts for about 12 percent of the nation’s economic output and has been a driving force of the recovery, feeble as it is, so far.

Specifically, contractions in new orders, inventories and inventory backlogs telegraph rising caution among wholesalers and retailers. New orders fell to 49.2, the lowest level in two years, from 51.6 in June. The employment index fell to 53.5 from 59.9.

Some of this could be attributable to caution by businesses amid the protracted stalemate over the debt limit in Washington. After weeks of rancorous debate, the White House and congressional leaders hammered out an agreement to boost the nation’s borrowing authority in return for deep cuts in spending. The House and the Senate still need to approve the deal, but most expect it to get the necessary votes despite resistance from conservatives and liberals.

Without the deal, the U.S. may have had to default on paying some of its debt, which would have resulted in a downgrade of its triple-A credit rating and in a jolt to the economy that it could ill afford.

But the manufacturing sector’s travails are hardly confined to the current economic uncertainty. Manufacturing has been on a decline in the U.S. since the 1970s. Even a sustained stretch of rising employment and GDP will, at best, only put a brake on the shrinkage of American manufacturing, economists warned.

Two million manufacturing payroll jobs were lost in the Great Recession, according to a new report by the McKinsey Global Institute, a unit of the consulting company, which looks at three models of economic recovery stretching out to 2020.

In its best-case scenario, manufacturing jobs could have a zero net loss. In the most pessimistic scenario, which calls for the addition of 9.3 million jobs across all sectors of the economy by the end of the decade, manufacturing jobs still could drop by another 2.3 million. The manufacturing sector currently employs about 11.7 million people, according to the Bureau of Labor Statistics.

In the U.S., factories churning out complex, highly technical items like semiconductors and fighter jets have largely replaced those producing labor-intensive, low-cost goods like apparel and consumer electronics. The upshot is fewer jobs and more high-tech expertise required to fill positions in the new economy.

The McKinsey report offers some glimmers of hope, though.

"In the recovery so far, the manufacturing sector has been a standout, adding about 300,000 jobs since January 2010. … We can envision a scenario in which manufacturing job losses are much smaller or even stop in the decade ahead," the report said.

But for this to occur, the rebound in demand has to outstrip the steady growth in productivity, which has been climbing about 7 percent each year.

Even if we expand our export market share, much of the necessary demand will have to come from American consumers, which makes manufacturing extremely vulnerable to the spending cuts Congress is demanding.