Manufacturing is a small part of most advanced economies. The modern consumer spends much more on services. But manufacturing has not shrunk to zero. Making things still matters. It is between 10% and 30% of what major economies do. A lot of the recent economic growth slowdown has been caused by a slowdown in manufacturing. So what has happened to making things?
For the developed economies, manufacturing slowed suddenly last year. Before June, manufacturing growth was easily above trend. Developed economy manufacturing has grown about 1.5% on average since the early 1990s. From June to October last year, manufacturing growth slowed to trend. After October, manufacturing growth plunged. This was nearly all due to the Germans. Germany was behind 70% of the drop in growth while Italy made up 15% of the drop.
Looking at different parts of the economy, the slowdown was focused on machinery. This fits with why exports weakened. There is still a need to make things for consumers. Consumers are doing well and are spending money. However, companies have been delaying investment. US trade taxes have created uncertainty. The UK’s impending departure from the European Union and a recession in Turkey have also meant companies are less sure of the future. Less investment means fewer orders for machinery.
This fits with the German story. Making machines is a far more important part of the German economy than, say, the US economy. The Germans dragged down global manufacturing because machinery production dragged down German manufacturing.
If we get more stable investment, we should get more stronger manufacturing. There are signs that this is happening, in data from both Asia and the US.
Alongside the short-term slowdown in investment, manufacturing also has some longer-term issues to face up to. In the future, the world will make fewer things than today. Some things are just not being made anymore. To take one obvious example, the CD and the DVD are museum exhibits. Streaming is a service; nothing is made (in a physical sense).
Making things for entertainment has been dragging down the manufacturing sector for most of the past eight years. This seems unlikely to change. Of course, that has wider effects. Making (effectively) no CDs will reduce the need to make the plastic, packaging and marketing materials associated with making discs. Making less plastic, packaging and marketing materials will reduce the demand for the underlying chemicals and commodities — and so on. Making stuff will become less important to economies. Providing services such as music or (of more value still) economic research will become relatively more important. This means that structurally, manufacturing could grow more slowly than the overall economy.
More efficient use of technology and investment spending also reduces demand for manufacturing. Beyond the current cyclical slowdown in investment, the rise of homeworking and people using their own technology at work means that fewer things have to be made. Having a work phone and a personal phone merge into a single (personal) phone with a work app on it, for example. Flexible working means companies buy fewer desks, or indeed fewer buildings. A more efficient economy uses fewer things to achieve a standard of living.
What about China? The country has become a lot more important as a manufacturer in the last 10 years. So, is there any value in looking just at advanced economy data? The value of advanced economy data is that it is available. China’s data is limited in both scope and quality. Looking at advanced economies can still offer insights, even as they make fewer things. China does not tend to make a product from start to finish. Instead, the country is one link in long, complicated global supply chains. By looking at what is happening in other parts of the supply chain, we can understand global manufacturing.
The increased weight to Chinese manufacturing has one obvious impact on advanced economies. China’s Lunar New Year holidays have always been a significant disruption to the country’s production process. The Lunar New Year, inconveniently, takes place on a different date each year. This makes it difficult to smooth out the data. Indeed, Chinese statistics merge January and February data together to try to deal with the problem.
Chinese factories have become more important over the past 10 years. Ten years ago, the Lunar New Year was a local problem for China and parts of Asia. As China has become a dominant, integrated part of global supply chains, the Lunar New Year holidays add more disruption up and down the supply chains.
Disruption to Chinese factories may have a bigger seasonal effect on factories in other parts of the world. The volume of goods moved by air tends to drop during the Lunar New Year period. It seems as if the Lunar New Year effect on air freight has become larger in recent years. This means that investors need to be careful about how they read manufacturing data at the start of the year. It is not just China, or even Asia that is disrupted by the passage of the moon. More and more, European and US production could be seasonally weaker at the start of each year.
Paul Donovan is global chief economist at financial services company UBS