Manufacturing Feeds the Recovery, but Can It Persist?

As the U.S. economy began to show signs of life late last year, it was carried largely by an unusual leader: manufacturing. In terms of both output and new jobs created, U.S. manufacturers have posted strong numbers for several months running.

Car Manufacturing
Car Manufacturing

Yet with the mixed results of two regional manufacturing reports this week—the New York Federal Reserve's Empire State Manufacturing Survey and the Philadelphia Federal Reserve's Business Outlook Survey—it remains to be seen if the short burst manufacturing received from U.S. businesses cautiously re-entering the economy this spring will extend much longer.

"People had to restock shelves at some point," says Cliff Waldman, an economist for Arlington, Va.-based Manufacturers Alliance, (MAPI). "What has to happen now is real demand has to enter."

But Thursday's Philadelphia Fed survey, which covers factories in eastern Pennsylvania, southern New Jersey and Delaware, suggested that business demand remains tepid. Despite a slight increase in the survey's diffusion index of current activity—its most comprehensive measure of manufacturing conditions—certain line elements dipped, including an eight point drop in new orders.

"Domestic demand, while recovering, is not exactly a barnburner," says Waldman.

The Philadelphia Fed survey also revealed a softer-than-anticipated outlook on factory hiring. Manufacturing employment has been a bright spot in an otherwise bleak job market, adding 101,000 jobs since December 2009, according to the U.S. Bureau of Labor Statistics. While both the Philadelphia Fed and the Empire State survey, released Monday, recorded positive readings for May hiring, they also found future employment outlooks tied heavily to business demand. Forty-three percent of the Philadelphia-region factories who reported no present intention to hire further employees indicated uncertainty over product demand as the "most important" reason why they were keeping ranks trim.

As a sector whose share of the economy has only shrunk with each passing decade—manufacturing accounted for 11.5 percent of total GDP in 2008, versus 21.3 percent in 1978—its current performance is hard to appreciate when speaking in relative terms. Still, U.S. manufacturing remains a positive indicator for economists analyzing a nascent economic recovery.

Omair Sharif, an economist for RBS Securities, remains unfazed by any recent pullback in manufacturing's strong run for 2010.

"Philly and Empire reports still point to very healthy growth in the manufacturing sector," says Sharif. "[Both] show continued growth in factory activity in May, even if it is somewhat slower than it was in April. Because the reports run through the first half of each month, my sense is that some of the slowdown may have had to do with caution on the part of firms due to the escalation of the European debt crisis."

Global markets stretched and shaken by a historic economic downturn will likely continue to impact the fate of U.S. manufacturing. An Asian-led export rebound has had strongly positive implications for the sector, as booming Asian economies have stepped up their demand for American goods. Yet with shaky European markets threatening to unsettle business operations worldwide, manufacturing could take fresh hits just as quickly as it gains, leaving its progress caught in a murky middle.

"It's an uneven global recovery to say the least," says Waldman. "My best guess in manufacturing output growth is moderation."