Growing Upside Potential for U.S. Manufacturing Growth

by: Cliff Waldman, Chief Economist

Overview

The global economy continues its slow but persistent march to improved health. 

Encouraging signs:

  • While growth in the U.S. remains moderate and constrained by domestic political and policy challenges, there is no sign that the lengthy U.S. economic expansion, which began in June 2009, is about to end.
  • Recent data out of China are more diverse than a few months ago, but it is clear that the rebound from China’s protracted slowdown continues.
  • The Eurozone economy is showing markedly better growth performance.
  • Using a quarter-over-quarter measure, Japan has now had the longest stretch of growth in 11 years.
  • Adding to the good news, the persistent fall in the value of the dollar, nearly 7% since January 2017 using a nominal measure of the value of the dollar against a range of currencies from major industrialized and developing country trading partners) is a compelling aspect of the current MAPI Foundation forecast. The greenback might depreciate more than many forecasters expect if global financial markets sour on the dollar as a portfolio asset. If the decline of the dollar does not turn into a destabilizing rout, it will be positive for U.S. manufacturers in terms of global competitive pricing, somewhat mitigating the challenges that arose with the dollar’s post-2014 appreciation.

Current uncertainties:

  • The impact of Hurricane Harvey that descended upon South Texas and Louisiana in late August is the most significant uncertainty for U.S. manufacturing growth for the balance of 2017 and into the early months of 2018. While the impact of Hurricane Irma, which ravaged the large state of Florida, won’t be known for some time, it seems clear that it will exacerbate the already substantial supply chain interruptions that follow from Hurricane Harvey, with measurable implications for manufacturing growth performance.
  • Escalating U.S. political and policy uncertainties resulting from a multitude of difficulties with the current U.S. administration could have significant financial market repercussions, which could adversely affect U.S. growth. The potential threat from simmering tensions with North Korea could have destabilizing impacts in currency markets and would likely slow the pace of East Asian business investment spending.

All told, the MAPI Foundation’s forecast remains almost completely unchanged from our June or February 2017 reports. Between 2017 and 2020, we expect annual U.S. GDP growth to be an average 2.2% across the four-year period.

In June, the MAPI Foundation began exploring the boundaries of plausible factory sector growth through 2020. In addition to a quarterly scenario for U.S. manufacturing growth, this report also offers both a pessimistic and an optimistic alternative scenario. Our alternative global growth scenarios suggest a range for average manufacturing growth through 2020 of between 1.5% and 2.2%.

Forecast of U.S. Economic and Manufacturing Growth

The MAPI Foundation’s current projections for growth in inflation-adjusted U.S. GDP, as well as key components of GDP through 2020, remains moderate.

F=Forecast, Source: MAPI Foundation, August 2017

F=Forecast, Source: MAPI Foundation, August 2017

U.S. economic growth is constrained over the long-term by demographic and labor supply challenges and in the short-term by a range of political and geopolitical uncertainties, as well as questions about the path of labor productivity growth. We currently project that average U.S. GDP growth will be 2.2% between 2017 and 2020, unchanged from the May simulation.

Catalyzed by rising employment, consumer spending remains the primary driver of U.S. economic growth.

F=Forecast, Source: MAPI Foundation, August 2017

F=Forecast, Source: MAPI Foundation, August 2017

We project total consumer spending growth to average a moderate 2.7% from 2017 to 2020, largely driven by an expected 5% average growth rate in spending on durable goods. By contrast, business equipment spending remains historically sluggish with only modest hints of improvement. Given recent disappointing data on U.S. economic growth, our capital spending forecast has softened.

We currently project average business equipment spending growth to be 3.6% in 2017-2020 as compared to our May forecast of 4%. Since our February 2017 forecast, we have reduced our projection for business equipment spending growth by a significant 0.8 percentage points, mostly due to slower than expected growth in the overall U.S. economy. Capital spending is highly sensitive to GDP growth. Historical norms suggest that equipment spending growth should be more than twice these rates.

The improvement in global economic growth results in a modestly improved but still sluggish U.S. export outlook. We currently project that U.S. export growth will average 2.9% in 2017-2020, somewhat slower than the 3.7% average growth projection from our May simulation, but above the 2% growth forecast from our February simulation.

F=Forecast, Source: MAPI Foundation, August 2017

F=Forecast, Source: MAPI Foundation, August 2017

Given that import demand is projected to grow faster than export demand over the next three years, trade pressures will remain an issue for U.S. manufacturing even as the global economy strengthens.

Capital spending and export growth have long been the principal drivers of U.S. manufacturing growth. Thus, with only modest adjustments to our capital spending and export outlooks, it is not surprising that our outlook for U.S. manufacturing growth is little changed.

The current forecast projects that U.S. manufacturing growth will average 1.7% from 2017 to 2020, just slightly faster than the 1.6% average growth rate projected in June.

F=Forecast, Source: MAPI Foundation, August 2017

F=Forecast, Source: MAPI Foundation, August 2017

The year-to-year progression of growth does change in our September forecast, however. The MAPI Foundation is projecting slightly slower manufacturing output growth rates for 2017 and 2018 and slightly faster growth rates for 2019 and 2020. Learn more about our forecast methodology.

Exploring Possible Future Headwinds and Tailwinds

In this report, we offer three alternative scenarios to our baseline forecast. The persistent dollar depreciation since January of 2017 is a compelling aspect of the current macroeconomic climate for manufacturers. 

Source: Federal Reserve Board

Source: Federal Reserve Board

To test the implications of a greater than expected fall in the dollar for U.S. manufacturing growth performance, we simulated an alternative dollar scenario. We assumed that the dollar would fall by an average of 1.6% against industrialized country currencies and by an average of 0% against a bloc of major developing country currencies in 2017-2020. We compared this assumption to the baseline forecast assumption of a 0% average increase against industrialized country currencies and a 0.7% average increase against developing country currencies.

Under this alternative dollar scenario, manufacturing growth averages 1.9% between 2017 and 2020 as opposed to 1.7%.

Source: MAPI Foundation

Source: MAPI Foundation

The biggest absolute difference occurs in 2019 when manufacturing growth in the alternative dollar scenario is projected to be 2.7% versus 2.2% in the baseline, a significant difference likely to be felt across a wide range of manufacturing industry subsectors.

We also simulate two alternative scenarios on global growth.

Source: MAPI Foundation

Source: MAPI Foundation

The pessimistic scenario references the headwinds from simmering U.S. political and policy risk as well as the escalating confrontation with North Korea. In this scenario, industrialized country growth is assumed to average 1.5% between 2017 and 2020, versus 1.7% in the baseline, and developing country growth is expected to average 3%, versus 3.1% in the baseline. U.S. manufacturing growth is forecasted to average 1.5% in the pessimistic scenario versus 1.7% average growth in the baseline. The biggest growth difference is expected to occur in 2019 with a projected 1.8% in the pessimistic scenario versus 2.2% in the baseline.

The optimistic scenario reflects the possibility that forecasters are underestimating the tailwinds of economic improvements in one region reinforcing improvements in others. In this scenario, we assume that industrialized country growth will average 2.3% between 2017 and 2020 versus 1.7% in the baseline while developing country growth is expected to average 3.4% versus 3.1% in the baseline. U.S. manufacturing growth in the optimistic scenario is forecasted to average 2.2% versus 1.7% in the baseline. The largest difference is expected to occur in 2019 with manufacturing growth projected to be 3.4% in the optimistic scenario versus 2.2% in the baseline. While not the most likely outcome, the potential for rapid improvement in the global picture is not trivial and portends a much more profitable outlook for U.S. manufacturers after 2018.

These three alternative forecasts highlight an improving picture for U.S. manufacturing with growing upside potential. The risks from the stand-off with North Korea, the growing political and policy uncertainty in the U.S., and the structural impediments facing a range of advanced economies very much remain a part of the story. For the balance of 2017 and into the early months of 2018 the collective impact of Hurricane Harvey and Hurricane Irma is also an issue for the manufacturing outlook.

Conclusion

The improvement in world economic growth is having a modestly positive impact on U.S. manufacturing performance. Recent data from key regions, such as Japan and the Eurozone, suggest an upside risk to improving global growth, which, along with the potential for a continuous depreciation of an elevated dollar, could create the best outlook for a stable and moderately strong U.S. manufacturing output gains in a decade. The manufacturing impact of Hurricane Harvey, which descended upon a region whose economic power in oil and other commodity resources is important to the U.S. manufacturing sector whose energy related output has been consistently growing, is the most significant current risk to the 2017 and early 2018 growth performance for U.S. manufacturing. The impact of Hurricane Irma, which is still being assessed as of the writing of this report, will likely exacerbate the supply chain difficulties and distortions that have come out of Harvey. There are other risks, notably of escalating tensions with North Korea and the potential for a political shock in Washington. Further, structural impediments in the advanced economies cap the potential for world economic strengthening.