Will U.S. manufacturing lead job creation?

So far the US economic recovery has been jobless. But unemployment is a lagging indicator. Employers won’t add permanent jobs until they see rubust demands for their products. They’ll increase hours per worker first, then add temp workers, before they hire new ones. This Friday’s employment report will again be a critical one for the market.

Yet arguably a better way to look at job creation is in the leading sectors. US manufactoring has been expanding in recent months. It’s one of the potential leading sectors for job creation, besides technology, healthcare and governments. The just-released Institute of Supply Management (ISM) report for Feburary is worth a close look.

The table below gives a snap shot of manufacturing in February. Click to enlarge.

The PMI came in at 56.5, still expanding but at a slower pace compared to January’s 58.4. This is the 7th month of consecutive expansion. Much of this expansion has been discussed or associated with replenishing business inventories. But notice how it coincides with the continuing expansions in both export and import.


And both surging export and inventory restocking was the main factors behind 4Q GDP’s 5.9% growth. Many commentators and economists are worried that the “one-time” inventory effect will not last long. Yet, looking at the ISM report, Customers’ Inventory index is still too low, even though it registered one of the highest increase in February. One can make a case that the inventory push may still have some way to go towards contributing to GDP growth in 2010.

The most important trend to focus on is the Manufactoring Employment index, which has recovered dramatically since the depth of the great recession and is now in its 3rd month of expansion. Manufacturers appear to be hiring for real to produce goods that go to replenishing inventories and to export. This trend is certainly helped by the weak dollar, notwithstanding the recent strength due to Euro-zone turmoil. It’s also helped by the abundant supply of labor.

The strength in export will most likely continue because emerging market consumers are now consuming more than that by US consumers, according to JP Morgan’s recent estimate.

Much of the strength may ultimately depend on US consumers. Here we run into a loop. For US consumers to step up their consumption, there has to be more jobs. But to create more jobs, US businesses need the consumers to step up spending. There is no circularity of logic here, it’s a feedback loop that can go either way. On the way leading to contraction, the loop went negative until it hit a bottom. Now, on the way to recovery, we believe that this feedback loop has become a positive one: More consumer spending will lead to more jobs and more jobs will lead to more consumer spending. The initial trigger for this positive loop was probably the inventory rebuild and external demand.
We leave governments outside of this picture, because public spending and financial stabilization were critical but are not part of the normal forces that the economy can count on.

CalculatedRisk shows an interesting regression result on ISM employment index on changes in BLS employment, and stated:

“Although there is significant variability, the current level of 56.1 percent in February suggests around a 22,000 gain for manufacturing jobs.”  Click to enlarge.

Obviously, US will need a lot more than 22,000 jobs per month from manufacturing if it is going to lead the job creation. Let us say 88,000. Using the slope CalculatedRisk computed, that level of job creation would imply a reading of 74.4 for the ISM employment index. Such a high level is off the chart, as can be seen from the index series above for the recent decades. In fact, the highest reading in the ISM series went back to the Feburary of 1951 when it registered a 73.7 reading. We all know the history of US manufacturing since then, especially in the 1990s and 2000s. Many manufacturing jobs have gone overseas to low-cost producers such as China and India.

Certainly the competitive envornment has changed since the 1990s. Wages have increased in these development nations. Energy costs have increased dramatically, along with the costs of raw materials. With high unemployment and a favorable monetary policy, US does have a fighting chance, provided the healthcare costs can be brought under control.

The challenge is huge.