Markets in a Minute: The Manufacturing Decline – Why it Matters

President-elect Donald Trump plans to impose more-aggressive tariffs on foreign goods as a way to bolster
America’s declining manufacturing sector. (For more on what those tariffs may look like, you can watch this recent video.) While his plan has grabbed headlines, less attention has been paid to why this critical sector needs bolstering. In this week’s Markets in a Minute, we take a look at why the sector has suffered and some near-term
considerations.

The Rocky Path Out of the Pandemic

In 2021, the manufacturing sector came roaring back from a pandemic-related plunge, fueled by strong demand for everything from cars to computer chips. Since then, however, the picture has changed dramatically. In October, economic activity in the sector contracted for the 23^rd time in the prior 24 months, according to the Institute for Supply Management’s (ISM) monthly manufacturing survey.

Manufacturing initially began to decline in late 2022, as companies struggled to work off excess inventories. More recently, a wide variety of factors, from strikes that hobbled ports and production lines to higher input costs, have weighed on activity.

Manufacturers surveyed for ISM’s October report noted that election-related uncertainty – and by extension the
outlook for trade policy, electric-vehicle demand and other key issues – has also served as a headwind. In addition, economic pessimism among consumers has contributed to weaker demand for goods. The bottom line is that manufacturers are producing less, hiring fewer workers, depleting inventories and getting
fewer new orders.

The contraction in manufacturing isn’t just a U.S. problem. Global factory output has also slipped recently,
according to the latest S&P Global Manufacturing PMI index. Only India, Thailand and the UK appear to be bucking the broader downturn.

A Long Time Coming

In the U.S., manufacturing has long been seen as a bellwether for the broader economy. That said, the sector has
meaningfully declined in significance over many decades, both in terms of its contribution to gross domestic product (GDP) and the labor market. This long-term trend may help explain the recent divergence between manufacturing and the overall economy’s performance. 

Manufacturing’s Contribution to U.S. GDP and Employment Since 1948 (%)

_{Source: Kestra Investment Management with data from the Bureau of Economic Analysis, FRED. Data from 1950-2023}

Why All the Fuss Over Manufacturing?

Despite its decades-long decline in economic significance, manufacturing continues to be a key focus for both
political parties. Both President-elect Trump and President Biden have made protecting and reviving American manufacturing a top priority.

Why have they devoted so much political capital to the sector?

As we saw during the pandemic – when global production and supply chains ground to a near standstill – manufacturing encompasses a variety of industries deemed strategically important for America’s economy, national security and even health. In fact, the sector is far more diverse than you may think. Manufacturers large and small make products that we consume every day, from food to pharmaceuticals.

Value Added to U.S. GDP by Manufacturing Type ($B)

_{Source: Kestra Investment Management with data from the Bureau of Economic Analysis. Data as of 2023.}

While the number of manufacturing jobs has declined over time, the sector continues to be a source of innovation
and high-paying jobs. One industry trade group reports that in 2023 manufacturing employees earned nearly
$103,000 per year on average, including pay and benefits. This figure exceeds the average annual pay and benefits for all American workers, which stood at $65,470 according to the Bureau of Labor Statistics. Most U.S. manufacturers are quite small. An estimated three-quarters of all American manufacturers have fewer than 20 employees.

Brighter days ahead?

The last couple of years have demonstrated that the economy can expand even while manufacturing declines.
That said, that growth will be difficult to sustain without more help from manufacturing.

Tariffs could help stimulate domestic production of goods by making it more costly for companies to import
goods from abroad and encourage firms to boost domestic production. Countries have long used tariffs to give key industries time to develop without heavy foreign competition or to avoid becoming overly reliant on products made by foreign adversaries.

U.S. Tariffs Have Risen but Remain Below Past Peaks

_{Source: Kestra Investment Management and Council of Foreign Relations with data from the U.S. International Trade Commission. Data as of 2023. Note: The lines represent two ways of measuring tariffs. They differ because not all goods are subject to tariffs.} 

The trade off with higher tariffs is lower global trade and higher prices for end consumers. At extremes, tariffs
can slow economic growth. For instance, some economists credit the 1930 Smoot-Hawley Tariff Act, which imposed nearly nine hundred tariffs designed to protect agricultural interests, with worsening the Great
Depression.

In the aftermath of the Smoot-Hawley tariffs, Congress granted the president wider powers to make changes to
tariffs. For many decades that power was used to lower tariffs. More recently, however, both Biden and Trump have used that power to raise tariffs, pointing to the potential benefit for American workers – encouraging more manufacturing at home means more jobs for Americans. One research report concludes that higher tariffs on aluminum encouraged US manufacturers to reinvest in aluminum manufacturing, hiring an additional 4,500
workers and ramping up production.

It’s safe to assume that if tariffs are used more aggressively, as the president elect has proposed, we should
expect to see additional investment in the manufacturing sector. However, it is likely to take years for that capacity to be built out. And the benefits of that additional capacity will have to be weighed against the potential
drawbacks such as higher prices.

As always, we’ll be keeping a close eye on the sector, trade policy and other important economic issues.

Invest wisely and live richly,

Kara