GDP: Is Manufacturing Really Healthy?

BusinessWeek has an interesting little article which questions measurement of "import price data" in the GDP numbers. It's heavily conditioned, but the core argument is one we've seen before.

The underlying problem is located in an obscure statistic: the import price data published monthly by the Bureau of Labor Statistics (BLS). Because of it, many of the cost cuts and product innovations being made overseas by global companies and foreign suppliers aren't being counted properly. And that spells trouble because, surprisingly, the government uses the erroneous import price data directly and indirectly as part of its calculation for many other major economic statistics, including productivity, the output of the manufacturing sector, and real gross domestic product (GDP), which is supposed to be the inflation-adjusted value of all the goods and services produced inside the U.S.

OK so far.

The result? BusinessWeek's analysis of the import price data reveals offshoring to low-cost countries is in fact creating "phantom GDP"--reported gains in GDP that don't correspond to any actual domestic production. The only question is the magnitude of the disconnect. "There's something real here, but we don't know how much," says J. Steven Landefeld, director of the Bureau of Economic Analysis (BEA), which puts together the GDP figures. Adds Matthew J. Slaughter, an economist at the Amos Tuck School of Business at Dartmouth College who until last February was on President George W. Bush's Council of Economic Advisers: "There are potentially big implications. I worry about how pervasive this is."

BW's own estimate is that since 2003, the "phantom" GDP could be $66bn, about 40% of gains in manufacturing output in the period. But they are careful to note that it could be less than that--or more.

More broadly, it becomes clear that "gains from trade are being measured instead of productivity," according to Robert C. Feenstra, an economist at the University of California at Davis and the director of the international trade and investment program at the National Bureau of Economic Research.

"This has been missed."Pat Byrne, the global managing partner of Accenture Ltd.'s (ACN ) supply-chain management practice, goes even further, suggesting that "at least half of U.S. productivity [growth] has been because of globalization." But quantifying this is tough, he notes, because most companies don't look at how much of their productivity growth is onshore and how much is offshore. "I don't know of any companies or industries that have tried to measure this. Maybe they don't even want to know."

How did the statistical question arise?

When Houseman first uncovered the problem with the numbers that is created by offshoring, she was primarily focused on manufacturing productivity, where the official stats show a 32% increase since 2000. But while some of the gains may be real, they also include unlikely productivity jumps in heavily outsourced industries ...such as furniture and audio and video equipment such as televisions. "In some sectors, productivity growth may be an indicator not of how competitive American workers are in international markets," says Houseman, "but rather of how cost-uncompetitive they are."

For example, furniture manufacturing has been transformed by offshoring in recent years. Imports have surged from $17.2 billion in 2000 to $30.3 billion in 2006, with virtually all of that increase coming from low-cost China. And the industry has lost 21% of its jobs during the same period.

Yet Washington's official statistics show that productivity per hour in the furniture industry went up by 23% and output by 3% between 2000 and 2005. Those numbers baffle longtime industry consultant Arthur Raymond of Raleigh, N.C., who has watched factory after factory close. "And we haven't pumped any money into the remaining plants," says Raymond. "How anybody can say that domestic production has stayed level is beyond me."

The simple explanation could be that BEA counts "sales" as a measure of manufacturing--forgetting that not all "sold goods" are actually manufactured in the USA. After all, the simplest measure of 'productivity' is Total Sales/Employee. If BEA is ignoring the fact that Hooker Furniture (e.g.) has NO domestic manufacturing plants, there's a real problem here, folks--or that big chunks of Delco/Delphi replacement parts are manufactured in Mexico (etc., etc.) You get the idea.

Phantom GDP can also be created in import-dependent industries with fast product cycles, because the import price statistics can't keep up with the rapid pace of change. And it can happen when foreign suppliers take on tasks such as product design without raising the price. That's an effective cost cut for the American purchaser, but the folks at the BLS have no way of picking it up.

What's the implication?

...If domestic productivity growth has been overstated for the past few years, that suggests the nation's long-term sustainable growth rate may be lower than thought, and the Fed may have less leeway to cut rates.

In terms of trade policy, the new perspective suggests the U.S. may have a worse competitiveness problem than most people realized. It was easy to downplay the huge trade deficit as long as it seemed as though domestic growth was strong. But if the import boom is actually creating only a facade of growth, that's a different story.

It's also true that "productivity" is not as important as "profits;" and that the profits still accrue to US companies. In that sense, the BEA's measurement is just fine.