Tuesday, August 10, 2010

ISM July 2010 & Data|Can Exports dig Us out of this Recession?

It is always important when analyzing data to consider the relevance and importance of such numbers. So, before looking at the numbers from the lastest ISM reports, let us look at what Briefing.com states about the ISM manufacturing reports at Economic Releases: Ism Index. Under the title "Big Picture" it states the following:
This is a highly overrated index. It is merely a survey of purchasing managers. It is a diffusion index, which means that it reflects the number of people saying conditions are better compared to the number saying conditions are worse. It does not weight for size of the firm, or for the degree of better/worse. It can therefore underestimate conditions if there is a great deal of strength in a few firms. The data have thus not been either a good forecasting tool or a good read on current conditions during this business cycle. It must be recognized that the index is not hard data of any kind, but simply a survey that provides broad indications of trends.

Obviously any report can be overrated if interpreted in the wrong way. One way this report seems to be over used and misinterpreted is by relative changes in the index instead of considering the "breakevens" in practice. For example if the headline ISM index drops by 6 points it is significantly more important if it drops from above 50 to below 50 than if the index drops from the 60s to 50s range. The first signifying a reversal of growth and the second a slowing of the growth rate which might actually be good. That is, instead of an overheated economy with growing number of bottlenecks it may signify a stable growth trajectory.

Since the reports are based on sentiment, then it is true that biases are a big factor to consider but that is also its strength as we are trying to have forward looking indicators of the strength and direction of the overall economy, and this should always be taken along with a look at the "Non-manufacturing ISM" reports also. While it may not be as good at forecasting as Briefing.com may desire, it has provided us clues as to what is not likely to happen. For example, they have not so far indicated a double-dip recession. Inflation for a while has been a concern but that trend has reversed and most indicators show a "slowing economy". It is also worth pointing out that perceptions create reality and what people's sentiment is now about the future is likely to be created in reality.

But it is an important consideration that the index is not weighted by size of firm or the degree of sentiment. Since the reports have been around for a long time {since 1931}, changing the reports now may not be a good idea but it might be nice to have "weighted scores" versus the standard unweighted scores. On some of the individual indicators, they indicate not only the breakdown of the industries that are expanding, contracting and staying the same, but also percentages of firms responding in the three categories. This can help indicate broad expansion or more narrowed. With these things in mind let us proceed to the latest reports.

ISM Reports:
Overall the reports are positive but most definitely no indication of an overheating economy. The links used in this portion of the post are:
1. ISM - Media Release: July 2010 Manufacturing ISM Report On Business®
2. Econoday Report: ISM Mfg Index August 2, 2010
3. ISM - Media Release: July 2010 Non-Manufacturing ISM Report On Business®
4. Econoday Report: ISM Non-Mfg Index August 4, 2010

Both headline indexes were solidly in positive territory with manufacturing {PMI} at 55.5 and non-manufacturing {NMI} at 54.3 which signified 12 months of positive growth for the PMI and positive growth for the 2010 year for NMI. The PMI went down by .7%, but the NMI increased by .5% which showed signs of convergence in the economy, that is slow but steady growth. What may be more significant is that both indexes were above consensus at 54 for PMI and 53 for NMI. NMI was even above the range of 52.8 to 54.0, while PMI was at the top of the consensus range of 52.5 to 55.5. Overall the experts had expected a slower growth rate for July. The respondent statements for the most part on the manufacturing was down and could signify an even slower growth in the future with Fabricated Metal Products respondent being the one positive voice. The non-manufacturing on the other hand was mostly positive or lukewarm at worst.

One significant aspect that has changed in the reports since the June reports is that "Commodities in Short Supply" for both sectors is reporting shortages, while last month no shortages were reported. The non-manufacturing shortages seem of little consequence but manufacturing stated that "Capacitors; Electrical Components; and Titanium Dioxide" were in short supply. Already the list of commodities with rising prices is getting longer and it has greater numbers in the parentheses (number of consecutive months of rising prices). Under neoclassical economics of supply and demand, shortages would indicate greater price pressures to clear the market and some of those commodities already show signs of rising prices. Either way these "bottlenecks" could create a drag on the economy. While sectoral rising {or declining} prices signify to the market to adjust, if too many or too rigid of constraints could prevent the necessary adjustments in the economy. Arguably the labor markets are indicating rigidity in a variety of ways including labor migration has been muted partially because of the housing crisis.

That brings us to the issues of price changes as respondents stated and ultimately the issues of Inflationistas And Deflationistas. After the dramatic drop in the price index of manufacturing by 20 points in the June report, the index rose slightly {.5%} and was still significantly above 50 at 57.5. The non manufacturing price index continued its downward trend by dropping 1.1% to 52.7 which is still above the 50% mark and indicating rising prices overall. The downward trend started in April with an index high of 64.7. One significant difference in the two reports is that breath of the price changes. The industry groups are about par {manufacturing 10-3, non-manufacturing 9-4 for increases and decreases respectively}, but the percentage break down by respondents shows that under 50% are experiencing same price levels for manufacturing and over 70% for non-manufacturing. Thus a much larger percentage are not affected by changing prices in non-manufacturing. Even if the trend continues in non-manufacturing for lower prices as it dips below 50%, it will be narrowly focused and less likely to cause a cascading deflationary spiral. Either way, there should be little concern for both inflation or deflation according to these numbers.

This does not stop talk from the "deflationistas". Paul Krugman, as the easiest target around, gives us his back of napkin analysis at Trending Toward Deflation with the chart below. First, trending is a very tricky science and as such he presents no supporting information to help his arguments. Secondly, he does not provide any historical data to show that a trend as such would continue through the zero point of completely stable prices. While, I think that such a point is highly unstable and would be more like a knife edge, I am just not certain that momentum would work so easily to create an economy of deflation from long term inflation. I think there has to be an impetus for such transitions. For example, rapid increases in technology or productivity could bring on deflation but that is hardly happening at the present time.

New orders slowed abruptly in July, in what is the key headline of the Institute For Supply Management report. New orders fell to 53.5, still above 50 to indicate month-to-month growth but down five points from June to indicate a significantly slower rate of growth. The 53.5 reading is the lowest since the manufacturing sector emerged from recession this time last year. Backlog orders also slowed, to 54.5 for a 2-1/2 point decline and its lowest reading since December.

That was the introductory paragraph from Econoday for the manufacturing sectors. It is one of the reasons for looking beyond just the headline numbers as this could signify even slower growth in the preceding quarters or possibly a double dip recession. But on the positive side the non-manufacturing increased by 2.3% to 56.7 and overall the non-manufacturing had a good report as Econoday stated:
This report is a big positive given the prospect from prior reports for gradual slowing. The double dip is still on hold.

One of the positive aspects of the report on non-manufacturing sectors was employment, as it edged above the 50 mark again, which was twice in 3 months. This signifying that there is no trend but at least treading water. For the 8th consecutive month the employment index for manufacturing was above 50% {positive job growth} at 58.6% which was a rise of 0.8%.

Can Exports dig Us out of this Recession?
Last month, the manufacturing import and export indexes were roughly the same levels with imports slightly higher. This has reversed this month as exports edged higher at 56.5% {+0.5} and imports dropping 4% points to 52.5%. While the non-manufacturing sectors {services} has less effect on balance of trade, the report still was positive as new export orders surged ahead of the break even of 50% with a 4 point gain to a total of 52%, and import index staying below 50 at the same rate as last month of 48%.

Those are certainly positive signs for the question posed above and it is certainly possible. It is a question that I have been asking on this blog for quite some time. Now, it looks like the Democrats and especially Obama also think this might be the answer, as this article from the Washington Post talks about at New Democratic strategy for creating jobs focuses on a boost in manufacturing. But the Democrats have the obstacle of their base not being so keen on "free trade" and more trade agreements. Luckily, I have not heard any more news on Obama's pledge to renegotiate the NAFTA treaty. The Wall Street Journal blog stated the union opposition in the following manner, "Even if the White House may see the benefit of more bilateral trade deals, the administration risks losing support from a core supporter–unions–if it presses forward on a raft of FTAs." at Trade Deals {are} Vital to Meet Obama’s Export Goal. The opening paragraphs also frame the issues in the following manner.
U.S. trade and business groups are skeptical the U.S. can double exports without the Obama administration signing a raft of new free trade agreements.

Although President Barack Obama’s administration is pushing ahead with a South Korean FTA, officials say their strategy focuses less on bilateral deals and more on boosting exports through promotion and more rigorous enforcement of trade rules.

While I fully support any endeavor at expanding trade, I seriously doubt and are skeptical about those two initiatives will do much good. First, all countries are "promoting" export trade and we are already in many ways. Demonizing businesses and claiming that we subsidize outsourcing of jobs is not likely to promote exports also. Secondly, not likely to win friends and influence people {countries} by taking them to the teacher and complaining about them. Trading partners are not likely to give us more without us also giving up something also. Talking is not likely to lead to spontaneous open markets for US manufacturing.

Adam Ozimek thinks it is more like trying to bring back
Glory days. It should be apparent that the US is a post industrial society and we are not going back but that does not mean that exports and thus manufacturing can not lead the way to economic recovery. Three international economists from the Centre for Economic Policy Research {VOX} ask the question Can the US raise employment with more exports?. Their paper is based on standard economic theories which even from the opening their statement provides the framework for their analysis.
Can increasing US exports create US jobs? Manufactures dominate US exports, but US manufacturing employment is declining. This column suggests that increased US exports are unlikely to lead to dramatic manufacturing employment gains, but employment in related services sectors may improve.

The US economy has shifted from production to services.

They do a good job providing some thoughts on the reasons service sectors may benefit more from increases in manufacturing output than actually the manufacturing employment. But let me expand their ideas and bring up 3 reasons that support their contentions.
1. Using simple Keynesian models, any autonomous spending will produce a rippling effect on the economy through the multiplier effect. Increased investment in manufacturing has the same initial effect than an exogenous spending increase by government, but can provide more long term growth potentials.
2. Spillover effects on different sectors of the economy can increase productivity in other sectors and expand their respective output levels. The economists discuss these issues within the framework of upstream and downstream sectors of the economy to manufacturing. While spillovers are a general phenomenon, the more exact economic concept occurring here is linkages. Overall manufacturing tends to have the most "linkages" to other sectors of the economy, and thus they are the easy and most likely candidate for development policies. The economists show how this effect is dramatic with their graph on employment in the three economic segments with manufacturing and its upstream and downstream linkages.

3. As productivity in the manufacturing {also farming and resource extraction} sectors increases, this raises the GDP and thus per capita GDP. There is a strong correlation between higher productivity in manufacturing and the average workers pay. The authors provide another important correlation in stating the following.
It is also worth noting that previous research has found that the share of services as an input to a country’s manufacturing exports is significantly correlated with the country’s per capita income (Francois and Woerz 2008).

That is basically self evident, that as more value is added to the end products then income increases. Either theory points out that instead of dreading the demise of the manufacturing job, we should praise the rise in productivity as ultimately we all benefit from this. Most praise the productivity of the American farmer and this same should go for the manufacturers of the US.

Talking to Mozart about how rapid economic growth is temporary

Why the Doomsayers Are Wrong - WSJ.com

AEI - The Rising Threat of Deflation

July ISM factory index slows to lowest 2010 level - MarketWatch

Misc. Links:
Econoday Report: Construction Spending August 2, 2010

Marginal Revolution: Negative Equity in Underwater Homes

EEF : Manufacturing performance exceeding expectations but road ahead to diverge– EEF/BDO report

We’re Still #1 (Unfortunately)-Compares this recession with others including "Great Depression".

Underneath the GDP report

Mish's Global Economic Trend Analysis: ADP vs. BLS Job Reports - Who to Believe?

Economics Bloggers Turn Sour - The Entrepreneurial Mind
Economist's View: "Make it in America"

“Make it in America” bills will advance U.S. manufacturing Robert E. Scott

German recovery: Betting on exports | The Economist

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