Recession Influenza

Another Manufacturing Slowdown?

We’ve all heard the catchphrase: “When the US sneezes, the world catches a cold”[1], which kind of culminated in a double pneumonia of the global financial crisis (GFC) in 2007/08. As plenty of research has shown, balance sheet recessions (like the GFC) are a particularly difficult breed of recessions for monetary policy to handle. However, and thankfully, they are also less common than many other economic viruses that can spread throughout economies.

Traditionally, the main culprit to recessions are negative shocks to spending – aggregate demand – often in the form of more dramatic changes to the investment outlook (for a plethora of reasons, such as interest rates, confidence, trade regimes etc.), as consumption of both households and governments tend to demonstrate quite stable developments (even contracyclical in the latter case).

This means that, historically, the instigation of recessions has often been decided by the manufacturing industry, where the lion’s share of investments (in non-residential equipment) have been taking place.

[1] In turn (and probably) a paraphrase of the Prince of Metternich-Winneburg zu Beilstein quote: “When France sneezes, Europe catches a cold.”

Macrobond moment: I have always thought that the histogram analysis is underrated and under-used, it is one of the best ways to really understand the data you’re using in – and how it affects – your analysis!

This is, admittedly, a very simple illustration of the connections between behavior in different sectors and recessions, so I am always open for suggestions on how to improve the analysis! (Had the data existed, i.e. longer and with higher frequency, contributions to value added from manufacturing and retail trade industries could have been an alternative). 

Sure enough, when looking at a histogram-analysis of GDP-contributions from consumption (PCE) and investments in non-residential equipment (GFCF), it is obvious that the lower outcomes are much more common for GFCF than for PCE. This holds true whether you look at the percentiles or the tail values for GFCF and PCE (or, put another way, the distribution is fat-tailed with a negative skew). Admittedly, and importantly, this merely shows that GFCF is more prone to large, negative contributions to GDP (than PCE, for example). But as a common definition of recession is two consecutive quarters with negative q/q GDP-growth, we can at least assume it to be an event that relatively often coincides with recessions.

And now, with the US manufacturing sector ripe with recession warnings again, maybe it’s not strange that many analysts believe that we are in for another one.

Macrobond moment: Continuing on the “know your data” theme, in the next two graphs, I’ve used two simple transformations in the formula analysis that I think we should “apply (more) liberally” – standardization and natural logs. This makes data both more comparable (standardization) and easier to interpret (natural logs).

But is “this an imminent recession“ true by default? – No, of course not. The important distinction, I think, is not whether manufacturing or industrial sectors in general are through a soft spot, but rather how severe the slowdown is and how big an impact manufacturing has on the overall US economy. In the chart below I have plotted the log of Industrial Production (NB., Industrial production also includes mining, etc.) against the ISM. An obvious pattern is that every time industrial production decline the US is either in, or on its way into, a recession. However, there is one notable exception; the “shale recession” of 2015/16.


While interesting in itself, I will not cover the specifics of that period here[1]. Instead, I would like to turn the focus to the possibility that the industrial composition of the US economy might have shifted so much over the past few years and decades that even a pronounced industrial/manufacturing downturn, such as the “shale recession”, is insufficient to provoke an economy-wide recession.

[1] Suffice to say that the oil price collapse between 2014 and 2016 wreaked havoc in a (until then) booming US oil/shale industry.


For a long time, manufacturing has seen its importance shrink, and it was only around the “great recession” that manufacturing seemingly stabilized as share of both output and employment. These developments also seem to have been nicely balanced by the rising importance of the services industry (at least for the period where we have comparable data). That said, and what we must not fail to recognize, is that while manufacturing’s share of output has been diminishing, its level of output has been steadily rising, not least in the wake of the GFC (visible in the stabilization of share of output and employment over the past few years).

Now, the importance of manufacturing has obviously decreased over the past decades, possibly explaining why a manufacturing slowdown need to be quite dramatic before having an effect on the overall economy. In contrast, the services industry has increased its share of total output and, in particular, the advent of computer and internet related activities have risen in prominence over recent decades.

To illustrate, when we exchange non-residential equipment (where computers are included) for intellectual property products (IPP) in our histogram above, we can see that investment in IPP has increased its average contribution over time, that its rarely negative (and, thus, not in itself a cause of recessions), but that it actually seems to lead the contribution from PCE, which can be seen when downloading the MB-document. Although far from a perfect indicator or instigator of recessions, the chart below nicely captures the dramatic changes, and some consequences, of a changing US economic structure towards high value-added services (on a related note, I can’t wait for this to be published!)


The above analysis suggests that US manufacturing no longer leads (if it ever did) nor is it any longer sizable enough to by itself decide the fate of the US economy. But what about the world economy, surely the US still has an outsized share of global manufacturing?


As can be seen, while a large share of manufacturing output emanates from the US, China has decisively taken over the dominant role in global manufacturing. However, and more importantly, manufacturing is in turn a sizable share of the Chinese economy, indicating a much stronger relationship between manufacturing and the overall Chinese economy. This situation is not unique to China, but also holds for many developed, industrial, juggernauts in the rest of the world, e.g., Germany.


In a previous blog, we made the simple observation that while economic developments in the US and China tend to lead those in their export markets, that is not the case in the Euro Area, which rather seems to lag its export markets. Admittedly, the above is not irrefutable evidence of a new world order. US monetary policy and FX, have a very strongstrengthening (sic!) – influence on the world economy. But the analysis at least provides a plausible narrative for the world economy:

  • Manufacturing has lost its sway over the US economy as it is becoming more and more dependent on, and driven by, new technology behemoths like Facebook, Apple, Amazon, Google, etc.
  • China is the new manufacturing leader and is as such becoming the new locomotive of the global economy. Its stabilisation policies are, nonetheless, a derivative of US economic policies.
  • As manufacturing is still a large part of most other economies – developing as well as developed, small as well as large – this suggests that developments in China are now, for all intents and purposes, probably a better gauge of where the global economy is heading than those of the US economy.

And only last week, we posted a new analysis of Chinese economic developments, indicating that the country is still in a slowdown.


In other words, don’t take too much comfort in signs of US stabilisation just yet – it’s “when China sneezes the rest of us catch a cold” – we can only hope that the FED:s recent flu shots will make it bearable.

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