Will Manufacturing Save the Midwest?

Rarely a week passes in which I hear someone suggest that a manufacturing renaissance is underway, and that the return of factories are poised to revive Midwest communities. That belief is not confined to a few oldsters affected by nostalgia, but by elected officials from Midwestern governor down to city or county council members.

In this post, I wish to expose the future of manufacturing to data, and extrapolate recent developments into a short narrative about its future. I begin with China.

Much of the belief in U.S. manufacturing renaissance comes from the belief that a strategic decoupling of trade with China will return production to the U.S. For some sectors that is possible, but for most manufactured goods, we should expect merely a geographic adjustment to other trading partners. After all, the U.S. government doesn’t trade, people and businesses do, and economics, not geopolitics continue to drive their firm location decisions.

However, even if there is supply chain adjustments, China faces the same issue U.S. factories do — productivity growth. China manufacturing has grown substantially over the past few decades, but like the rest of the world, the share of manufacturing employment has stalled, and is now in decline. These data are from the International Labor Organization.

The stark factory job losses of the first decade of this century deeply affected the Midwest. But, most of the losses were due to productivity growth (automation, digitization, etc.) not trade. My colleague Srikant Devaraj and I published a pretty well reported study on the matter here. But, you don’t have to rely just upon our work, there is a growing body of research that suggests job losses in factories are being driven mostly by productivity, not trade.

This graphic reports the findings from all the studies of the issue we could find. These studies report different time periods from 1990-2015, and use different methods and assumptions. However, the median finding was about 25% of jobs lost to trade, the remainder due to productivity growth.

Share of Manufacturing Jobs Lost to Trade, various studies (1990-2015 data)

The point of this is that manufacturing job losses are really being caused by the productivity of manufacturing growing faster than demand for manufactured goods. But, the story is a bit more complex than just that.

The jobs that are being replaced in manufacturing aren’t the high productivity positions, but the low productivity positions. The reason for this is that employment, particularly in the developed world has high fixed costs. Health care costs, payroll taxes and benefits all add up to perhaps $12-$14 an hour to start. So, a highly productive worker will likely have lower unit labor costs than a low productivity worker. The result of this is that the jobs that are destroyed by productivity growth are the low productivity jobs.

This is not only not a new phenomenon, it is the oldest of phenomena. To illustrate this, here’s the manufacturing share of employment in the USA since 1939. Note that during the longest economic expansion in U.S. history, when the U.S. saw its longest uninterrupted factory employment growth alongside an anti-China trade war, the factory share of jobs dropped from 8.9% to 8.4%. Since World War Two, the period from July 2009 to January 2020 was the single best stretch, and we still saw a 1/2 a percent decline.

The Midwest experienced much the same challenge, with long term manufacturing employment share declines. Perhaps the only difference is that the share increased slightly from 2009 to 2019 (annual data). That growth is now over.

Over a shorter period (I’m just using the easiest data series to access), incomes also shrank. These data on employment and personal income are from the Bureau of Economic Analysis.

So, the key question for Midwestern policymakers to ask is whether or not their manufacturing industries employ relatively high or low skilled workers. Again, it is high productivity workers who are more likely to maintain employment, and low skilled workers who’ll lose jobs. To summarize this, I can present a couple of data points.

Both of these come from Devaraj, Wornell, Hicks and Faulk (2017) assessment of vulnerable communities in the nation. The fist graphic connects educational attainment at the county level to an occupational assessment of county automation risk.

The second figure connects wages by occupation to offshoring risk. While neither of these are exclusively manufacturing, it is factory jobs that are at most risk of automation.

Our bottom line is that the worse an individual’s education or the worse educational attainment is in a region, the higher their risk of losing a job to automation. This carries into manufacturing as well.

I think one big take away from the Brookings Institution study on Indiana’s economy pointed out the need to improve worker productivity. Explicitly this was through increased investment, and implicitly through better educated workers. Their national study said much the same.

So, this begs the question for Midwestern states? Just how is the manufacturing workforce doing? To answer that we can simply assess the education level of manufacturing employment along with the wage premium of college workers in manufacturing.

Increases in the share of better educated factory workers is one data series that points towards higher productivity. Here we present two series, the first is the college to non-college ration of adult factory workers. This series is useful in comparing the share of workers who have been to college (graduate or not) against those who have not been to college. The second series are the ratio of Bachelors degree holders to those without a high school degree.

Both of these data series tell much the same story. The education mix in Midwestern factories peaked during the Great Recession, and has fallen since. The declines in educational (skill) mix has been most acute for Michigan, particularly since the start of the Great Recession, but no Midwestern state is doing well.

The final series are the college wage premium. This is the additional salary received by college graduates relative to high school graduates.

Again, this is a similar story, of a declining premium for skill or education. This bodes poorly for the upskilling of factory work across the Midwest. Just to isolate one state (Indiana) with a comparison of median wages tells the story.

The typical new hire in Indiana earns less today than they did in a factory at the end of the Clinton Administration, and an existing hire has higher volatility of wages, and identical salary (adjusting for inflation).

From the standpoint of employment and earnings, not only has manufacturing failed to better economic conditions in the Midwest the weight of evidence suggests that it will worsen in the future. In the matter of jobs and wages, manufacturing won’t save the Midwest.

Of course, employment and income isn’t the only thing that matters. Gross Domestic Product is also important, and there the story is better, but not good. Manufacturing GDP as a share of Midwestern GDP dropped from 19.4% to 17.1% from 2005:Q1 through 2021:Q3. These data are from the Nat’l Income Accounts at BEA.

And, we tax manufacturing as well, so it is useful to see what that looks like. These data re also from the BEA, and show the tax on manufacturing production.

Across the Midwest, we tax manufacturing far less than the typical household or business, and with the exception of Illinois, at a lower rate than we do other businesses.

So, will manufacturing save the Midwest? No. In terms of share of GDP, employment and incomes, and in tax revenues, manufacturing is of diminishing importance across the Midwest. The decline that really began in the decade after World War Two will continue, and even if there is a good year or two, it is nearly an arithmetic inevitability that the manufacturing industry will be smaller, less important, employ fewer Midwesterners, pay fewer tax dollars in the future than they do today.

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