US Manufacturing Renaissance Proves Elusive Despite Cheap Gas

According to many commentators, cheap natural gas is producing a renaissance in U.S. manufacturing and putting European competitors at a disadvantage.

But empirical studies show the impact has been small and concentrated in a handful of energy-intensive industries that account for only a small share of manufacturing value-added.

Cheap gas has produced big benefits for most energy-intensive industries but for the rest of the U.S. manufacturing sector the impact has been modest.

Following a detailed study of industry-level data, economist William Melick concluded: "The roughly two-thirds decline in the price of natural gas in the United States relative to the price of natural gas in Europe (over the last nine years) has boosted activity in the manufacturing sector as a whole by perhaps two to three percent."

"For the handful of industries that are heavy users of natural gas, the estimated effects are much larger, on the order of a 30 percent or larger increase in activity," he explained in a working paper published by the Federal Reserve ("The Energy Boom and Manufacturing in the United States," June 2014).

Employing data for energy consumption and use of natural gas as a feedstock in 79 manufacturing sectors, Melick found the reduction in gas prices caused investment to increase by up to 10 percent while output and employment rose by two to three percent.

The gains are "not trivial but by no means overwhelming," Melick observed. Given that manufacturing accounts for only around 12.5 percent of U.S. gross domestic product, the impact has boosted GDP by 0.2 or 0.3 percentage points. It hardly qualifies as the manufacturing renaissance heralded by some commentators.

But for a small number of energy-intensive industries - including makers of fertilisers, alkalies, chlorine, carbon black and flat glass - the impact has been profound. The drop in relative prices "is associated with at least a tripling of capital expenditure, an almost 40 percent increase in production and a 30 percent increase in employment."


Renaissance Postponed
Melick's findings are consistent with similar studies performed by the International Monetary Fund and others which find the whole-economy impact of cheaper gas is "positive but modest".

In January 2013, the Industrial Energy Consumers of America, a trade association that lobbies on behalf of energy-intensive industries, published a list of 107 new capital projects worth an estimated $95 billion which had been recently announced.

"Experts believe that this is just the beginning of the manufacturing renaissance the country needs for job creation and exports," the lobbying group wrote in a letter to the U.S. Department of Energy.

But more than 70 of the projects on the list were in the fertiliser and petrochemicals sector, with another 18 in steel and aluminium, and just a handful elsewhere.

The list tends to confirm that gains from cheap natural gas have been concentrated in just a few industries and that the impact elsewhere has been far more modest.

The North American energy revolution has produced real benefits for the United States in terms of improved energy security, lower volatility in fuel prices, increases in employment and incomes, and foreign policy freedom.

Most of the benefits have been captured by upstream by oil and gas producing states and businesses. Big energy producing states like North Dakota, Wyoming, Oklahoma and Texas have seen large income gains over the last decade as a result of the shale boom ("Divided by shale, only some U.S. states win" Oct 27).

But there is not much evidence for a significant impact downstream among manufacturers which use gas and energy more generally as an input into their production processes. The gains which have occurred have been narrowly concentrated in industries like fertilisers, petrochemicals, iron and steel.

Gains in energy intensive industries are real and valuable but are not representative of the fortunes of the manufacturing sector as a whole. For that reason, talk about a widespread "manufacturing renaissance" and challenge to European manufacturers appears premature.

"It could be that the energy boom will only ever be noticeable for the most intensive users of natural gas in the manufacturing sector," Melick wondered.

"However, given that firms typically adjust their production processes only gradually, it may be that the full effect of the energy boom is still some years away."

In many ways, the current debate over energy and the manufacturing renaissance resembles the debate in the 1980s and 1990s about information technology and productivity trends in the broader economy.

Researchers found almost all the productivity gains were concentrated in the computer and technology sectors themselves, with little impact on productivity at firms which used rather than made computers.

"You can see the computer age everywhere but in the productivity statistics," wrote economist Robert Solow, the leading specialist on productivity trends and growth accounting, in 1987.

Something similar may now be occuring with the energy boom. If cheap energy is going to fuel a broad manufacturing renaissance in future, there is scant evidence for it so far.

(By John Kemp, Editing by William Hardy)