FRBSF Economic Letter
1998-36 | November 27, 1998
Over the past few years robust growth in manufacturing employment has helped California expand more rapidly than the nation. Recently, however, the financial crisis in East Asia and general imbalances in supply and demand in some high-tech sectors have combined to damp growth in the state’s manufacturing sector. As a result, total payroll employment growth in California is slowing, drawing closer to the national rate. Within California, the San Francisco Bay Area has experienced the largest deceleration, slowing by more than 60% over the pace a year earlier. In contrast, growth in Southern California has slowed by about 10%. The disproportionate slowing in the Bay Area is serving to equalize regional growth rates across California, albeit at a slower overall growth rate than last year. This Economic Letter reviews some of the reasons for the recent slowdown in California’s manufacturing sector and looks at its impact on California total employment growth.
After growing by 3.8% in 1997, payroll employment in California has expanded by 2.5% at an annual rate over the first eight months of this year, more than a percentage point below last year’s pace. Although a number of sectors in the state’s economy have decelerated, the bulk of the downturn is due to large and ongoing declines in manufacturing employment growth. Figure 1 shows 12-month growth rates for manufacturing employment and for total employment less manufacturing. Growth in manufacturing employment began to slow in the third quarter of 1997, a period when most other sectors of California’s economy were expanding. In September 1997, 12-month growth in manufacturing employment dipped below the average rate of employment growth for the state’s other sectors. Since that time, manufacturing employment growth in California has declined almost steadily, and as of August (on a 12-month basis) was well below the 3.5% rate of the remaining sectors of the state’s economy.
To estimate the direct effect of the slowdown in manufacturing on California payroll employment growth, it is useful to consider how rapidly the state would be growing if manufacturing had continued to expand at its earlier pace. Between August 1996 and August 1997 manufacturing growth in California averaged 3.6%. If manufacturing employment had continued to expand at this pace during the 12 months ending in August 1998, California’s total nonagricultural employment would be growing by 3.5% per year rather than the 3.0% actually realized. Thus, the slowdown in manufacturing has shaved nearly 0.5 percentage point off growth in the state.
East Asia. The slowdown in manufacturing, in part, reflects California’s exposure to developments in East Asia. California merchandise exports represent about 11% of gross state product (GSP) and nearly 50% of those exports are shipped to countries in East Asia (Western Economic Developments, August 1998). Merchandise exports from California to East Asia have fallen rapidly in 1998. During the first half of 1998, California’s exports to East Asia fell 17.5% compared to the first half of 1997. The largest contractions were to the ASEAN(4) and South Korea, but exports to the other NIEs and Japan also declined significantly (Valletta 1998).
Exacerbating California’s vulnerability to East Asia is the fact that state exports are dominated by three industry categories: industrial machinery and equipment (SIC 35), electronic and electrical equipment (SIC 36), and instruments and related products (SIC 38), which contain most of the state’s high-tech manufacturers. Collectively, these three industry categories account for more than 60% of California’s total exports to East Asia.
In 1995 and 1996, while Asia was investing heavily in high-tech capital equipment, computers, and telecommunications products, exports from these three manufacturing categories grew rapidly. However, ongoing weakness in many Asian nations has significantly damped demand for these exports. Compared to last year, 1998 numbers reveal a 2.1% decline in total exports of industrial machinery, a 2.3% decline in exports of electrical machinery, and a substantial slowing in total export growth of instruments and related products. (California’s exports of these products began to weaken in 1997.) State exports of these products to East Asia declined by much more, 17.0, 18.4, and 5.3%, respectively.
Slowing in the high-tech sector. Weakening East Asian demand for high-tech products has aggravated a more general imbalance in supply and demand growth in the industry. By most measures the high-tech manufacturing industry never fully recovered from an earlier product-cycle downturn in 1996. This left the industry particularly vulnerable to market disruptions brought on by East Asia. Recently, these circumstances have combined to produce an industry-wide slump at least as severe as the decline experienced in 1996.
Indicators of industry-wide trends show ongoing weakness in both the semiconductor and equipment manufacturing sectors. As of August, worldwide semiconductor sales (three-month rolling average) were about $9.8 billion, down roughly 16% (nearly $2 billion) from year-ago levels. Although sales in all regions declined, the Asian market experienced the greatest weakness. August 1998 sales to Asia were 22% lower than August 1997 sales. In the Americas, sales fell by 14%, while in Europe, sales dropped by 2%. Declining sales figures have resulted in manufacturing overcapacity problems.
Declining sales and worsening overcapacity problems have significantly affected the industry’s investment in new plant and equipment. Indicative of the decline in purchases of new equipment is the monthly North American Semiconductor Equipment Industry’s “book-to-bill” ratio. The semiconductor equipment “book-to-bill” is the ratio of semiconductor equipment orders to shipments, from U.S.-based semiconductor equipment manufacturers. After making a partial recovery from the 1996 industry downturn, the equipment “book-to-bill” began to decline steadily in July of last year. In January 1998 it fell below 1 and as of August was just 0.60, representing $60 of new orders for every $100 of shipments.
As East Asian developments and the high-tech slowdown have softened demand for manufactured products, California’s employment growth in this sector has decelerated. While the deceleration has been broad-based, producers of high-tech products have been particularly hard hit. Figure 2 illustrates the disproportionate decline in high-tech manufacturing growth (defined as SIC categories 35, 36, and 38) relative to other manufacturing sectors. Figure 2 compares 12- month growth rates for three categories: high-tech, transportation, and all other, which includes a variety of non-high-tech durable manufacturing sectors, such as primary and fabricated metals and furniture and fixtures. (Specifically, the “other” category includes the 2-digit SIC groups: Furniture and Fixtures; Stone, Clay, and Glass products; Primary Metal Industries; Fabricated Metal Industries; and Miscellaneous Manufacturing Industries.) Figure 2 shows that all manufacturing sectors slowed in recent quarters, but the deceleration in high-tech was particularly large. Twelve-month employment growth in high-tech fell from an average of about 5% in 1997 to just 0.1% as of August 1998. In contrast, the slowdown in most other areas of manufacturing, the exceptions being transportation and lumber and wood products (not shown), was more modest, falling only about 1 percentage point, from 3.5% on average in 1997 to 2.8% in August.
As noted earlier, California’s slowing manufacturing sector shaved approximately 0.5 percentage point off state payroll employment growth over the past 12 months ending in August. To understand which sectors contributed to this slowing, Figure 3 compares the employment shares of various manufacturing sectors with their percentage contributions to the 0.5 percentage point reduction attributable to manufacturing. Calculation of these contributions accounts for changes in the growth rates of various sectors and differences in their share of total employment.
Within manufacturing, both the non-durable and durable sectors slowed. Non-durable manufacturing, which constitutes about 40% of total manufacturing employment, accounted for about 25% of the total decline in employment growth, or about 0.13 percentage point. Durable manufacturing accounted for the remaining 0.37 percentage point, or about 75% of the total decline. Thus, durable manufacturing accounts for a larger share of the total slowing than its employment share would predict.
Looking within durable manufacturing reveals that the vast majority of the durable manufacturing decline is attributable to industries containing high-tech manufacturers, namely, industrial machinery and equipment, electronic and electrical components, and instruments and related products. Taken together, these sectors account for nearly 80% of the slowdown in durable manufacturing and 56% of the deceleration in total manufacturing (Figure 3). In contrast, these high-tech sectors make up only 35% of manufacturing employment. The remaining sectors of durable manufacturing account for a much smaller share of the total decline and account for less of the slowdown than their employment shares would suggest.
The disproportionate slowdown in high-tech is changing the regional pattern of growth in the state. Employment growth in the San Francisco Bay Area fell from 4.4% between August 1996 and August 1997 to 2.4% over the 12 subsequent months. Both San Jose and San Francisco experienced the sharpest slowing. San Jose’s job growth fell from 5.8% on a year-over-year basis during the 12 months ending in August 1997 to 2.2% on the same basis during the 12 months ending in August 1998. In San Francisco, growth dropped from 3.8% in August 1997 to 1.7% in August 1998. This slackening in the Bay Area reflects its high-tech specialization and strong ties to East Asia. In contrast, growth in Southern California has accelerated. Growth in Southern California increased from 3.1% to 3.4% on a year-ago basis. In the Los Angeles-Long Beach area the increase was larger: growth climbed from 2.2% over the 12 months ending in August 1997 to 2.7% over the 12 months ending in August 1998.
After being a leading contributor to California’s rapid payroll employment growth, the state’s manufacturing sector has weakened. Manufacturing employment growth has declined, and many of the state’s manufacturers are shedding jobs. Although manufacturing declines have been broad-based, producers of high-tech products have been particularly hard hit. Regionally, the Bay Area has felt a larger share of the impact than other parts of the state. This is equalizing growth across California, although overall growth is slower than last year.
Valletta, Robert. 1998. “East Asia’s Impact on Twelfth District Exports.” FRBSF Economic Letter 98-35 (November 20).
Western Economic Developments. 1998. Federal Reserve Bank of San Francisco (August).
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