China's manufacturing sector has been growing so quickly in recent years that the size of its output is set to exceed output in the U.S. manufacturing sector in the foreseeable future. Nevertheless, the exact time frame for this change in ranking depends on how we measure the size of output.

Indeed, when sales revenues (gross output) that are earned by the manufacturing sector are used to measure the size of output, China will grow to outrank the United States as early as 2008. If, however, the value added of the manufacturing sector is used to measure relative size, China will not outrank the United States until 2013. Furthermore, when output is measured using real (inflation-adjusted) "1997 U.S. dollars," then the manufacturing value added in China will not exceed that of the United States until after 2020.

An obvious follow-up question is whether the prospect of China’s ascension in manufacturing is a cause for concern. Will the rapid rise in China’s manufacturing sector stifle the U.S. economy? A closer analysis suggests that such anxiety is probably unfounded.

The expanding market in China is more likely to open up greater opportunities for the United States as well as other producers. Several important areas of economic growth are all expected to remain larger in the United States than in China, including finance, information technology, and business services, as well as manufacturing subindustries such as aircraft, pharmaceuticals, heavy capital equipment, and precision equipment for scientific and medical purposes.

The sectors where the United States is forecasted to lose the most ground in terms of share of world output are textiles, basic metals, computers, electrical equipment, and household appliances.

Choosing the Right Measure to Compare Manufacturing-Sector Output

One easily understood measure of manufacturing output is gross output (GO), defined as the sum of all sales revenue across all production units within the manufacturing sector. Such summing up of sales revenue, however, results in substantial double counting in terms of output.

To illustrate, note that the purchase price of a car includes the cost of the parts the auto manufacturer buys from the parts manufacturer. The price of parts, in turn, includes the cost of iron and steel, and other inputs purchased by the parts manufacturer. Consequently, adding up the sales revenue of the car manufacturers with the sales revenue of parts manufacturers, plus the sales revenue of iron and steel manufacturers to make up manufacturing GO, results in obvious double counting of output, potentially multiple times.

Such business-to-business (B2B) interindustry transactions are taken out of the GDP calculation to avoid double counting of the true size of output. In addition, gross output includes the value of imported inputs, which is not a legitimate component of sector production. Therefore, total gross output (sales) is a flawed measure of the true size of sector output.

A better measure is industry value added(VA), defined as sales revenue less the cost of all purchased inputs, thereby eliminating any such double counting of B2B transfers as well as the value of imported inputs. Consequently, the sum of VA across all sectors represents GDP.

The distinction is important because the U.S. manufacturing sector has a higher share of VA in total revenues (GO) than does China's manufacturing sector. The U.S. share of VA in GO is 36%, whereas in China, it is much lower at 25%. The lower share of VA in China partly reflects the large import components in its manufacturing industries. (Importing parts for assembling and re-exporting is a significant share of China’s manufacturing sectors.) Furthermore, the smaller share of VA in GO in China also results from the lower levels of labor productivity in Chinese manufacturing, lower wage rates and management costs, narrower profit margins, and more modest fixed cost components.

Global Insight forecasts inflation in China to be relatively more aggressive than in the United States. Further, the robust economic growth is also expected to support an appreciation of yuan relative to U.S. dollars in the coming years. Hence, manufacturing VA in China measured in nominal U.S. dollars shows a faster rate of growth than when measured in “real” U.S. dollars.

Implications of China’s Manufacturing Growth for the U.S.Economy

The anxiety that the rapid growth of China’s manufacturing sector will be at the expense of the manufacturing sectors of other countries, particularly the United States, should be mitigated for several reasons.

The fall in the world share of U.S. manufacturing is not a sign of weakening U.S. performance, but rather, a result of the rapid growth in China itself. Global manufacturing VA estimated at US$8.4 trillion in 2006 is forecasted to grow another US$7.1 by 2015, with China accounting for US$2.4 trillion of that growth.

In the past, while China saw manufacturing growth surging to a 10–15% compound annual growth rate (CAGR, which is based on VA in “real” terms) in its post-liberalization period, the growth in the United States remained resilient at above 3%, with no evidence of choking by the rapid expansion in China. In the future, our forecast shows China's CAGR being trimmed from the current 15% to 8% by 2015, and the United States' long-term manufacturing growth will remain mostly stable at around 2.8%.

Furthermore, manufacturing means more to the Chinese economy than it does to the U.S. economy. China’s manufacturing sector accounts for 34% of its GDP, whereas in the United States, the share is 14% of GDP, with much greater reliance on services sectors, including the financial, wholesale, and retail sectors, and other business services.

Also note that globally, manufacturing accounts for only 18% of GDP (in nominal terms), while the service sector is by far the dominant one at 67%. The U.S. share in global service sector output (currently at 33%) will remain far larger than China's share, which is currently at 3.4% and is expected to grow to only 6.5% of the world total by 2015.

While foreign demand has supported China’s manufacturing growth in the recent past, future growth in manufacturing will be increasingly diverted to meet the growing domestic demand instead. Income growth and the consequent demand growth in this giant nation can be expected to enhance rather than hinder opportunities for external (U.S.) producers.

Within manufacturing, there are specific subsectors where the United States will maintain its superiority in the size of output, even beyond 2020. Aircraft manufacturing, heavy capital equipment, and precision equipment to be used for scientific, medical, and related purposes are all expected to remain larger in the United States than in China.

The United States is forecasted to lose the most ground in terms of output in such sectors as textiles and apparel, processed food and tobacco, basic metals manufacturing, computers, electrical equipment, and household appliances.

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