Despite the high price of energy, the U.S. economy is growing at a healthy pace this year. Led by a stable rise in consumer spending and solid increases in investment, especially in machinery and equipment, real GDP is on track to expand by 3.4% this year; in 2004 and 2005, it grew 4.2% and 3.5%, respectively. The industries that typically grab most of the attention as "the ones to be in" are high-tech oriented. However, the traditional manufacturing sector, which has helped support strong GDP growth over the last couple of years, has generally been overlooked.

In 2004 and 2005, output by U.S. plants and factories grew 5.0% and 3.9%, respectively. This year, manufacturing output is on target to expand by 5.0%. If this forecast is realized, it will be the third consecutive year in which the growth of manufacturing output has outpaced that of the overall economy (GDP). Leading this increase is an eclectic mix of investment-related high-tech industries such as computers, communications equipment, and semiconductors, although traditional equipment has also played a substantial role.

In an effort to maintain their competitive edge, internationally, U.S. businesses have had to retool, increase efficiencies, and improve productivity. As a result, equipment manufacturers of agricultural machinery, construction machinery, metalworking machinery, general industrial machinery, engine, turbine and power transmission equipment, and electrical equipment have all seen sharp increases in orders over the past three years. U.S. production of this equipment has also risen sharply to meet these orders. The transportation equipment industry has also seen booming orders for medium and heavy trucks, railroad equipment, and even ships and boats. The U.S. aircraft and parts industry, which was on the skids from 1999 through 2003, has seen a remarkable turnaround since 2004. Boeing's initial success was due to an increase in military orders, but this year commercial aircraft orders and production are up sharply. Furthermore, the aircraft pipeline should remain long because deliveries of Boeing's new Dreamliner are not expected to occur until 2008.

But how much longer can manufacturing lead the general economy? This depends on how long the investment and the equipment markets continue to humm. While year-to-date durable goods orders through May 2006 were close to10% higher than in the first five months of 2005, look for the rate of new orders arriving during second-half 2006 and into 2007 to slow considerably. The three-year expansion in investment is starting to show some signs of being a little "long in the tooth." This is especially noticeable because many corporations have announced a significant slowdown or decline in capital spending for next year.

The combined impact of the investment cycle winding down and the reaction to high energy and other material prices should result in a new mix of leading industrial sectors next year. Manufacturing, which has been growing faster than the general economy, is now expected to increase at the same rate as GDP in 2007, namely 2.6%. At that time, the service sector is expected to dominate. As a result, a new crop of industry-growth leaders is likely to surface, including: architectural, engineering, and special design services; computer systems and design services; and professional and technical services. Also included are social assistance, scientific research and development services, and various healthcare-related services such as the offices of physicians and dentists and other health practitioners.

This year, 6 of the top-12 fastest-growing revenue sectors are expected to be manufacturing based. In 2007, only 2 of the top dozen will be in manufacturing; and only 2 in 2008, as well. The United States has been undergoing a long-term economic transition from manufacturing to services. Between 2004 and 2006, however, that transition was put on hold. Next year, the service sector will once again dominate.

Raul Dary

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raul.dary@globalinsight.com

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