The Supply Chain Economy – A New Categorization of the US Economy

A few weeks ago I attended The Supply Chain Economy: Understanding Innovation in Services, a virtual seminar sponsored by the Council on Foreign Relations with economists Mercedes Delgado and Karen Mills discussing their recent paper A New Categorization of the U.S. Economy.

The debate about the drivers of innovation and job creation has long been centered on manufacturing versus services. The predominant view has been that manufacturing drives good wages, economic growth, and innovation as measured by its large share of patents, while services provide lower-wage jobs, less innovation and significantly fewer patents.

But Delgado and Mills argue that categorizing the economy in terms of manufacturing versus services is no longer meaningful. Instead, they’ve proposed an alternative framework for understanding the drivers of innovation and economic performance that’s focused on the suppliers of both goods and services: the supply chain economy.

“A long academic and policy debate has focused on the role of the manufacturing capacity of a country in its economic and innovative performance,” wrote the authors. “This question has become even more relevant as the U.S. economy has shown a large decline in manufacturing employment in recent decades, in part due to increased import competition. In this debate, the predominant view is that a country's manufacturing capacity drives innovation because of externalities associated with the production of intermediate goods (e.g., machine tools, automation equipment, and semiconductors) that improve the efficiency of the innovation process. Most prior work on innovation focused on a narrow view of suppliers as producers of intermediate goods. However, in today's economy suppliers increasingly produce services (e.g., enterprise software).”

To illustrate the evolution of the US economy over the past few decades, the seminar opened with a slide that showed that between 1998 and 2015, US manufacturing declined by 32% while services grew 25%. Average 2015 wages were $56,600 in manufacturing and $49,800 in services. Given the predominant view that manufacturing is the key driver of  innovation and growth, one may conclude that this slide represents a pessimistic view of the US economy.

But, such a view is no longer meaningful because, according to the Bureau of Labor Statistics, the manufacturing labor force was only around 12 million in 2015, while the services workforce was more than 120 million, – over 10X bigger. Furthermore, the BLS estimates that by 2030 manufacturing employment will show little growth while the services workforce is expected to surpass 230 million.

In addition, services employment spans a broad range of occupations, from relatively low paid retail and restaurant jobs to highly paid, high skilled ones in business and technology. While the average 2015 wages in the services industry was indeed $49,800, their second slide showed that the average 2015 wages of supply chain traded services was $83,500, and those well paid services jobs grew 39% between 1998 and 2015.

In A New Categorization of the U.S. Economy, Delgado and Mills systematically explained their novel supply chain framework and what they mean by those highly paid supply chain traded services jobs. First, they classified the private-sector non-agricultural workforce into two categories:

  • business-to-consumer (B2C) – the 57% of the workforce employed in industries that sell primarily to consumers; and 
  • supply chain (SC) – the 43% of the workforce employed in industries that sell primarily to other businesses and government.

Next, they classified each industry into tradable, – those whose goods and services can be traded internationally;  and local, – those whose output isn’t tradable. In 2015, B2C employment was mostly local, – 83% versus 17% in tradable industries. In SC industries, the majority of employment was in tradable industries, 60% versus 40% in local ones. And, a large majority of SC tradable jobs, 75% were in services while 25% were in manufacturing industries.

“A key finding of this paper is the size and economic importance of the suppliers of traded services – a result that challenges most prior work that focuses on a narrower view of suppliers as manufacturers. Suppliers of traded services accounted for three times as many jobs than the suppliers of traded manufactured goods (20% versus 7% of U.S. employment).”

Their paper took a close look at the changes in the employment composition of the US economy in the 18 years between 1998 and 2015 that gave rise to what Delgado and Mills call the supply chain (SC) economy:

  • SC employment – grew 11%, added 5.1 million jobs, and its wages grew 18% to $65,800;
  • SC local employment grew – 14%, added 2.5 million jobs, and its wages grew 12% to $$47,200;
  • SC traded employment – grew 9%, added 2.6 jobs, and its wages grew 22% to $77,600;
  • SC traded manufacturing employment – declined 34%, lost 4.3 million jobs, and its wages grew 9% to $59,800; and
  • SC traded services employments – grew 39%, added 6.9 million jobs, and its wages grew 20% to $83,500, the largest increase in employment and wages of all the subcategories;

Patents are the traditional measure of innovation. As expected, 86% of all patents are in manufacturing and 14% in services. 87% of all patents are in supply chain occupations, with the vast majority, 85% of patents in SC traded occupations.

In addition to patents, the paper explored another measure of innovation: STEM intensity, defined as the percentage of employment in STEM occupations for each subcategory. Supply chain occupations had a STEM intensity of 10.7% compared to 1.9% for B2C occupations, and manufacturing occupations had a STEM intensity of 9.3% compared to 5.3% for services. At 17%, STEM intensity was highest in SC traded services, even higher than for SC traded manufacturing at 11.4%.

“Besides having the greatest STEM intensity, suppliers of traded services account for more than 59% of all the STEM jobs. Hence, they have high technology intensity and can play an important role in the innovation and growth of a country by producing specialized inputs for multiple industries.”

The paper identified three key attributes of supply chain industries that make them particularly important for innovation and growth:

  • Specialization and constant learning. SC industries tend to be highly focused, and their specialized inputs are integrated into the value chain of firms, thus improving the speed, cost, and overall efficiency of the innovation process; 
  • Downstream linkages with other industries. The innovations of SC industries can thus cascade and diffuse more broadly to other industries, e.g., semiconductors, cloud computing, robots, AI; and
  • Geographical concentration. SC industries particularly benefit from co-location with their customers in industry clusters that contribute to innovation and growth.

“The new categorization of the U.S. economy described in this paper has implications for policy,” wrote Delgado and Mills in conclusion. “The ability to define and measure the total category of suppliers in the economy and its sub-categories – in particular the suppliers of traded services – can improve the ability of policymakers to create and assess new programs that target the unique challenges that suppliers may face, particularly with regard to accessing three critical resources: skilled labor, buyers, and capital.”

“Access to skilled labor is relevant because supply chain industries rely on STEM workers. Service suppliers may be especially at risk since their innovations are highly dependent on access to and retention of skilled workers. The growth of supply chain traded services suggests that policy emphasis on STEM training is warranted. With regards to access to buyers, suppliers can particularly benefit from policies that facilitate collaboration with buyers in industry clusters. Finally, access to capital can be difficult for service suppliers because they produce innovations that often cannot be patented. Policy solutions could include loan guarantees, credit support, or research funding that facilitate capital for these suppliers to start and grow.”