What drives this, generally speaking, high correlation? One factor is the cause of the slowdown. If the shock is global, like in 2008-2009, or economy-wide, like the eurozone sovereign debt crisis in 2011-2012, one would expect that manufacturing and services suffer simultaneously from a drop in confidence, income, access to financing, etc. If the shock is sector specific, which to a large degree has been the case since early 2018, the extent of the spillover effect from manufacturing to services will depend on the degree in which both sectors are intertwined. In a study in 2014, the ECSIP Consortium[ii] noted that “as services are used in the production processes of a manufactured product, the value of a final manufacturing product embodies directly and indirectly value added created in services to a large extent.” Based on data for 2011, in the EU-27, “services account for slightly less than 40% in the value of a final manufacturing product”.[iii] This implies that a drop in the demand for manufactured goods has a considerable impact throughout the value chain and hence on services.[iv] Confidence effects may also play a role: companies in the services sector may end up becoming concerned about their business prospects when they observe that the manufacturing sector is in a dire situation with no end in sight. This may weigh on their recruitment and investment plans.
To explore these relationships, the charts below show, on the horizontal axis, the 12-month change in the manufacturing PMI and on the vertical axis, the equivalent for services. In France, Italy and Spain, the correlations are very high but this is less the case in Germany.In that country, the slope of the regression line is also less steep, which suggests that services are more insulated from what’s happening in manufacturing or depend on other factors. What is striking however is the degree in which the latest observation of the 12-month change of the German services PMI diverges from the expectation based on the historical relationship between the two sectors and given the huge drop in the manufacturing PMI. One would expect that, eventually, this outlier would correct itself, either because manufacturing rebounds, or because services weaken significantly or a mixture of these two. Considering that for the other countries both indices are well in line, when gauging the resilience of services in the eurozone to the worsening international business climate hitting manufacturing, the analysis has to focus on Germany. Clearly, absence of a pick-up in manufacturing sentiment would end up weighing on confidence, not only in Germany, but, given its weight, also in the rest of the eurozone.
[i] ECB, Introductory statement to the press conference of Mario Draghi, President of the ECB and Luis de Guindos, Vice-President of the ECB, Vilnius, 6 June 2019
[ii] Study on the relation between industry and services in terms of productivity and value creation, 2014. The report was written for the DG Enterprise and Industry of the European Commission by the partners of the ECSIP Consortium: WIIW (The Vienna Institute for International Economic Studies), Ifo and Ecorys
[iii] In France this percentage was even higher (48.5%) and the opposite holds for Germany (35.9%). Italy (40%) and Spain (39.4%) are in line with the EU average.
[iv] The authors make a distinction between upstream (development) services (R&D, design), core (production) services (supply management, production and process engineering, other technical services) and downstream (market) services.
