Say No To Drugs

I often write about the economics of the chemical industry, so I use a lot of U.S. government data relating to chemical production, pricing, foreign trade, employment, and the like. And, in the couple of decades that I've been doing this, I've come to the futile conclusion that pharmaceuticals should not be included in the data about the chemical industry that comes from the government.

I say it's futile because the government has been using the same sector format for years, separating the industry into basic chemicals; plastics, rubber, and man-made fibers; agricultural chemicals; pharmaceuticals; paints and coatings; soaps, detergents, and toiletries; and the always-handy "other" sector. It has been that way forever, or at least since about 1938, with the development of the Standard Industrial Classification system. This was replaced by the North American Industry Classification System (NAICS) beginning in 2000, with full implementation in 2004.

Granted, the pharmaceutical industry does fit the broad government definition of chemical manufacturing: "the transformation of organic and inorganic raw materials by a chemical process and the formulation of products." But there are big differences in the way the pharmaceutical industry produces, prices, trades, and sells its products, and these differences separate it from the rest of what the government calls chemical manufacturing. This was recognized long ago by Wall Street, which has separate security analysts covering pharmaceuticals and chemicals.

Take prices, for instance. Most of what people consider the chemical industry prices its products by using large-scale measures such as tons, gallons, and pounds. But the pharmaceutical industry essentially micro-prices its product as pills or other dosages. One has to believe that the government converts these data to some sort of unit basis, but a composite price index mixing these disparate measures just seems to invite problems.

Then there is the wide gap between the producer price indexes for pharmaceuticals and other industry sectors that are tabulated by the Bureau of Labor Statistics. Between 1982, the base year for the producer price index, and 2006, the price index for all chemicals increased at an average annual rate of 3.1%. In contrast, the pharmaceutical index rose at an average rate of 4.2%. Among the other chemical sectors, only the basic chemicals index managed to beat the overall increase, rising 3.2% per year.

The problem for economists and other interested parties is that there is no way to extract the skewed pharmaceutical component from the overall chemical index. Thus, a producer of agricultural chemicals has no way to compare his or her sector's price performance to that of what most people think of as the chemical industry.

This problem is especially vexing for production indexes from the Federal Reserve Board. Not only do analysts want to track growth trends, but multiproduct chemical companies also want to compare production trends in individual sectors against the total industry, without pharmaceuticals skewing the data.

Government statistics that report in real measures such as dollars, employees, or volumes usually don't pose such problems, but each has idiosyncrasies that can get in the way of meaningful economic analysis. These include data such as employment, shipments and inventories, and foreign trade.

For employment, the Labor Department gives industry sector totals both for all employees and production workers. Thus, I simply subtract pharmaceutical employment from the total to get a number that fits the traditional chemical sectors.

But just because I and other chemical industry watchers know to subtract out pharmaceuticals doesn't mean everyone does. The result is that the broader business world can be left with a distorted picture of the chemical industry.

In today's economic climate, the government's foreign trade figures are closely watched. When business publications report on chemical trade, they typically include the trade balance—exports minus imports—and that balance has been running negative since 2002. However, if pharmaceuticals are excluded, chemical trade did not show a deficit until last year, when it was just $183.5 million. Compare that to a $7.72 billion deficit when drugs are counted.

Probably the most exasperating data come from the shipments and inventories figures compiled by the Commerce Department. First comes data regarding shipments and inventories for all chemicals, then comparable data for three sectors: pharmaceuticals; agricultural chemicals; and paints, coatings, and adhesives.

Nobody I have talked to at Commerce seems to know why this method of reporting is used, but it has been around for a long time. Prior to the adoption of NAICS, it was even worse. Commerce provided the data for all chemicals; drugs, soaps, and toiletries combined; and industrial chemicals. But even under NAICS, this practice leaves a huge "other chemical" category: 62.8% of total chemical shipments in 2006. What's exasperating is that the Commerce Department finally provided data for pharmaceuticals but failed to break out other important sectors.

The omission of major industry sectors such as basic chemicals and plastics from the Commerce report is unfortunate, to say the least. Not only do plastics-producing companies, for instance, want to know the value of shipments of their products, but perhaps even more, they want to know about inventories, because inventory building often can signal a slowdown in demand.

It is only wishful thinking, but a move by the government to exclude drugs in the way it reports on chemicals would be a huge step toward getting a statistical handle on both pharmaceuticals and the rest of the chemical industry.

Views expressed on this page are those of the author and not necessarily those of ACS.