The Deteriorating U.S. Manufacturing Sector and the Role of Tariffs in Sustained Contraction

The U.S. manufacturing sector, long a cornerstone of economic resilience, is now in a state of sustained contraction, driven in large part by the Trump administration's aggressive tariff policies. Data from the Labor Department reveals a stark reality: manufacturing employment has declined by 59,000 jobs since April 2025, with durable goods manufacturing-the lifeblood of cars, appliances, and electronics-bearing the brunt of these losses. This trend marks a continuation of a six-decade-long decline in manufacturing employment, a trajectory that tariffs have failed to reverse. The economic costs are not confined to job losses. Tariffs have exacerbated inflation, with the Federal Reserve Bank of St. Louis estimating they contributed 0.5 percentage points to headline inflation and 0.4 percentage points to core inflation between June and August 2025. For households, the toll is tangible: the Yale Budget Lab calculates that tariffs cost the average U.S. household $1,800 in 2025, with price surges in categories like apparel (17%) and food (2.8%).

The stagnation of manufacturing productivity further compounds these challenges. Sector-specific productivity growth has averaged a paltry 0.5% annually during the current business cycle, far below the historical average of 2.1% since 1987. Tariff-induced uncertainty and higher input costs have discouraged capital investment, creating a self-reinforcing cycle of underperformance. While trade agreements with the European Union, Japan, and China have mitigated some damage, they have not reversed the broader economic consequences of the tariffs. Even with reduced tariff rates for certain countries, U.S. manufacturers still face higher input costs compared to pre-April 2025 levels.

Amid this contraction, a critical question emerges: where should investors reallocate capital? The answer lies in export-oriented sectors insulated from the tariffs' drag. Notably, the AI and data center industries have emerged as a counterbalance to the economic headwinds. According to a report by PIMCO, AI and related investments contributed approximately 0.5 percentage points to U.S. GDP growth in 2025, with companies like Amazon, Google, Meta, and Microsoft alone investing $400 billion into AI-related capital expenditures. This surge in technology investment has partially offset trade uncertainties, with AI-driven infrastructure becoming a primary engine of growth during a period of broader economic fragility.

Data center development, driven by hyperscalers such as Microsoft, Alphabet, and Meta, has also seen explosive growth. By 2025, global data center capacity in the U.S. exceeded 40% of the global total, with over $61 billion in investment and M&A activity. However, this growth is not without challenges. AI data centers paid $6 billion in tariffs in 2025, raising concerns about U.S. AI competitiveness. Yet, the long-term potential of these sectors remains compelling. The One Big Beautiful Bill Act, expected to provide fiscal stimulus in 2026, could further stabilize the labor market and support broader economic growth.

Strategic asset reallocation must prioritize sectors insulated from tariff volatility. While manufacturing employment in September 2025 stood at 12.7 million workers-a figure that underscores the sector's fragility-export-oriented industries like AI and data centers offer a path to sustained growth. Investors should consider the following:

1. Tariff-Insensitive Sectors: AI and data centers, despite their own tariff burdens, are less exposed to the broader contraction in manufacturing. Their growth is driven by global demand for digital infrastructure and innovation, not domestic trade policies.
2. Supply Chain Resilience: Sectors that have adapted to tariff pressures-such as technology industries reliant on domestic investment and supply chain adjustments-demonstrate resilience.
3. Policy Uncertainty: The Trump administration's threats to exit agreements like USMCA and reimpose tariffs create an environment of unpredictability, deterring long-term investment in traditional manufacturing.

The case for reallocating capital is clear. As the U.S. manufacturing sector continues to contract under the weight of protectionist policies, investors must pivot toward sectors that are not only insulated from tariffs but also positioned to drive the next phase of economic growth. The AI and data center industries, despite their challenges, represent a rare convergence of technological innovation, global demand, and policy tailwinds. In a world where strategic asset allocation is paramount, the path forward lies in embracing these emerging opportunities.