Throwing cold water on the U.S. manufacturing rebound by Tory Newmyer @FortuneMagazine March 20, 2012, 3:52 PM EDT E-mail Tweet Facebook Google Plus Linkedin Share icons FORTUNE — President Obama is becoming the cheerleader-in-chief for the manufacturing recovery, hitting factory floors to make his case that the fragile turnaround should earn him a second term. “America thrives when we build things better than the rest of the world,” he told the crowd at a Rolls-Royce plant in Virginia earlier this month.But a new report argues that recent headlines touting a nascent manufacturing renaissance belie a grimmer reality: The sector suffered a cataclysmic decline over the last decade and is in much worse shape than most economists will admit.The report — out today from the Information Technology & Innovation Foundation, a technology policy think tank — says that measured by job creation, manufacturers registered their worst performance in history over the last decade, shedding 5.7 million jobs. As a share of total jobs, that decline is worse even than the one manufacturing suffered during the Great Depression.And unlike the periods following most post-World War II recessions, when manufacturing helped lead the recovery and jobs lost in the sector were restored in relatively short order, the vast majority of manufacturing jobs that disappeared over the last ten years haven’t come back — in the case of the Great Recession, that number is less than 14%.MORE: The biggest winners of a new Russia trade dealThe group uses the numbers to make the case that American manufacturing is now facing a structural decline. It’s a situation they argue that economists and pundits across the spectrum have papered over, owing both to faulty data that has understated the severity of the challenges facing the sector and a misbegotten belief that changes in the labor force can be chalked up to market dynamics — like productivity gains — that are taking similar tolls on our competitors.“We need to at least understand reality before we can make the right decisions,” says Rob Atkinson, president of the ITIF. “We have a competitiveness challenge that’s bigger than what we thought.”The report argues that the key claim of the rose-colored glasses crowd — that increased efficiency has made it possible to produce more with fewer workers, which is ultimately a sign of the sector’s strength — is in fact wrong. The problem is that economists have been using government data to measure the growth in the output of American factories and finding plenty of good news: it takes one worker today, for example, to do the work of five in 1950.But ITIF holds that the numbers telling that story don’t adequately account for an increasingly globalized supply chain. Adjusting for those changes, the group found manufacturing output actually fell by 11% over the last decade, the only time outside of the Great Depression when the sector notched a dip.MORE: GM’s Akerson talks bailouts, Europe, Chevy Volt problemsWhile many economists say manufacturing’s decline doesn’t matter — or that it actually augurs progress toward a service-oriented, “ideas” economy — Atkinson’s group hopes to make the case that the sector has an unrivaled ripple effect throughout the rest of the economy: for every manufacturing job we lose, 2.5 others go with it.“Two-thirds of our economy is non-traded, so if it goes out of business, the demand is automatically supplied by an American supplier,” Atkinson says. “If a barbershop goes out of business, I’m not going to Canada to get a haircut. But when our traded sector goes out of business, or loses market share or cuts back or moves a factory, that demand is not necessarily replaced by American supply.”Atkinson says economists have been slow to grapple with the data problem for fear that the truer picture of the sector’s straits will encourage protectionists. But, he adds, “there are multiple paths one could go down as a response to this and that’s only one of them.” His group favors an aggressive strategy to restore U.S. competitiveness in part by overhauling the tax code and investing in public-private partnerships to develop higher-tech production lines — an approach it will spell out in greater detail later this spring.