The sector contracted in three months from June through August.
Any reading above 50 represents an expansion.
Business groups have been arguing for months that protracted congressional action on the "fiscal cliff" would put a dent into activity until lawmakers reach, at least, a short-term agreement by the end of the year to avoid scheduled tax increases and spending cuts.
The White House and congressional leaders came out of the weekend talking more about falling over the cliff than trying to find ways to solve their differences.
Meanwhile, the report showed that hiring contracted for the first time in 37 months, falling to 48.4 from 52.1, the lowest reading since September 2009.
Inventories also contracted to 45 from 50 and new orders grew but at a slower pace, the third straight month of growth after three consecutive months of contraction.
Production expanded for the second straight month, bouncing back from two months of contraction.
The economy showed stronger signs of growth in the third quarter, up to 2.7 percent from 2 percent. But economists aren't expecting those numbers to hold through the fourth quarter because of the effects of Hurricane Sandy and the fiscal cliff issues.