Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
For some time I have been promising to write a blog about the role that manufacturing plays in a modern economy. There is a strong presumption, especially from the progressive side of the political debate that manufacturing – or what you produce – defines the capacity for a nation to enjoy growth in real wages and therefore standards of living. So when I have said in the past that I am against industry protection I usually get attacked from the left and I note that this if often coming from people who think it is cute to sound technical by saying the government should balance their budget over the course of the business cycle. As if! Neither viewpoint coming from that quarter has much credibility. I take a more experiential viewpoint. People prefer to consume than to work. What we consume is more likely to give us joy than what we produce especially if the latter is in the context of exploitative capitalist production relationships. I am painting this in black and white terms to garner your interest. Clearly it is more complicated but in general I do not think you need a manufacturing sector to enjoy strong growth in material living standards and perhaps a polluting manufacturing sector erodes the capacity to enjoy broader concepts of growth and well-being. My flame resistant suit is now in place … so here goes.
I also don’t think you should see this as my definitive statement on the matter. I am just musing today – looking back through old notes and snippets from the press.
A related argument about manufacturing concerns phobias about trade. This blog is not extolling the virtues of free trade. I support fair trade only. That is the topic of another blog.
But from a monetary perspective I don’t think worrying about external deficits is valid. I would rather advocate the enjoyment of advantageous real terms of trade while you can because if the situation ever turns sour (as foreigners start losing their desire to accumulate financial assets denominated in your currency) and the currency depreciates then you have to make corrections in your real living standards and these adjustments might have to be made rather quickly if the exchange rate depreciates quickly enough.
But I live in a nation that has made its wealth independently of manufacturing and experiences very large terms of trade fluctuations regularly. While there are distributional consequences of this our long-term per capita living standards have not been severely impacted relative to other nations. The evil hedge funds have not destroyed our floating currency and our lowest exchange rates have been associated with record budget surpluses. There is no statistically significant relationship that has been found between the fiscal stance and movements in our exchange rate. That result broadens to all nations.
I also note a commentator made the point the other day that considering exchange rate adjustments to be an aid to an external balance was a neo-classical solution and therefore the implication was that it was a morally bereft position to take for a progressive economist.
However, Modern Monetary Theory (MMT) considers floating exchange rates to be the only way to maximise the potential of fiscal (and monetary) policy in pursuit of domestic public purpose. Once a nation ties its currency to any arrangement with another country, full currency sovereignty is lost.
But it is not an exclusively neo-classical (that is, mainstream free-market) position to note that price adjustments invoke quantity changes. All economists understand that impacts emerge from changing prices and changing incomes. The neo-classical position is to maintain that the price responsiveness is much stronger than the income effects whereas the “Keynesian” position is the reverse.
So in acknowledging that movements in exchange parities (for example, a depreciation) may improve the trade prospects for the export sector and choke off some import demand is in no way a “neo-classical” position. They do not have a monopoly on recognising relative price movements as being capable of impacting on real demand and supply.
Further, one of the sub-themes here is that the austerity push in the Eurozone at present is predicated on a naive belief in trade-led revivals with competitiveness in manufacturing seemingly paramount in this strategy. I plan to examine the Eurozone situation soon – I am just accumulating data at present.
The short insight is this: despite their harsh attack on standards of living in some of the weaker EMU nations or exchange-rate tied neighbours, there is very little evidence that the strategy is working and lots of evidence to say it is not. Real terms of trade are not moving very quickly in their favour and exchange rate movements between the Euro and other non-Euro (non-tied) currencies seem to be more important than domestic cost pressures in determining competitiveness.
In the New York Times (September 4, 2010) Thomas Friedman’s article – Superbroke, Superfrugal, Superpower? – argued that the world of “too little American power” was “coming to a geopolitical theater near you”. Friedman said:
Yes, America has gone from being the supreme victor of World War II, with guns and butter for all, to one of two superpowers during the cold war, to the indispensable nation after winning the cold war, to “The Frugal Superpower” of today. Get used to it. That’s our new nickname. American pacifists need not worry any more about “wars of choice.” We’re not doing that again. We can’t afford to invade Grenada today.
This sort of stuff could only be written by an American in denial of reality and in the sense that he invokes fiscal statements (being able to afford to invade Grenada) he also demonstrates his lack of knowledge of monetary systems.
Please read my blog – It will only take 6 months – for the last time I bothered to comment on Friedman’s opinions.
The only reason America might not be able to afford to invade Grenada is because they have used up all their real resources (unlawfully) invading several other countries.
Friedman claims that the US cannot afford these wars anymore and he quotes from a recent book:
This – on top of all the costs of bailing ourselves out of this recession – “will fundamentally transform the public life of the United States and therefore the country’s foreign policy.” For the past seven decades, in both foreign affairs and domestic policy, our defining watchword was “more,” argues Mandelbaum. “The defining fact of foreign policy in the second decade of the 21st century and beyond will be ‘less.’ ”
When the world’s only superpower gets weighed down with this much debt – to itself and other nations – everyone will feel it. How? Hard to predict. But all I know is that the most unique and important feature of U.S. foreign policy over the last century has been the degree to which America’s diplomats and naval, air and ground forces provided global public goods – from open seas to open trade and from containment to counterterrorism – that benefited many others besides us. U.S. power has been the key force maintaining global stability, and providing global governance, for the last 70 years. That role will not disappear, but it will almost certainly shrink.
The US has incurred significant “costs of bailing” themselves out of the recession in the sense that they are leaving a significant proportion of their productive resources idle. This waste is the cost and it would have been better if the idle labour and capital was in use.
In other words, fiscal policy has not been expansionary enough to incur enough “costs”. The numbers on the budget spreadsheet which Friedman and his ilk always invoke in these sorts of discussions are not costs at all. There is no opportunity cost in the government writing a number in its budget. Only when these spending flows engage real resources do you start measuring the cost!
Further, apparently this decline in America’s capacity to continue in its role as global governor or peacemaker will make “the world will be a more disorderly and dangerous place …”
You mean that the last 10 years of US interaction with the rest of the world has been making it a safer place? If the US does reduce its martial excesses around the world perhaps some degree of peace will emerge. But this is off my topic and distant from my actual professional expertise so I will just leave that.
As a non-American I reject the martial influence that the US government imposes on us in the name of peace and freedom. I would recommend they withdraw their troops from all foreign soils and defend their own borders and spend the military budget on helping nations achieve full employment. I may write another blog someday about the relationship between unemployment and terrorism!
Anyway, the reason Friedman’s article took my eye is because in proposing “(h)ow to mitigate this trend” Friedman says:
… we need to get ourselves back on a sustainable path to economic growth and reindustrialization, with whatever sacrifices, hard work and political consensus that requires.
Reindustrialisation – promote the growth of manufacturing as the engine of growth. This argument comes up everytime there is a recession. Each time it is largely flawed.
But it remains a powerful “working class” narrative and allows all sorts of racist and xenophobic arguments to command “respectability” in the public debate. Almost all the arguments are spurious.
Former Cambridge economist, Nicholas Kaldor set out four observations which became known as Kaldor’s growth laws, which supported the proposition that a nation’s standard of living depended on its level of industrialisation.
Three nations defied these laws – Australia, Canada and New Zealand – which became and stayed rich by exploiting agriculture and primary commodities in general. That is a strong lesson which is normally ignored.
Kaldor’s growth laws (which were just correlations) indicated that:
- The growth of the GDP is positively related to the growth of the manufacturing sector (the share of industry in GDP is rising).
- There are increasing returns to manufacturing (Verdoorn’s Law) – so the larger the sector the lower the average costs with learning by doing an important source of these gains.
- The productivity of the non-manufacturing sector is positively related to the growth of the manufacturing sector. Allegedly, the non-industrial sector has diminishing returns to scale so if increase all inputs proportionately, you get a less than proportionate increase in total output.
Kaldor also extended the notion of circular and cumulative causation that had initially been developed by Allyn Young. The basic argument is that the process of industrialisation is cumulative. So capital goods manufacturing precedes consumer goods production and the economy moves from local sale to export sale.
Of crucial importance to this cumulative causation process is the primacy of manufacturing. The argument is based on the idea that only manufacturing can exploit the division of labour that growth permits and that increasing specialisation benefits the wider economy. This was the basis of explaining the benefits of vertical integration.
Ultimately, the growth of manufacturing drives the entire economy and increase productivity growth in other sectors via technological change. Specialisation generates increasing returns (unit costs fall) and strong complemenetarities via learning by doing.
Once products are cheap enough and of sufficient quality, then export markets open up and provide a relief from the saturated local markets.
This is what was considered to be a virtuous cycle where productivity increases would drive costs lower which would stimulate further growth as long as aggregate demand was strong enough to absorb the production.
Ultimately, export-led growth models are traced back to this (flawed) idea. There was not real understanding presented as to how this process evolves.
Further, Kaldor’s observations were never concretely established by the empirical literature. You might want to read the article in the Economic Journal in 1975 – What Remains of Kaldor’s Law? – by fellow Cambridge economist Bob Rowthorn who was also sympathetic to Marxian interpretations.
In explaining how Kaldor “found a strong positive relationship between productivity growth and employment growth in manufacturing”, Rowthorn shows how Kaldor “followed an inappropriate statistical procedure” and “he used a misleading sample of countries”.
More recently, many progressive people were influenced by the 1987 book (published by Basic Books) Manufacturing matters : the myth of the post-industrial economy written by Stephen Cohen and John Zysman. Their basic argument is that manufacturing and services are complementary (whereas other progressives argue they are substitutes) and so without a strong manufacturing sector you cannot have a sophisticated services sector.
In Chapter 2, Cohen and Zysman argue that:
There are … other kinds of linkages in the economy, such as those which tie the crop duster to the cotton fields, the kethchup maker to the tomato patch, the wine press to the vineyards (to return to our focus on agricultures [as a parallel]). Here the linkages are tight and quite concrete … the linkage is a bind, not a junction or substitution point. Offshore the tomato farm and you close or offshore the ketchup plant. No two ways about it.
In his book Protectionism (page 114), Columbia University’s Jagdish Bhagwati noted that as he read that paragraph he was eating his favourite English marmalade and wasn’t aware that “England grew its own oranges”.
But the debate is regularly aired. In the recession of the early 1980s, it was fear of Japan and the NICs (South Korea, Singapore, Hong Kong and Taiwan). Today it is China and India.
In the early 1980s, for example, the former US Vice President, Walter Mondale, who at the time was lobbying to become the 1984 Democratic Presidential nomination was a pursuing “a more strident and protectionist theme” than in his earlier days.
The New York Magazine (January 30, 1984) ran a story – Is Mondale the Man and recounted how in the early 1970s he was a free trader but by the time he sought the Presidency as a Democrat he had become converted to “protectionism” as part of his “new look”.
In 1970, he was quoted as saying “Protectionism is no solution … [it’s a] … Pandora’s box … ]that] … openly invites higher prices to the American consumer and serious retaliation.”
By 1984, he was quoted as saying “I am not a sucker … From now on it’s going to be fair … We’re all going to play on a level table … If they lowball us, we’re going to lowball them.”
On October 13, 1983, the New York Times ran a story – Washington: Mondale’s Tough Line – where Mondale outlined his protectionist stance. He said:
We’ve been running up the white flag when we should be running up the American flag … What do we want our kids to do? Sweep up areound the Japanese computers?”
Interestingly, Mondale later became the US Ambassador to Japan in the Clinton Adminstration and was full of praise for them.
Consume or produce?
Is it necessary to produce goods if you can consume them via trade? Much of the argument rests on whether there are learning and efficiency gains in services. The cumulative causation argument suggest that firms improve by receiving feedback from customers and if this capacity is spatially separated quality suffers.
Hence you need to have a localised manufacturing sector.
This is another positive externality generated by local high technology manufacturing. It is also an important feature of localised clusters which are either horizontal or vertically integrated along the production chain.
Clustered development is said to further entrench the increasing returns to scale and the transfer of knowledge and provide competitive trade returns.
But it is not clear whether the production and the specialised services (design, etc) are the source of the gains. It is true that a lot of the now outsourced services were formerly part of the manufacturing firm and service-based firms (engineering, design etc) are still dependent on the production-segment of the industry for growth.
In the UK Guardian last week (August 30, 2010) Jagdish Bhagwati wrote that There is no proof that economic health depends on manufacturing. His argument is that there is no solid evidence and indeed conflicting evidence relating to this proposition.
Economists long ago put to rest the error that Adam Smith made when he argued that manufacturing should be given primacy in a country’s economy. In the second volume of The Wealth of Nations, Smith condemned as unproductive the labours of “churchmen, lawyers, physicians, men of letters of all kinds; players, buffoons, musicians, opera-singers, opera-dancers, etc.” We may agree with Smith (and Shakespeare) about the uselessness of lawyers, perhaps, but surely not about Olivier, Falstaff, and Pavarotti. But the manufacturing fetish recurs repeatedly, the latest manifestation being in the United States in the wake of the recent crisis.
He reflects on Kaldor’s law and says that the observations were “clearly at odds with the massive technical changes sweeping across the retail sector, and eventually the communications industry, which soon produced Fedex, faxes, mobile phones, and the internet.”
You might want to read an address that Bhagwati gave to the World Trade Organisation in 2007 where he outlines the “semiconductor chips versus potato chips” argument that also is rehearsed in the Guardian article.
He notes that semiconductors are “fitted onto circuit boards in a mindless, primitive fashion” while potato chips can be “produced through a highly automated process”. But this impacted on the consume or produce argument. He said:
Many proponents of making semiconductor chips also presumed that what you worked at determined whether, in your outlook, you would be a dunce (producing potato chips) or a “with-it” modernist (producing semiconductor chips). I have called this presumption a quasi-Marxist fallacy. Marx emphasized the critical role of the means of production. I have argued, on the other hand, that you could produce semiconductor chips, trade them for potato chips, and then munch them while watching TV and becoming a moron. On the other hand, you could produce potato chips, trade them for semiconductor chips that you put into your PC, and become a computer wizard! In short, it is what you “consume”, not what you produce, that influences what sort of person you will be and how that affects your economy and your society.
I have some sympathy for this argument and will elaborate on it in later blogs (if I get time).
The vital part of the argument that I support is that increasing returns, cluster development etc can also come from within the services sector.
While many believe that nations can only support the growth of high value-added services if they also have strong manufacturing sectors the evidence is not convincing. In the past, the computer industry has been cited – that was before the manufacturing part was shipped off to China and India.
Please read my blog – Protect your workers for the sake of the nation – where I promised to consider this issue.
It is often thought that the rise of manufacturing sectors in poorer nations steals jobs from the richer nations. So at present China is undermining the opportunities for industrial workers in the US and elsewhere. But this ignores the fact that “a majority of China’s exports to the US are produced by US-funded companies and huge profits go back into American pockets … half of China’s exports came from the processing trade – where imported components were assembled at factories in China and 60 percent were made by foreign-funded companies or joint ventures with foreign partners” (Source)
Some US researchers at UC Irvine studied this question and in 2009 published – Innovation and Job Creation in a Global Economy: The Case of Apple’s iPod. They examined who benefits when there are large investments in new technologies and infrastructure in a global economy.
They were seeking to see whether investment in the US (perhaps as a fiscal stimulus measure):
… will create more jobs outside the U.S., because many high-tech products currently are manufactured offshore … The same could turn out to be true of alternative energy, hybrid/electric cars, and other new technologies. While these investments have other merits beyond their job-creation potential, it is worth looking at how innovation in a global economy creates jobs in the U.S. and elsewhere.
They used the iPod as a case study and “looked at which companies and countries capture financial value” from their production. They found that in 2006, iPod’s “accounted for about 41,000 jobs worldwide” (27,000 outside the US). The “offshore jobs are mostly in lowwage manufacturing, while the jobs in the U.S. are more evenly divided between high wage engineers and managers and lower wage retail and non-professional workers”. China had the largest share of off-shore jobs.
They found that “the iPod supports nearly twice as many jobs offshore as in the U.S., yet wages paid in the U.S. are over twice as much as those paid overseas.”
In relation to who benefits overall, they found that:
We found that the largest share of financial value (defined as gross margin) went to Apple, which captures a large margin on each iPod. Although the iPod is assembled in China, the value added in China is very low … So it appears that innovation by a U.S. company can benefit both the company and U.S. workers, even if production is offshore and foreign suppliers provide most of the inputs. However, there is no guarantee that U.S. firms will keep engineering and other white collar jobs in the U.S. in the future.
The computations on a $US300 iPod suggests that China retains $US4 of value-added yet the whole value is billed against China’s exports.
So the real debate in this situation might be about a fairer distribution of income within the US and more public employment rather than seeking to constrain trade.
It is clear that once the computer industry split its high- and low-wage components across national borders that the traditional manufacturing arguments about clusters etc faded.
Even the claims (by people influenced by the likes of Michael Porter in the The Competitive Advantage of Nations that linkages between the production and associated service have to be within national borders do not bear scrutiny. Sure enough the development of a product usually requires an accompany service to be established (equipment servicing, systems design and maintenance, training, consulting etc).
But it doesn’t matter where the good is manufactured for this service function to be viable. We make very few cars in Australia relative to the total market but there is a huge service sector associated with the motor trade.
Even the development of so-called service-enhanced products is not dependent on having a local manufacturing sector. Companies can specialise in design, customisation, delivery chain dynamics etc and sell those services locally or abroad. The cluster can be within or across national borders. These high level services are more likely to emerge in a nation with a strong commitment to public education than one which adopts fiscal austerity strategies and dumbs-down its workforce in a race to the bottom.
Trade and Protection
Many progressives (and others) think that manufacturing is an essential vehicle to improve trade deficits, which they erroneously consider to be problematic.
It is a reality that currency speculators will usually chase relative margin. But the notion that a current account deficit is something that is a problem is well-rehearsed in the orthodox economics literature and public debate.
We have been instilled with the notion that exports are ‘good’ and imports are somehow ‘bad’. However, if we take a material perspective (which all economic measures do and this debate is no exception) then exports are a real costs and imports are a real benefit. If we can persuade the rest of the world to send more ships packed with goods to us than we have to send to them then we are relatively (in real terms) better off!
So to repeat: exports are a cost. They constitute real resources that we send away and cannot consume ourselves.
The issue about us buying imports is this. If we buy more imports than we sell in exports then in net terms we are using up ‘purchasing power’ and that means that we will not have enough private spending capacity to purchase all of the domestic goods and services which we could produce if we fully employed everyone and everything (capital).
The solution – the national government has to run budget deficit (net spending) of sufficient magnitude to fill this spending shortfall. The benefits of this are obvious but typically lost on neo-liberal economists: (a) we have full employment – only frictional unemployment of short duration remains; (b) we enjoy the benefits of higher government spending – both households and private producers benefit from better infrastructure, better public services, and such AND/OR we enjoy lower taxes; (c) we enjoy access to the commodities from abroad – that is we can consume BOTH whatever we can produce AND whatever the rest of the world wants to (net) send us.
That does not sound like a trade rut to me. A rut is something you never want to get stuck in. The only problem with the deficit in net exports is that the Government does not have an appropriate policy response – it should be running higher budget deficits to ensure there is sufficient aggregate demand to plug the output gap and thus push us to full employment.
And what of the warning about currency markets abandoning our currency? From a ‘money’ perspective, the fact we can ship less and receive more (trade gap) reflects the fact that foreigners have a current desire to net save in $A financial assets. The only way they can realise this desire is to net export to us hold the net $A as cash or financial securities denominated in $As.
It does not have any connotation that we are dependent on foreign borrowing to maintain our ‘profligate’ importing. It just means that offshore investors want to hold $A financial assets. Our trade gap ‘finances’ that desire. Everyone is better off! We get lower priced imports provided as foreign producers compete among each other for our business (to get the $A).
So what about when they ‘abandon’ the $A? Despite all the fear rhetoric that pours out daily from the spokespersons with vested interests from the financial markets, all they are saying is that there may come a time when the foreign investors lose their desire to hold $A which means they will either spend them here or not sell us products to begin with – which means the current position we enjoy in real terms (more imports, less exports) will move more towards a balanced trade position.
It could mean some adjustment in foreign currency markets as the $A is sold down – this is reality but not a financial crisis for Australia. It just means it is harder to buy imports at the previously attractive terms.
In my view progressives (including many Post Keynesians) also get it wrong. They talk about ‘exporting jobs’ to cheap labour countries. Domestically, the appropriate use of fiscal policy (deficits) is the way to ensure that we all have enough spending power to purchase both our own full employment output and anything the foreign sector may wish to sell us to meet their savings desires.
If we do not like the labour or environmental practices of some of our trading partners then we can deal with that by government to government dialogue, which may mean the Australian Government (legitimately) bans some imports and/or provides consumers with adequate levels of education and information so that we will also not purchase unfair traded goods.
Is there any role for tariffs? Not generally, they are massive profit subsidies to capitalist interests and provide disincentives to invest in best practice, high productivity, high real wage capital.
Some industries might be considered to be of strategic importance – such as the steel industry – in times of war you need to build tanks (do you anymore?). In that case, tariffs still are not useful. Once again a straight Government decree that defence contractors have to buy local steel would be sufficient. Non-strategic steel would then be cheaper but we can still wage our wars!
In the late 1970s a major Australian government report (I can no longer find the reference to it) said that the levels of protection to car manufacturing in Australia were so high that the Australian government could “save” outlays by closing the industry down and paying the same wage bill to the workers. Meanwhile all the rest of us consumers were getting cars that were of no quality or reliability match to the Japanese imports.
I also think that as a private capitalist industry closes and moves to where there is cheaper labour that presents an opportunity to the nation to harness that labour in more productive and forward-looking sectors. It does require a policy framework based on what I have called a Just Transition approach.
Economic restructuring at a regional level is always painful and the decline of manufacturing usually hurts specific cities/regions. In a Commissioned Report that I co-authored modelling the transitions away from coal-fired power to renewables, we noted that a just transition policy recognises that people and ecology are both important.
But in general, the just transition policy approach can be applied to any industrial restructuring. A just transition ensures that the costs of economic restructuring and the shift to new industries do not fall on workers in declining industries and their communities. A just transition in any declining region requires government intervention and community partnerships to create the regulatory framework, infrastructure and market incentives for the creation of well-paid, secure, healthy, satisfying environmentally-friendly jobs with particular attention to appropriately meeting the needs of affected workers and their communities.
I recognise that this debate is an emotional one and this blog doesn’t address all issues.
But I agree with Bhagwati’s sentiment that “financial services are unproductive – even counterproductive – and need to be scaled back by governmental intervention” but as he says this does not make a case for expanding manufacturing again.
As he notes:
Even if you wanted to curtail financial services, you could still focus on the multitude of non-financial services. Diesel engines and turbines are not the only alternatives; many services, like professional therapy, nursing, and teaching are available. The case for a shift to manufacturing remains unproven, because it cannot be proved.
Most advanced nations have seen a sharp shift in the composition of industry towards the services at the relative (and in some cases absolute) expense of manufacturing. The approaches by governments in different cases has been very significant.
In the Anglo-speaking nations we have seen the services sector largely develop as a low-wage, precarious employment sector with little innovation or clustering. Most of the service sector growth has been in the private sector.
In nations like Norway, they have seen a rapid rise in the service sector too. But the government has played a major role and created many high-skill, well-paid and secure service sector jobs in the public sector which have allowed complementaries and productivity gains to be made elsewhere in the economy.
This should be the focus on nations rather than become obsessed with keeping dirty jobs that only involve them in a race to the bottom with developing nations like China in terms of wages and conditions.
That is enough for today!