Should We Still Make Things?
Should We Still Make Things?
Jeff Madrick: We Need Realistic Industrial Policy
THERE ARE at least three major reasons why a nation must indeed make things to maintain its prosperity: First, making goods is on balance—with exceptions—more productive than providing services, and rising productivity is the fundamental source of prosperity; second, related to the first, making goods creates higher-paying jobs on balance—again, with a few exceptions; third, a major nation must be able to maintain a balanced current account (and trade balance) over time, and goods are far more tradeable than services. Without something to export, a nation will either become over-indebted or forced to reduce its standard of living.
The United States has looked the other way regarding these important issues for a variety of reasons, but underlying its neglect are certain narratives about how economies work that have been highly misleading. One of the more misleading narratives of recent decades involves the rapid growth of services industries when compared to the rest of the economy. It goes like this: Services will naturally replace manufacturing in an advancing economy exactly as manufacturing replaced agriculture in the 1800s. Do not be concerned. Remember how inappropriately concerned people were a century and a half ago with the rise of manufacturing? The rise in services is the best use of American resources.
Of course, within every overgeneralization lies a pit of truth. Same here. Once we feed, clothe, house, and auto-mobilize ourselves, many economists agree that we mostly want to go to the movies or watch TV, hang out at the mall, trade stocks in our Schwab accounts, and, if financially healthy, go to the doctor a lot. There is thus no need to be alarmed that only 8 or 9 percent of American workers are employed at a factory that makes things. To the contrary, this is proof of the economy’s sophistication and its evolution towards providing Americans with what they really want. Moreover, manufacturing’s productivity is rising rapidly—which means fewer workers are needed for the same output and the price of an equal quantity of goods falls.
A lower manufacturing share of GDP is therefore the natural course of events. In fact, productivity gains are the core reason for job loss. There are even good services jobs—finance, for example. Meantime, corporate profits rise, which is proof of the pudding and the guarantor of high levels of capital investment and the future of the nation. Not long ago, the management guru, Peter Drucker, wrote that all America had to do was learn how to more productively make services. I suppose America listened, because it has now created the remarkably productive Wal-Mart, which in turn supplied America with some of the worst jobs in the nation.
ACCORDING TO the neo-classical equilibrium theory, all of this was supposed to happen as naturally as a dolphin plies the tides. As always, there are controversies over how fast manufacturing’s share of GDP has fallen but in recent years, I don’t think there are many that argue there hasn’t been a significant drop since the late 1970s. In addition, I don’t think many argue that the trade deficit in manufactured goods, which is pretty enormous, has virtually nothing to do with job loss.
Thus, manufacturing should have always been a focus of government policies. But America did far worse than merely neglect it. The decline of manufacturing has gotten a big push from the Democrats in charge in the 1990s, and from most of the Republicans since the early 1980s, in particular the hard Rightists, and increasingly most of mainstream economic academia. This push—really a shove—was the tolerance and further promotion of an overvalued U.S. dollar.
The American dollar had been high through much of the Bretton Woods period, but in 1979 it took off and rose some 60 to 75 percent, depending on the trade-weighted average used, until 1984. High real interest rates in the early 1980s under Federal Reserve Chairman Paul Volcker attracted foreign funds while Reagan’s simultaneous Keynesian thrust of tax cuts and defense spending produced a fast-growing economy in the mid-1980s. In five years, the high dollar dramatically lifted the price of manufactured goods. Coupled with the steep recession, manufacturing was clobbered.
After the dollar declined during the run of Jim Baker’s Plaza Accord, the value of the dollar again turned up and kept rising inexorably until only a couple of year ago. Manufacturing thus did not decline as a consequence of natural causes, but was hastened to the edge of the cliff and pushed off by the high dollar. The relevance of manufacturing was minimized by policymakers who saw an easy way to attract foreign investment and compensate for ever more borrowing, and all the while satisfy Wall Street profit seekers.
And thus America stopped making things. American manufacturing was at an enormous disadvantage in the world. One consequence was the permanent loss of many hundreds of thousands of jobs. But not only that. Entire industries were decimated, needed skills lost, R&D foregone, the innovation from learning-by-doing never undertaken—and so on.
The rest of the world did not mind. American demand was the growth machine for Japan, the Tigers, and finally China. If America wanted to undermine good jobs in its own country, who were they to complain?
THE DISASTER of this policy is now clear. Left to its own devices, the free market in currencies is probably the most devastating economic idea of our times. Because the dollar reigned for so long as the only trustworthy reserve currency, America got a free pass to run up a big trade deficit without the concomitant rise in interest rates. This led to self-destructive abuse. Americans didn’t have to save to finance borrowing and they could still borrow to buy what they wanted.
This led to borrowing at damaging levels. Greenspan, for example, could push interest rates to rock bottom in the early 2000s without undermining the value of the dollar and raising inflationary fears. Meantime, the Chinese and others, intoxicated by the power of their export-led growth model, felt no pressure to raise wages at home and build a domestic market which the early rich nations of Europe and North America had long ago learned was a critical foundation—an idea that some have now forgotten.
The world’s trade and investment imbalances led directly to the current crisis. Debt, not wages, propelled demand in America. And not only America but international institutions invested dollars in bad American mortgages and the housing bubble. Earlier they had done the same in the high-technology sectors.
So the extent of the decline of manufacturing in the United States was not natural. Meantime, under this economic model, finance became America’s leading industry, accounting for more than 30 percent of profits in recent years and more than 40 percent of profits among the Standard & Poor’s 500.
If a high dollar had not been allowed to become the centerpiece of the economic model, manufacturing would have declined but to a far lesser degree. This raises the second issue. Should we let manufacturing follow a natural, market-driven course? The answer is that we should not. It is nonsense to think that free markets will automatically create the industries a nation needs. The thinking that suggests it will is the result of the ascendance of simplistic free-market economic theory.
In America, we fail to develop industries for which there are few short-term incentives or that are too risky or large to be undertaken by private capital. There are gaping holes in what we make in America: no light rail or subway cars to speak of, for example, and far less agricultural equipment and almost no machine tools, once the pride and joy of our early industrial era. We are in desperate need of money for alternative energy solutions. We spent torrentially on fiber communication lines that were unneeded. We lag in broadband coverage. We of course make almost no consumer electronics products or textiles.
We remain leaders in chip-related high technology. But it was the government that saved Intel in the 1980s, and it is the remarkable fall in the cost of computer power with Intel micro-processors that was the principal causal factor in the so-called “New Economy.” We lead in big pharmaceuticals, but that’s because the National Institutes of Health and other government agencies have so intelligently subsidized science and research at U.S. universities. We have a huge defense industry, which is a big exporter, including aircraft. (We know why.) Meantime, the nation’s overall R&D is spotty and weak. The education of engineers and scientists remains well behind our production of MBAs.
Today, to take the most straightforward measure, manufacturing final sales are 10 percentage points lower as a share of GDP than they were in the early 1980s. That’s 1.5 trillion dollars worth. Losing one million manufacturing jobs more than necessary has put an enormous dent in wages in America where the typical male in his thirties now makes less after inflation than the typical male in his thirties did in the 1970s.
SO HERE we are: Enormous imbalances in current accounts everywhere has put the world in a hole from which it may not climb out in the near future. The imbalances are a consequence of everyone taking the easy way out—and most doing so against the most vital long-term interests of the U.S. economy. The United States has succumbed, in particular, to the short-term interests of powerful Wall Street players.
To take one end of the spectrum, the Chinese, now in serious recession, must develop a domestic market. At the other end is the U.S., which, until the 1970s, paid the highest wages in the world since the Colonial years. But it no longer does. It is a high productivity, low-wage nation. Wal-Mart is the symbol of the broader demise. A major reason is the loss of manufacturing jobs.
Because the United States can no longer make many things—it doesn’t have the factories, the labor or management expertise, the new ideas or proper incentives—the trade deficit is that much harder to correct, even if the dollar falls again. An industrial policy, such as the one partly incorporated in the new Obama stimulus package, has fewer teeth because much of the domestic spending will necessarily go to imports.
In sum, then, no nation can sustain the imbalances America has had since the late 1980s. Goods are largely what are exported. Critically, making things also makes good jobs, it creates ideas for the future, it educates and trains workers, it has enormous multiplier effects through the purchase of goods for production and by paying high wages. Contrary to widespread conventional wisdom, no rich nation will survive on services alone.
The United States requires an appropriate currency policy. Since it needs the cooperation of all nations, it is difficult to be optimistic. But present events may cause this to happen, and we can only hope in a stable way. The United States also requires a realistic industrial policy to support needed industry, the ongoing development of skills and products, and appropriate levels of R&D. The lack of such thinking in America—even after the crisis—is yet another failure of over-simplified, market-oriented economic theory.
Jeff Madrick is editor of Challenge Magazine and director of policy research at the Schwartz Center for Economic Policy Analysis, The New School. He is the author of Taking America, The End of Affluence, and most recently The Case for Big Government.
