Wednesday, February 25, 2009

The Bite of Reality

You often hear people bemoan the negative impacts of the globalized economy on America by claiming that "We don't make anything anymore." The truth is that we still make stuff. It's just not necessarily the same stuff we used to make and requires far fewer people to make it. To believe that we don't make anything anymore is to embrace the fallacy that manufacturing jobs and output are positively related. It would be like saying "We don't grow anything anymore" based on the number of workers involved in the agricultural sector today compared to the past.

Jim Manzi has an article in the latest edition of National Review called Factory Man (sub req) with a helpful graph to illustrate that while the percentage of the workforce in manufacturing in America has been declining for some time, manufacturing as a percentage of the total US economic output has remained relatively steady:

Manzi is a self-described "Factory Man" and he fondly recalls the hey days of American manufacturing. However, he recognizes that nostalgia for the past should not influence our perception of the realities of today nor our policies for the future:

This same dynamic has been playing out for manufacturing over the past 60 years. It has been exacerbated by international competition to a degree not seen in agriculture. Countries with much lower wages can produce goods cheaply and export them to the U.S. market, especially goods with labor-intensive manufacturing processes. Consequently--unlike the case with agriculture--the U.S. runs a consistent merchandise trade deficit. Those American manufacturing industries that are not in secular decline typically respond to this situation with one or more of the following strategies: (1) automate production to reduce the labor content, (2) manufacture overseas and become a research, design, and marketing company, (3) employ low-wage/low-skill manufacturing labor (very often illegal-immigrant labor with pre–New Deal economic protections), and (4) produce complex goods that require frequent manufacturing innovation and provide high-wage jobs. As Jack Welch, the legendary CEO of General Electric who probably did as much as any individual to drive manufacturing reform, put it in the 1980s: American factories must "automate, emigrate, or evaporate."

Most of these alternatives are bad for traditional-production workers, though some can work out well for manufacturing employees who can be flexible and develop advanced capabilities. As a result, while there is always a wage premium for those with better skills, manufacturing-sector jobs are increasingly re-segregating into high-skill/high-wage and low-skill/low-wage ghettos in a pattern very reminiscent of early-20th-century America. According to research by Claudia Goldin, an economic historian at Harvard, the ratio of pay for a starting engineer to that of the average production worker declined from about 1.4 in 1904 to about parity in 1956, at the peak of the post-war economic high tide. In 2007, the average starting industrial engineer made about $55,000 per year, or about 1.5 times the $37,000 that the average non-supervisory production worker made. And more broadly, wage inequality and the economy-wide skills premium have been rising in the U.S. for the past 30 years.

The days of getting out of high school, working in a factory, and having a middle-class life are pretty much gone, because the economic world of 1955 is gone. The jobs that provided this opportunity have been automated out of existence, and our international position no longer allows us to protect them at feasible cost. I take no joy in the need for restructuring the auto industry. I wish that old world still existed, but it does not.

I realize now that my attempts to resist this change were like William Jennings Bryan's attempts to resist the coming of the economic order that I was trying to preserve. I slowly came to understand through experience that my original vision of saving manufacturing would have destroyed it. Theories for how to revive American manufacturing abounded in the 1980s, and it's hard to exaggerate how difficult it is to understand which alternatives are feasible and which are not in the face of an economic transformation. It is almost impossible not to be guided by our sentiments in such a situation, and this happened to me. I fought the direction in which market price signals were pushing manufacturing, but in the end, they were the only reliable guide to what might work.

As a crude generalization, new economic sectors that rely on innovation are the ones that produce lots of high-wage jobs for an economy. It is often said that services are less productive than manufacturing, but in a certain way, this is the good thing about services: They provide jobs. Eventually, what we now call services will presumably go through the same transformation as farming and factories have, and we'll have to find a new sector to provide employment.

At each of these stages, we don't abandon the maturing industries. We still need food and manufactured goods, and it would be foolish to become completely dependent on foreign supplies for either. In the event of a real shooting war we couldn't book enough conference rooms to protect ourselves from a determined adversary. But, as we've seen, we are well able to feed ourselves, and we have an extremely robust manufacturing economy. In fact, had we tried to freeze in place either family farms or employee-intensive factories, we would probably have a far worse defense capability because we would have less domestic agricultural output and antiquated factories.

Which new sectors will actually be productive, and how they will ultimately develop, is highly unpredictable. This is why the free play of markets with limited intrusion by the government is so essential. Almost all industrial policy ends up protecting existing institutions: This is a function of human nature and is not fixable with clever program design. In practice, industrial policy normally means maintaining jobs that a ruthless market would eliminate, and subsidizing technological developments that can be exploited by existing large firms. But these are rarely the sources of new high-wage jobs. Ironically, these attempts to protect ourselves end up creating a sclerotic economy that in the long run puts everyone at greater risk. The painful reality of economic growth is creative destruction, and in a globalized economy, to lose out in this race is ultimately to put ourselves at the mercy of those who may or may not share our interests.

No one will deny that the transformation of manufacturing in American has been and continues to be painful. We do need to do a better job of recognizing and managing the changing world of manufacturing to ameliorate that pain.

But when people start talking about how we need the government to "fix it" or "protect it," you have to ask yourself whether the cure will be worse than the disease. As Manzi says, it ain't 1955 no more and we can't go back to the way the economy worked then. To pretend that we can is a false promise and to try to turn back the clock is likely to result in far worse consequences than any wrought by the change.


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