How Important is a Manufacturing Base?

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How Important is a Manufacturing Base?

Post by Tortoise » Fri Nov 12, 2010 12:21 am

I'm interested in hearing some of your responses to the following question:  How important is a country's manufacturing base as a determining factor in its long-term economic prosperity?

My own thoughts on the matter are mixed.  Until fairly recently, I tended to agree with people like Peter Schiff, who claim that a strong manufacturing base is absolutely essential in sustaining long-term economic recovery and prosperity.  The reasoning goes something like this:  Prosperity is achieved through trade, and without a strong manufacturing base, the people in a given country don't have much real stuff to trade with people in other countries.  In the case of the U.S., we've been "trading" our government debt for foreign goods for quite a while.

But today I was listening to one of Harry Browne's radio shows from 2005, and he brought up an interesting point.  He said an economy develops through various stages, and past a certain stage of development, an economy no longer needs to rely as heavily on a manufacturing base.  In the most primitive economies, everyone has to do almost everything--catch and cook their own food, make their own clothes, build their own shelter, etc.  As economies develop, they begin to utilize the division of labor more efficiently, which allows people to focus on what they're best at and thereby frees up more leisure time and spare resources (for investment, luxury, etc.).  In an extreme case, a sufficiently developed economy could potentially be 100% service-oriented.  No manufacturing, agriculture, or natural resource/materials production at all.  He mentioned Switzerland as an extremely service-oriented economy.

I can't argue with Harry Browne's logic there--it's what makes the division of labor so great--but surely there must be at least some truth to Peter Schiff's concerns regarding the disappearance of America's manufacturing base that used to be the envy of the world?  I'm thinking its disappearance was caused by more than just economic development.  Many manufacturing jobs have gradually disappeared or gone to more business-friendly environments overseas due to U.S. government interference such as union protection laws, business taxes, and mazes of regulations.
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Re: How Important is a Manufacturing Base?

Post by smurff » Fri Nov 12, 2010 1:07 am

The thing about division of labor is that it can be built up during the slow progression, but it can be torn down as well.  Often the take-down happens abruptly, such as during war or major natural disasters, but there have been examples where it has happened slowly (late 19th/early 20th century Argentina).  While abrupt take-downs have often wiped out large portions of the materials, tools, and knowledge bases (people) needed to rebuild the division of labor and continue the progression, I don't know of a case in recent history--at least since WWI--where so much was wiped out that the progression could not pick up again and continue.  (Even Argentina eventually picked up again.)

All previous war-related and natural disaster take-downs have been pre-globalization.  I know that one of the concerns about globalization is that in the event of a long-term disaster, the materials, tools, and knowledge for manufacturing and smaller scale but efficient agriculture (bigger than what can be called a garden, smaller than any place where the hog latrine can be called a "lagoon") may be outside the affected nation.  And there may be political tensions that prevent outside nations from helping re-seed the affected nation.  But so far no single disaster or group of disasters has come up that would be of such a scale to reduce the division of labor in the West, but I think Craigr has a saying in his signature line that applies here.

(BTW, Switzerland does still have manufacturing and agricultural production--not as much as in 1920, but it's not zip.  And there are countries--where union rules, taxation and overall government regulation are more substantial than in the USA--that have high productivity, higher quality of life, and no trouble developing and attracting manufacturing jobs.)
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Re: How Important is a Manufacturing Base?

Post by craigr » Fri Nov 12, 2010 2:02 am

I don't agree with Browne on this point when he's said it in the past. Countries need manufacturing for a variety of reasons. It is true that they may become more efficient than lesser developed nations, but this doesn't mean manufacturing is not needed. I think the crash of 2008 showed the weakness of relying on service based economics too strongly. Places like Iceland and the US had large parts of their economies based on financial services which exacerbated their respective problems.
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Re: How Important is a Manufacturing Base?

Post by Wonk » Fri Nov 12, 2010 8:13 am

Tortoise wrote: I'm interested in hearing some of your responses to the following question:  How important is a country's manufacturing base as a determining factor in its long-term economic prosperity?
Fantastic topic, I'm glad you brought it up for discussion.

Like you, I used to agree that a manufacturing base was an important part of any economy.  I don't agree with that statement as a whole anymore and do support Browne's position.  Put simply, world trade is the exchange of value from one individual or nation to another--whether it be in raw materials, widgets, or services.  The important idea is not what type of value you produce and exchange, but the balance of trade between the two.  For instance, China exports millions of widgets with a market value of $1T, but if the market value of banking services they receive from the U.S. matches $1T, it's a wash--even though it took a billion workers in China and only a thousand workers in the U.S.

As an economy matures, it will typically move up the value spectrum to receive a higher value unit per hour worked.  More higher-end value jobs like services and less manufacturing is the result.  Switzerland is a great example of this.  They do have manufacturing, but it is not a dominant part of the economy--it is mostly banking and service oriented.  An interesting case study would be Germany.  They still have a large manufacturing base, but what they manufacture primarily are advanced engineered products.  Their economy doesn't support manufacturing a $5000 Yugo, but does support manufacturing a $50,000 BMW. It requires a higher-skilled workforce (more engineers and less hammer bangers).  Also, see the Luxembourg economy (http://en.wikipedia.org/wiki/Economy_of_Luxembourg) as they have one of the highest per capita GDP in the world.  Do they need more $2 manufacturing jobs?  Nope.

One of the biggest problems the world currently faces is the balance of trade.  Since the 70s, China (even Japan, it can be argued) has engaged in mercantilist policies to stimulate exports.  They have prevented their currency from rising through that economic growth to maintain the advantages a developing economy offers.  This creates continued incentive to export lower-value jobs to China.  The problem is it has to stop at some point and it should have stopped long ago.  By allowing its currency to rise, the market can reflect the advances it's made over the years.  This, of course, would not be advantageous for exports--which is why they are fighting it.  

Last point, consider two areas: Palo Alto, CA and Detroit, MI.  Let's say they trade with each other.  Palo Alto produces software that Detroit uses to run their manufacturing plant.  Detroit produces the cars needed to commute daily in Palo Alto.  Although Palo Alto doesn't manufacture cars, they don't need to.  They "export" higher value in exchange for what they need on the lower value end of the spectrum.  The differences in average wages and standard of living are obvious.

But take that last example and move it up to countries.  That is what we see right now.  This is why dollar hegemony is so important from the U.S. standpoint.  The more dollars are exported to the rest of the world, the more the U.S. can use inflation as a worldwide tax on each dollar to make up for the imbalances in world trade (and dollar holders overseas don't vote).  Balanced trade used to mean $1 of value exchanged for $1 of value.  What the U.S. has traded is $1 of value for $1 of I.O.U.  When the U.S. needs to create another $1 to pay for the $1 promised, it will do so and dilute the value of the I.O.U.

Up to maybe 2009, China always thought the U.S. would make good on its obligations.  Oops.  They now understand they've been "check mated" and the value their manufactured goods were exchanged for (U.S. debt) will continue to be assaulted by inflation.  Of course, this opens up the gold issue--which has a life of its own--but an absolutely critical part of this discussion.  

Finally, I would support war-essential manufacturing sectors as a national defense policy, not a national economic policy.
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Re: How Important is a Manufacturing Base?

Post by Storm » Fri Nov 12, 2010 8:28 am

This is an interesting discussion, and I think Wonk brings up some particularly good arguments in favor of a service based economy.  However, let's take his example of Detroit and Palo Alto and replace it with China and Apple.  Apple designs amazing computing devices, and has them manufactured in China.  At first, China does not have the expertise to design and manufacture these devices on their own, so Apple must train them, design their factories and plants, and give them software used to manufacture the devices.  Over time, however, the Chinese factories learn to manufacture knock-off products that, while not quite as good as the Apple products, are close enough that people will buy them instead, and undercut Apple in the marketplace.  They no longer need to rely on Apple to help them design their manufacturing plants and process because they have become good enough at it that they can do it themselves now.  In this case, the service based economy is no longer needed, and the manufacturing based economy can now get a greater profit from exporting products on their own.

If you look back at history, you will see many examples where this has happened.  I can think of one big example:  British colonialism.  The British empire was the largest in the world at one point, with colonies on almost every continent.  The colonies were mainly farming and manufacturing based, and the American colonies in particular eventually surpassed the capabilities and technology of great Britain.

I would also ask if anyone could give one example where a country that exported it's manufacturing (like Great Britain) has ever maintained it's position as the primary economic superpower.  I can think of no example.

Our fate is more likely to become like the UK.  We will still be a large player in the world, and have a good quality of life overall, but by 2020 China will have a larger economy, and India will be close behind.
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Re: How Important is a Manufacturing Base?

Post by MediumTex » Fri Nov 12, 2010 8:45 am

As we have this discussion, remember the following:

The United States has the largest manufacturing economy in the world.

It's a smaller part of the economy than it used to be, but it's still bigger than any other country's.

I think that much of the decline of America's manufacturing base is a media-created narrative.
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Re: How Important is a Manufacturing Base?

Post by craigr » Fri Nov 12, 2010 11:08 am

MediumTex wrote: As we have this discussion, remember the following:

The United States has the largest manufacturing economy in the world.

It's a smaller part of the economy than it used to be, but it's still bigger than any other country's.

I think that much of the decline of America's manufacturing base is a media-created narrative.
Yes this is a point I have made as well when people want to exclude US Stocks from their portfolio and invest largely internationally due to things they've read. The US economy is still massive and exports all over the world. In over 20 countries I've visited I have seen the direct influence of US products at every level. It's almost impossible to travel anywhere and not run into a US Corporation selling their products locally.
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Re: How Important is a Manufacturing Base?

Post by craigr » Fri Nov 12, 2010 11:19 am

Wonk wrote:
Tortoise wrote: I'm interested in hearing some of your responses to the following question:  How important is a country's manufacturing base as a determining factor in its long-term economic prosperity?
Switzerland is a great example of this.  They do have manufacturing, but it is not a dominant part of the economy--it is mostly banking and service oriented.
The Swiss financial services model is under a lot of pressure from other countries, international organizations, tax laws, govt. snooping, etc. They face a situation now where they are not able to offer unique products that once before attracted outside clients (like banking privacy). They should be careful to prevent turning themselves into is just another bland banking establishment with high fees and pretty mountains. If they do this then their financial services industry could face very big problems going forward.

Up to maybe 2009, China always thought the U.S. would make good on its obligations.  Oops.  They now understand they've been "check mated" and the value their manufactured goods were exchanged for (U.S. debt) will continue to be assaulted by inflation.
China got a great deal. They haven't been checkmated at all. For the debt they bought in the US they had their economy brought from emerging market in many aspects to very high tech manufacturing as technology from the US has been shipped over there. If the US would go kaput tomorrow, China could simply write off that debt and still be light years ahead. The manufacturing capability US companies built out for them would continue forward for decades providing dividends. For a trillion dollars or so, China bought a very capable manufacturing base and knowledge to use it. That's a great deal compared to the Trillions the US has flushed down the toilet in overseas wars, bailouts, etc.
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Re: How Important is a Manufacturing Base?

Post by Wonk » Fri Nov 12, 2010 1:26 pm

Storm wrote: This is an interesting discussion, and I think Wonk brings up some particularly good arguments in favor of a service based economy.  However, let's take his example of Detroit and Palo Alto and replace it with China and Apple.  Apple designs amazing computing devices, and has them manufactured in China.  At first, China does not have the expertise to design and manufacture these devices on their own, so Apple must train them, design their factories and plants, and give them software used to manufacture the devices.  Over time, however, the Chinese factories learn to manufacture knock-off products that, while not quite as good as the Apple products, are close enough that people will buy them instead, and undercut Apple in the marketplace.  They no longer need to rely on Apple to help them design their manufacturing plants and process because they have become good enough at it that they can do it themselves now.  In this case, the service based economy is no longer needed, and the manufacturing based economy can now get a greater profit from exporting products on their own.
Good points Storm.  One great concern of mine is the pirating of intellectual property coming out of China.  They have been notorious for disrespecting international trade law.  Assuming that threat can be neutralized, I still believe the majority of value lies in the IP (including innovating new products) and service space.  You could have 1,000 Chinese in a plant developing a knock-off worth $1B, but if you have licensing royalties from 100 Americans equal to $1B, it's all the same in GDP.  Sometimes even superior products have a tough time winning unless they are marketed properly.  Take Android vs. Iphone as an example.  Droid is gaining share, but Apple knows how to sell.
Storm wrote:If you look back at history, you will see many examples where this has happened.  I can think of one big example:  British colonialism.  The British empire was the largest in the world at one point, with colonies on almost every continent.  The colonies were mainly farming and manufacturing based, and the American colonies in particular eventually surpassed the capabilities and technology of great Britain.

I would also ask if anyone could give one example where a country that exported it's manufacturing (like Great Britain) has ever maintained it's position as the primary economic superpower.  I can think of no example.

Our fate is more likely to become like the UK.  We will still be a large player in the world, and have a good quality of life overall, but by 2020 China will have a larger economy, and India will be close behind.
Looking back into history, I have a hard time finding almost any empire that lasts very long.  The Roman Empire appears to be the most successful.  A personal belief of mine from observing organizations of people is that when a "collective" in any form becomes too big, it starts to fall apart in relatively short order.  This includes empires, corporations....anything.  It just becomes too cumbersome to manage effectively.

Also, while I wouldn't bet against the outcome you described, I wouldn't bet on it either.  People were saying the same about Japan in the 80s.  No one is afraid of Japan right now and they have had a stagnant economy for the last 20 years.  I guess we'll just have to wait and see how it all turns out.
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Re: How Important is a Manufacturing Base?

Post by Wonk » Fri Nov 12, 2010 1:54 pm

craigr wrote:
The Swiss financial services model is under a lot of pressure from other countries, international organizations, tax laws, govt. snooping, etc. They face a situation now where they are not able to offer unique products that once before attracted outside clients (like banking privacy). They should be careful to prevent turning themselves into is just another bland banking establishment with high fees and pretty mountains. If they do this then their financial services industry could face very big problems going forward.
I would agree but I think they are still in the captain's seat.  The UBS fiasco was a major blow to Swiss credibility.  Although, they still have cache with the rest of the world.  As long as they continue to respect privacy, they will be fine.
craigr wrote:
China got a great deal. They haven't been checkmated at all. For the debt they bought in the US they had their economy brought from emerging market in many aspects to very high tech manufacturing as technology from the US has been shipped over there. If the US would go kaput tomorrow, China could simply write off that debt and still be light years ahead. The manufacturing capability US companies built out for them would continue forward for decades providing dividends. For a trillion dollars or so, China bought a very capable manufacturing base and knowledge to use it. That's a great deal compared to the Trillions the US has flushed down the toilet in overseas wars, bailouts, etc.
Sure, China flew in the tailwind of the U.S. to modernize it's society, but they will still have a steep price to pay.  I still believe in the old maxim: "He who has the gold makes the rules."  Notice China was not the buyer of 200 tons of gold from the IMF.  It went to India, more of an ally to the U.S. and less of a military threat.  I'm 100% guaranteed this was an intentional decision.  Right now, their gold reserves are 1,000 tons so they are just not in a place to make demands.  If they were to dump US treasuries right now the only thing you'd hear is the "swoosh" sound of their entire economy being flushed down the drain.  Modern manufacturing facilities are great until you figure out there's no one to sell widgets to.

From what I see, world power has its roots in the issuance of money and nothing else.  For as long as China accepts the routine haircut in purchasing power from the U.S., it will be better off than other developing economies, but it will not be a leader until it bucks the "buck."  China's economic existence right now depends on selling to U.S. consumers.  No one can step into that role from the rest of the world.  In order for China to be a superpower, they will need to figure out a way to diversify their economy and end dependence on the USD.  Both sides know this.  We like to party with their widgets and pay them with stuff that will be less valuable later on.  I do think there is a certain amount of chess going on and perhaps its unfair to say China has been checkmated.  Maybe it's more appropriate to say China just had it's queen taken for only a pawn in exchange.  Regardless, China now knows there's a player on the other side (however corrupt that player may be).

I'm not saying China won't pass the U.S. someday, but there are a lot of decisions to be made on both sides and major errors will have dire consequences.  Just look at Japan (of course the U.S. should start with this example).
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Re: How Important is a Manufacturing Base?

Post by Tortoise » Sat Nov 13, 2010 3:18 am

MediumTex wrote: As we have this discussion, remember the following:

The United States has the largest manufacturing economy in the world.

It's a smaller part of the economy than it used to be, but it's still bigger than any other country's.

I think that much of the decline of America's manufacturing base is a media-created narrative.
Perhaps you are right.  I suppose there is potential confusion out there between (a) the number of manufacturing jobs in the U.S., (b) the number of manufacturing jobs in the U.S. as a fraction of the total number of U.S. jobs, (c) the total economic output of the manufacturing sector in the U.S., and (d) the total economic output of the manufacturing sector in the U.S. as a fraction of the total economic output of the U.S.  Without clearly defined terms, the phrase "decline in U.S. manufacturing" is a bit ambiguous.  Come to think of it, even phrases like "total economic output" are a bit ambiguous unless defined clearly.

I came across an interesting graph that, if accurate, shows U.S. manufacturing employment as a percentage of the U.S. workforce has steadily declined since at least 1947.  Meanwhile, U.S. manufacturing output as a percentage of GDP has been pretty constant at around 13-15% since at least 1947 (presumably due to technological advancements increasing worker productivity over that period).  The employment decline--i.e., decline in the number of manufacturing jobs--is probably what most people are referring to when they lament the "decline of American manufacturing."

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Re: How Important is a Manufacturing Base?

Post by BobS » Sat Nov 13, 2010 12:04 pm

Tortoise wrote:
I came across an interesting graph that, if accurate, shows U.S. manufacturing employment as a percentage of the U.S. workforce has steadily declined since at least 1947.  Meanwhile, U.S. manufacturing output as a percentage of GDP has been pretty constant at around 13-15% since at least 1947 (presumably due to technological advancements increasing worker productivity over that period).  The employment decline--i.e., decline in the number of manufacturing jobs--is probably what most people are referring to when they lament the "decline of American manufacturing."
The U.S. represents approximately 21% of world Manufacturing, about 2.5 times more than China based on GDP.
The fallacy in globalization is that the decision to move or outsource jobs is based strictly on the cost of labor.  While a large consideration -
otherwise why would China be outsourcing to Vietnam and Indonesia, while India outsources to Mexico and the U.S.?  The one thing that makes
globalization possible is cheap energy.  As oil goes back up to $90/barrel and more, costs of everything will rise.

Given that the cheap, easy to get, high btu oil has peaked and is in decline, the cost of procuring energy will rise as the energy expended to extract
a barrel of oil (EROI) will decline from it's current 10:1.  (It was 30:1 in the '70s.)  Countries that were net exporters of oil will soon become
importers - Mexico.  See -

http://www.theoildrum.com/node/3810

Thus globalization will decline and follow more of a model that Emerson Electric is using - set up manufacturing where the market is and that means
some manufacturing comes back or we do without.
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Re: How Important is a Manufacturing Base?

Post by MediumTex » Sat Nov 13, 2010 2:48 pm

BobS wrote: The U.S. represents approximately 21% of world Manufacturing, about 2.5 times more than China based on GDP.
The fallacy in globalization is that the decision to move or outsource jobs is based strictly on the cost of labor.  While a large consideration -
otherwise why would China be outsourcing to Vietnam and Indonesia, while India outsources to Mexico and the U.S.?  The one thing that makes
globalization possible is cheap energy.  As oil goes back up to $90/barrel and more, costs of everything will rise.

Given that the cheap, easy to get, high btu oil has peaked and is in decline, the cost of procuring energy will rise as the energy expended to extract
a barrel of oil (EROI) will decline from it's current 10:1.  (It was 30:1 in the '70s.)  Countries that were net exporters of oil will soon become
importers - Mexico.  See -

http://www.theoildrum.com/node/3810

Thus globalization will decline and follow more of a model that Emerson Electric is using - set up manufacturing where the market is and that means
some manufacturing comes back or we do without.
I think we need to slice it a bit more finely than that.

For heavy manufactured goods (where transportation costs represent a larger part of the overall cost of production) then I would say yes, a permanent increase in the cost of energy would bring certain forms of manufacturing closer to the end user.

However, for other manufactured goods, such as microchips and silly plastic toys I would say that transportation costs are such a small part of the overall cost of manufacturing the product that at almost any energy input cost it would still make more sense to manufacture it in the lowest labor cost location.

The overall nexus between economic activity and peak oil, however, has MANY moving parts, and I think it's hard to draw any meaningful conclusion about what the future will look like, other than to say it will probably be different from today.

I could just as easily make the argument that peak oil will be deflationary as I could that it will be inflationary.  The idea that future shortages of oil relative to demand will necessarily result in price increases has, so far, not materialized.  What has happened instead is that world conventional oil production peaked around 2005, and by 2008 the anticipated inflation began to show up.  But then an interesting thing happened--the initial burst of inflation gave way to a much stronger deflationary trend that looks like it could be with us for quite a while.

In a pre-peak oil world, what would have been anticipated following an oil price spike would have been a decline in overall economic activity, followed by a collapse in the price of oil.  This collapse in the price of oil is part of the basis for an economic recovery as input costs become much cheaper, allowing for profit margin expansion.  In the first post-peak oil recession that began in 2007, however, what we saw was a very temporary collapse in the price of oil, only to be followed by a prompt return of high oil prices.  These high oil prices will make any durable economic recovery difficult, and any resulting price increases as a result of cost-push inflation are likely to lead to more economic softness, as opposed to sustained price inflation. 

Over at The Automatic Earth (a terrific blog, BTW) the energy piece of the puzzle is part of their overall case for long term deflation.

The really unfortunate aspect of where we find ourselves in the U.S. is that we have the macroeconomic triple threat of bad demographics, unfavorable fundamentals with respect to energy inputs, and the fallout from a financial crisis.  Any one of these three items can create a nasty set of economic headwinds for a long time.  What happens when all three of them happen at once?  I don't know, I guess we will find out in coming years.

The one bright spot on the energy front is that a lot of production is going to be coming online in Iraq in the next few years.  That may help with tight global energy markets and may provide some breathing room. 
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