Tuesday, April 12, 2011

Manufacturing, Services, and the Economy

Michael Spence and Sandile Hlatshwayo have published a paper titled: The Evolving Structure of the American Economy and the Employment Challenge. This article has attracted quite a bit of interest, with at least three articles published in response. The interest in the conclusions is explained not so much by any dramatic results, but by the timing and importance of the problem they address.

The authors divide economic activity into tradable and nontradable categories. Tradable refers to goods or services that can be exported to other countries. They point out that 97.7% of the net job growth between 1990 and 2008 has been in the nontradable category, with the dominant sources having been healthcare and government. With healthcare costs destined to be reigned in, and expanding government deficits, neither of these areas is likely to be able to sustain growth. The tradable sector has produced high-end job growth, but that has been balanced by job losses in the manufacturing sector.

Projecting trends into the future the authors foresee a continuing rise in value of the jobs in the tradable sector, but little net job growth. Meanwhile the value of jobs in the nontradable area will continue to decrease.
“Given the prospect of slowing employment growth in nontradables and rising competitive pressure on tradables, major employment problems in the near future are a certainty. Even if the nontradable sector is able to continue to absorb the growth in the labor force, pressure on wages and salaries will be downward, and consequences for income distribution unavoidable.”

“To create jobs, contain inequality, and reduce the U.S. current-account deficit, the scope of the export sector will need to expand. That will mean restoring and creating U.S. competitiveness in an expanded set of activities via heightened investment in human capital, technology, and hard and soft infrastructure. The challenge is how to do it most effectively.”
The authors consider any kind of protective tariff to be counterproductive. They suggest a few things that can be done to augment the tradable sector and to alleviate the growing income inequality. Included in their list are the standards such as improved infrastructure, and training and education enhancements. Their recommendation that has generated the most interest is this modest suggestion.
“It is probably a good idea to explicitly target some of the public-sector investment at technologies with the potential to expand the scope of the tradable sector and employment. Coinvestment with the private sector, which has relevant knowledge about where these opportunities might be, would make sense. This public investment would have the effect of shifting private incentives so that they are better aligned with social objectives.”
They had the nerve to suggest that the government should actually have an industrial policy and plan. How audacious!

The response from The Economist was to view the notion as having dubious validity. The basic assumption that the nontradables could not carry the employment load was rejected. These charts were provided.

They conclude from these data that the US is merely following a trend that is common to all developed economies. They disagree with the notion that the service sector will not be able to maintain job growth, even though Spence and Hlatshwayo did not actually conclude that, and dismiss any type of industrial policy as unnecessary and likely to fail.
“In fact, it is far from clear whether, and how, such a policy might work. But many would question the need for this sort of industrial policy in the first place. If weak demand keeps American interest rates and the dollar low, the tradable sector is likely to expand without needing a public-policy shove. America remains the world’s largest manufacturer. Both America and Japan roughly doubled manufacturing output between 1980 and 2009; nowhere in the G7 has output declined in absolute terms. Lower-end manufacturing has indeed moved to countries like China, with their masses of cheap labour, but it is not obvious why this pattern of comparative advantage should be resisted.”

“Nor is it clear that global demand for services—tradable or not—is going to slow. As emerging economies become richer, they will want more of all sorts of services, including sophisticated ones where countries like America and Britain retain a comparative advantage. Those who pitch for manufacturing on the ground that it is better at boosting exports often ignore the fact that an increasing number of services are traded, and that rich countries tend to export more of them than they import. America and Britain, for instance, typically run surpluses in services.”
The Economist provides the typical conservative economic point of view. While Spence and Hlatshwayo were concerned that an already intolerable degree of income inequality would continue to grow, The Economist takes no note of that. It is as if the fate of individuals is of no consequence.

On the other end of the spectrum is the response of Ian Fletcher in an article in the San Francisco Chronicle where a leftist viewpoint is provided.
“One thing is for certain already: global trade as we know it will not be here in 10 years. It may even be gone in five. The unsustainable U.S. trade deficit alone assures this.”

“Since the end of the Cold War, and accelerating after adoption of the North American Free Trade Agreement (NAFTA) in 1994, Washington has pursued a globalized American economy made possible by ever-expanding "free" trade agreements, a policy of unconditional economic openness. This is going to be replaced by some kind of managed trade, and hopefully, a kind involving a more protectionist United States.”

“This is not a utopian project. In fact, it was once already achieved, during the long 1790-1945 era of American protectionism. We wandered away from Alexander Hamilton's vision of a relatively self-contained U.S. economy in order to win the Cold War. We threw open our markets to the world as a bribe not to go communist. If we fail to return to a policy of strategic, not unconditional, economic openness, we may lose the next Cold War - to a Confucian authoritarianism no less opposed to the idea of a free society than Marxism, and considerably more efficient.”
Steven Pearlstein provides a more balanced approach in a Washington Post article.
“One response to this dilemma would be to build trade barriers, which Spence, like nearly every other economist, thinks would be a big mistake. But at the same time, he is equally dismissive of free-market cheerleaders who argue that globalization makes everyone better off in the long run — a view, he says, that is not supported by theory or experience. More significantly, it is a view that is increasingly rejected by voters.”

“Instead, Spence argues that what’s needed is a new policy tradeoff that strikes a better balance between the efficiency and overall economic growth that globalization delivers and the inequality of incomes and job opportunities that it creates.”

“In Spence’s view, redistributing income from the winners to the losers of globalization can only get you so far. The bigger challenge, he says, is to find a way to tilt the market incentives so that businesses — in particular, big multinational corporations — are more willing to invest in the physical and human capital necessary to make American workers more productive, rather than simply outsourcing work overseas.”

“There is a name for such “nudges” — it’s called industrial policy — and for the past 30 years it has had something of a bad odor in Washington under Democrats as well as Republicans. Larry Summers, until recently President Obama’s top economic adviser, was an unabashed skeptic and Treasury Secretary Tim Geithner seems to be squarely in that camp as well.”

“There’s no question that sometimes governments get it wrong. There’s also no doubt that governments can get it right, whether it be the lighter touch of European countries such as Germany and Finland or the heavier hand exercised by economic policymakers in China, Korea and Singapore.”
Pearlstein has struck the right note. The US is probably the only country that has not depended on a government-based industrial policy at some time in its past. They can be made to work. And he agrees that the growing income inequality must be addressed.

Spence and Hlatshwayo have produced a long and detailed analysis that must have required a considerable amount of time to produce, and their most recent data are probably at least a year old. Is it so that economists, like generals, are always fighting the last war, not the current one?

What a difference a year can make. Is it possible that globalization, as we have known it, will be limited by its own excesses, and produce some of the positive results we need without having to make difficult and uncertain investments? There may be a perfect storm gathering to force a reversal of some of the production outsourcing that we have experienced. Wages in China are going up and the government recognizes the need for a more balanced economy, while at the same time needing ever expanding imports to accomplish perhaps the most ambitious construction plan in history. Unpredictable transportation costs due to volatility in the petroleum market are beginning to weigh on the minds of many importers. International corporations have recognized the wisdom of manufacturing their products within the market for their products. Japanese auto plants in the US are now struggling because they depended on a steady flow of parts from Asia. Might it now make sense to have a plan B? Having a local source of parts that could provide a back-up and load-leveling capability seems like a prudent business practice. Hardly a day goes by where there is not at least one article reminding us companies are rediscovering that local businesses are accessible, provide faster turnaround, and are more convenient for monitoring quality. Perhaps major changes are already underway. But that is still no excuse for not having a plan.

On a positive note, here is another chart provided by The Economist.

Note that for the first time in the period covered the number of jobs in manufacturing has actually turned upwards. Let us allow ourselves a few brief moments of optimism.

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