DRI-406: The Narrative of U.S. Manufacturing Decline

Cassandra was the Trojan seer who foresaw the end of the Trojan War – the Greek ploy that lulled Troy’s inhabitants with the gift of a gigantic wooden horse and the city’s consequent fall when emerging Greek commandos overpowered the Trojan garrison. Since her day, the business of making prophecies of doom has gained popularity but lost accuracy.

Cassandra’s imitators presumably are not out to emulate her subsequent career, which was short. They are following the rule of thumb that the first duty of any prognosticator is to reach an audience. In this respect, doomsayers have a built-in advantage. Good news labors under the handicap that it is a call to inaction. Bad news is both attention-getting and galvanizing.

Economics is a ready-made field for predictions of doom because change is constant and virtually all change is bad news for somebody. Industry has been a popular venue for doomsayers since the heyday of mercantilism in the 17th century. Mercantilists believed that international trade was a two-edged sword from which domestic industry must be carefully shielded, lest its sharp edge cut against the grain of prosperity by draining the country of specie (monetary precious metals).

Modern-day mercantilists have refined their arguments. Doom now appears in the form of endangered industry. Wily foreigners are exploiting the good nature and naïve faith of American businessmen and officials. Their manipulations usurp American competitive advantage and cost the U.S. revenue, profits and jobs. These wounds are not suffered randomly but strategically, in sectors and industries that benefit us extravagantly and whose loss inflicts disproportionate harm. The most readily identifiable of these seems to be the manufacturing sector.

 

The Decline and Imminent Fall of U.S. Manufacturing

Rather than traffic entirely in generalities, we will allow one recent narrative of U.S. manufacturing decline to speak for all. Worse Than the Great Depression: What the Experts Are Missing About American Manufacturing Decline was published in March, 2012 by The Information Technology & Innovation Foundation. Its authors are Robert D. Atkinson, Luke D. Stewart, Scott M. Andes and Stephen J. Ezell. Generally speaking, its thesis is that U.S. manufacturing has been going to hell in a handcart ever since 1979, but that the cart was motorized around the turn of the millennium.

We know what it means when a person goes downhill – it means their health suffers in obvious, well-understood ways. We know what that means for an individual business – revenue and profit suffer. There may be other, more subtle indicators as well, such as declining market share and market size. But what does it mean to say that an industry is going downhill? And what, in particular, does it mean to say that an entire industry sector – like manufacturing – is suffering? Can any such meaningful condition even be identified?

The authors obviously think it can. They address the question using the vocabulary of the individual firm – as if an industrial sector were no different than a great big business firm. They begin by saying that in the (approximate) decade of the 2000s, America lost 5.7 million manufacturing jobs. They call this the “worst performance in American history…[an] unprecedented negative performance” that was nonetheless accepted complacently by pundits and politicians, who wrongly attributed it to landmark increases in U.S. manufacturing productivity that made it possible to produce more manufacturing output with less labor input.

Yet, the authors contend, 13 of 19 U.S. manufacturing sectors now produce less real (e.g., inflation-adjusted) manufacturing output than in 2000. Here, the authors rely heavily on their contention that government computation of real manufacturing output is very badly overstated – which in turn badly overstates labor productivity in manufacturing.

Labor figures importantly in the authors’ lament for the loss of manufacturing jobs. Mainstream economists view a manufacturing job as – well, just a job like any other job. Wrong, the authors contend. A manufacturing job is special. “Manufacturing jobs pay more.” They are “a source of good jobs for non-college-educated workers.” Manufacturing “is the key driver of innovation” – which in turn determines productivity and wages.

The stage is set for the entrance of the villain. A good prophesy of doom cannot subsist on a simple explanation like “market forces” or “normal evolution.” That would be an anti-climax. The decline of U.S. manufacturing is attributed by the authors to our “lost ability to compete in global markets – some manipulated by egregious foreign mercantilist forces, others supported by better national competitive fitness policies, like lower corporate tax rates.”

 

Newton’s Law of Polemic

There is an informal but powerful law governing polemical exchanges, which states that each contention must be met by an opposing contention of (at least) equal and opposite power. That is, the visceral reaction to this sort of thesis of decline is to vigorously insist that American manufacturing is not declining. “No, by George – why, it’s even increasing! It’s clear as a bell – even a fool could see it. Just look at this indicator, not that silly one that my opponents used. Just look at my data, not that rubbish produced by those boneheads.”

And it is true that, in this case, there is some basis for this reaction. After 27 straight years of decline, real U.S. manufacturing output rose 21% between 2002 and 2007. Then, between 2007 and 2012, it rose 13%, even into the teeth of the Great Recession. Even if we accept the author’s hypothesis that the absolute gains are overstated, the relative trend over the last decade would certainly seem to be upward. That hardly squares with their hypothesis of Kryptonian doom for the sector. The authors’ trump card is manufacturing employment, which fell for 38 straight years between 1979 and 2007. But it, too, rose by some 4% recently; manufacturing has been the most improbable of silver linings in an otherwise solid overcast darkening the employment horizon.

According to David Wessel and James Haggerty in The Wall Street Journal, the rebound in U.S. manufacturing employment was fueled by a decline in manufacturing wages. If true, this would hardly be a surprise, since classical economic theory posits that flexible wages and prices serve as “shock absorbers” to cushion the effects of real shocks such as declines in demand and temporary decreases in supply due to transitory factors. Instead of a scenario in which markets are thwarted by dark forces and sinister agendas, this sounds more like well-functioning markets at work.

In spite of this countervailing evidence, though, the Newtonian reaction should be resisted. The real problem with these dueling arguments is that “manufacturing” is an artificial category, not a true economic one. Consumers do not buy “manufacturing” – they buy individual products that economists more or less arbitrarily classify inside or outside of the box known as “manufacturing.” Businessmen do not decide to produce “manufacturing” – they produce the produces they think consumers want to buy, where “consumers” could refer to buyers of final products or other businessmen buying intermediate products in the production chain.

The Expert’s Error

A central underpinning of the sectoral decline hypothesis is the assertion that the composition of U.S. industry “should” be weighted in favor of manufacturing. Supporters propound this with such confident nonchalance that non-specialists may be startled to realize its flimsiness.

There is no reason to suppose that any a priori pattern or organization of industry is preferable. In effect, declinists want to impose their will upon the structure of production so as to guarantee a pleasing result for consumers and input suppliers. But it is precisely the wants of consumers and the welfare of input suppliers that should dictate the pattern of production.

The hypothesis cites levels of manufacturing output attained during past halcyon periods as the norm or desideratum by which we should be guided. But every industrial sector has its historic ups and downs. Throughout the 20th century, farmers demanded price and income “parity” with their status in the first decade or so of the century – not surprisingly, a time of unprecedented agricultural prosperity. Despite their failure to reach this standard and despite a prolonged and continual exodus of farmers from the industry, U.S. agriculture has continued to supply the needs of the world.

The authors point to the high historic wages paid by manufacturers. They juxtapose this against a backdrop of falling real wages in the U.S. Surely this is not coincidence. Falling U.S. wages must be caused by the loss of U.S. manufacturing jobs.

This analysis suffers a kind of error common to an information age preoccupied with the views of experts. Teachers of the game of contract bridge recognize a species of error almost always found in the precincts of expert bridge. An “expert’s error” is so named because it requires an expert to think of it – an ordinary player would not have either the imagination or the background to dream up the reasons for committing the mistake. Now we have an economic version of the expert’s error.

It would not occur to the average person to classify numerous, diverse business firms together according to the sole criterion that they transform physical inputs into a physical output. Still less would it occur to them to elevate this classification above all others on a normative scale. Only an “expert” in industrial organization would commit such a taxonomic blunder.

Classification and taxonomy, though, are activities in which experts regularly engage. They also make extensive use of government classifications such as the federal government’s Standard Industrial Classification (SIC) and North American Industrial Classification System (NAICS) codes, which classify business firms using a system in which longer numbers denote increasing degrees of fineness. To an expert, it seems only natural to see generalities and statistical regularities in these classifications, in the same way natural scientists discern the laws of nature from observation.

Thus, when the U.S. Commerce Department classifies thousands of businesses together as “manufacturers” because they perform various physical operations that seem to possess a family resemblance, the expert immediately grasps the opportunity to seem knowledgeable and important by referring to the “manufacturing sector” – as if all the firms inside this classification really and truly had enough in common to warrant such treatment.

But the overriding economic reason for viewing businesses analytically as a class is that they are competitors. That is, they produce goods and/or services that are viewed by consumers as economic substitutes. Since the SIC codes are organized by physical operation performed rather than by (consumer perceptions of) substitutability, this makes very little sense.

Similarly, when experts observe a big, successful nation that has lots of manufacturing firms, they tend to jump to the conclusion that – post hoc, ergo propter hoc – success must stem from manufacturing. But economists identify the locus of economic production value in a principle called comparative advantage, first noted in 1817 by English stockbroker-turned-economist David Ricardo. Ricardo explained that nations tend to specialize in producing goods in which their comparative costs of production (what economists have come to call opportunity costs) are lower than those of their trading partners. Comparative advantage has nothing to do with manufacturing or farming or finance or any sectoral designation as such.

The grand theses of sectoral decline have nothing to do with economics. They have everything to do with tradition and tribal loyalty and habit and appearance – almost everything except economics. They are not the result of profound, systematic thought. They are a substitute for thought.

This lends any analysis of manufacturing an artificial character that, in and of itself, should make anybody cautious about reaching conclusions, whether gloomy or sunny. Any that’s just the beginning of the reasons for rejecting the declinist hypothesis.

 

The Intellectual Pedigree of the Endangered Industry hypothesis

Another tipoff to the internal inconsistency of the industrial decline hypothesis is the behavioral history of the proponents. When their intellectual careers and pedigrees are examined, flagrant contradictions emerge.

A prime example is the common hostility toward finance. This is simply the mirror image of their insistence that a thriving nation must “make things;” that is, physical goods. Since the physical manifestation of a financial asset seldom amounts to more than a piece of paper – and may be merely digital symbols inside a computer – there is an apparent consistency between these attitudes. It is certainly ironic that a left wing that has lived by excoriating the crass materialism of capitalism should itself embrace such a crude form of materialism.

The materialists – descendants of early socialists like the Physiocrats and Mercantilists – are also devotees of the “limits to growth,” extreme environmentalist view that mankind must reverse the path of industrial society to avoid exhaustion of natural resources and planetary catastrophe. The substitution of services for goods and financial production for physical production should fit in with this strategy. After all, finance is defined as the allocation of resources over time under conditions of risk, which responds to the complaint of the physicalist school that capitalism takes a near-sighted, heedless view of reality.

In essence, the physicalists are reduced to saying not that markets are wrongly focused, but that they simply don’t work. But this contradicts not only with history, which clearly shows that only markets can successfully produce goods and services, but also with the doomsayers’ own position, which is that markets worked beautifully at providing manufactured goods – until they didn’t.

The fall-back position of the materialist, environmentalist school must then be that people just want the wrong things. The wants of the physicalists are inherently superior and should be substituted for those of the population at large – by force if necessary. And it will be necessary, because evidence and experience reveals a general unwillingness to forego the comforts and pleasures of modern industrial society for the dubious strictures of the totalitarian left.

What is the Remedy for Manufacturing Decline?

The authors prophesy a downward spiral for American manufacturing, presumably culminating in extinction. Unless – well, they list two types of remedial action: “egregious foreign mercantilist” ones and “national competitive fitness” ones. While they don’t actually advocate the former, note that they credit them with helping to wreck American manufacturing. This is another recurring theme of the doomsayer business – the bad guys have all the ammunition. Even their crudest tactics work; even the smallest and least capable countries can push America around because their very weakness and inferiority constitutes an advantage over us.

The concept of “national competitive fitness” is the really intriguing feature of their analysis. This is nothing more than the notion of industrial policy, thinly disguised. The national government decides which sectors, industries and firms will succeed, and then fulfills its own prophecies by choosing from a wide-ranging menu of economic policies. Some of those policies, like the previously mentioned lowering of corporate taxes, may have considerable merit quite apart from the question of industrial policy. That is, they may be the right thing to do not because they will help the “right” firms, industries or sectors emerge triumphant but because they will better serve the cause of economic growth.

Industrial policy itself, however, has a fairly long and decidedly undistinguished history. Readers with good memories will remember the 1980s, when the economic success story du jour was Japan. Conventional thinking ascribed its success to MITI, its industrial planning arm, which supposedly equipped its firms to rampage across the globe, undercutting domestic firms and wreaking export havoc. Bestsellers like the late Michael Crichton’s Rising Sun foretold that we would someday drink toasts to the yen in Saki.

How are the mighty fallen! Today nobody thinks about Japan at all, except to worry about whether radioactive fallout from its stricken nuclear reactors will reach our shores. Even before its disastrous earthquakes and tsunami, Japan had been an economic basket case for well over a decade, done in by its Keynesian over-spending and loose monetary policy. Apparently the wily Oriental mind is just as susceptible to bad economic advice as its Occidental counterpart.

The bald, bitter truth is that there is no precedent whatever for supposing that any government can micromanage its economic future to the extent of controlling the rise and fall of industries or industrial sectors. Bailouts of individual firms have never achieved unequivocally good results. Founding father Alexander Hamilton made a case for tariffs as industrial policy, but it is difficult to think of even one legitimate example of Hamilton’s famous “infant industry” – an industry picked out by the national government in its gestation period, carefully nurtured through its early, formative years and eventually growing to robust dominance and independence. Instead, firms and industries that feed at the federal trough become addicted and are never weaned away. They remain weak cripples for their entire business lives.

 

Industrial Declinism and Constructivism

The strong visceral appeal of industrial declinism probably traces to the emotional buttons it pushes. We had something good in the past. That thing is slipping away. We are losing control of our lives. That simply can’t be good, let alone necessary and inevitable. If we once had it, it must have been because we willed it so. By trying very hard, we can bring it back. We can will it to return. What we once created, we can once again regenerate.

In fact, there is no logic or empirical evidence to back up anything in the preceding paragraph – except for the fact that American manufacturing success was indeed a good thing. It may or may not actually be slipping away. But we are not losing control because we never had it. We never willed our manufacturing ascendancy and we cannot regain it simply through force of will.

Free markets work through a subtle and complex process of cultural evolution and information exchange that surpassed the full comprehension of any one person or any panel of experts. That is how markets extract the inchoate and dispersed information tucked away in the brains of billions of people and make it accessible to the world. It is a kind of hubris to pretend that national governments – one of humanity’s most cumbersome, least efficient, least benevolent institutions – can somehow reshape this process to the liking of a select group of politicians. This attitude was labeled constructivism by the late F. A. Hayek, Nobel laureate and social theorist extraordinaire.

Free markets allow consumers to dictate what is produced and in what quantities. Competition between producers determines what techniques are used in production. But the manner in which these determinations are made is impersonal rather than collaborative and consultative. There is no reason to think that a cartel or an industrial planning board could improve on the workings of the impersonal market and every reason to doubt it. That is why we should resist the urgings of the industrial declinists. They may be wrong. But even if they are right about the decline of manufacturing, they are wrong about the need to arrest it.

And if you’re wrong even when you’re right, you must really be missing the mark.

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