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Sunday, July 27, 2003


Along with the rest of the archives in the weeks between April 18th and July 2nd, the current article has disappeared into some dismal Black Hole of Cyberspace-Purgatory, its final fate not yet known. Originally published on June 7th, it now appears here as a re-run, revised and updated . . . part of the mini-series on the US economy that began in May and June here.

John Allen, a visitor to the buggy site, has kindly sent us the following observations and queries:

In thinking about the slow response of the US economy to its recession, what role has the loss of industrial competitiveness had to do with this? I read that Boeing will have the wings on its new jet design made in Japan. This is one of the critical technologies in the aerospace industry that another US company is strengthening overseas. Do you have any particular insight on why Fingleton is either right or wrong?

I am referring to this article in Insight Magazine ; Samizdata; unsustainable ; and again unsustainable

It seems despite all the billions that were put in R&D investment during the bubble in the 90s, our economy did not reach a new plateau in terms of technologically driven economic activity that competitively revitalized strength of the economy.



John, many thanks for the provocative comments, the more so since the underlying logic and worries connected with it are widespread among the public. Overwhelmingly, as it happens, that logic is misguided and the worries unnecessary (except, of course, for certain workers who might lose their jobs in those industries or firms referred to, something we'll take up in a few moments: there are ways to help them without resorting to protectionism).

Misguided --- how so? For several interconnected reasons.


How An Economy Remains Dynamic, Innovative, and Wealthy

Note first that a dynamic economy like the US --- which has maintained the highest per capita income in the world since the 1880s (it's about 30-50% richer on that basis compared to Germany and Japan and France and Britain and Italy) --- remains by far the most productive and most innovative. That's on an economy-wide basis. It does not follow that every industry will always be the most productive and most innovative or competitive in the world. It would be astonishing if that were the case.

In particular, as industries, especially manufacturing, have developed and improved abroad and have cheaper labor costs, their productivity exceeded ours in some areas of textiles, consumer electronics like TVs and VCRs, integrated steel and steel sheets (as opposed to mini mills and specialized steel), and some areas of autos and auto parts. In the process, the manufacturing sector of the US economy has fallen from about 40% of the US labor force in 1950 to around 13% today (see the link below). That parallels the big reduction in agriculture that employed 80-90% of Americans in most of the 19th century. The shift to a new information-base economy since the 1970s --- driven by the big breakthroughs in ICT (biotech is booming too, as will nanotechnology) --- is creating a new service-oriented economy, based on information-flows and brain-power, with innovation built into it.


Manufacturing Industries

That doesn't mean we're losing all manufacturing, only those parts that others can do better or cheaper, something that frees capital, skilled workers and scientists and engineers, and managerial talent for new, more promising high-value industries. In the meantime, the US auto and steel industries are now generally competitive again, but with a much smaller labor force and with Chrysler taken over by Mercedes Benz. Japanese auto makers, as we'll see in the next article at the buggy prof, are hastening to relocate their production here . . . a trend at work for a decade, but reinforced now by the cheaper dollar: about 80% of Japanese autos sold here are produced in the US (using mainly US component inputs, but not entirely). Integrated steel mills in this country, with less than half the labor force of the 1980s, actually have higher labor productivity than the Japanese mills these days (about the same as in South Korea), but are stuck with unusually high pension fees. They also no doubt face now and then some import surges owing to government-backed steel production abroad. Oppositely, mini-mills that produce specialized steel products out of sheet-metal are booming and are by far the most productive and competitive in the world. They now have over 30% of the US steel industrial output, and that figure will continue to grow.

As a general thing, the US remains highly competitive --- or the world leader --- in aircraft production, most vehicles, specialized steel, specialized textiles, computers, software, networking, communications equipment and technologies galore, chemicals and synthetics, weaponry of all kinds, food processing, agricultural products too numerous to mention, pharmaceuticals, bio-tech, petroleum products, construction, business services and consulting, lumber and wood products, and on and on; never mind the superior performance of US banks and the financial sector generally or CNN or the movie and TV business worlds. Or for that matter, Amazon, Wal-mart, MacDonald's, and the like.

Two other points are prompted here.

First, the distinction between manufacturing and services --- especially in ICT --- has been blurred: is IBM a manufacturer or a service industry or both? In VCRs, almost all the value added is in the software information: the actual hard materials that enter into the production are limited (though labor costs mean that most of them are made in the Far East and especially China and SE Asia now, where labor is cheap).

Second, as the last examples involving Amazon, Wal-mart and so on suggest, the distinction between "high-tech" and "low-tech" isn't so much the product, as it is which firms are rapidly making good use of ICT: think of Walmart, suddenly bursting onto the scene two decades ago in Arkansas, and then --- because of good management and a quick use of new ICT for inventory control --- becoming the biggest retailer in the world. Or think of MacDonald's, with its tens of thousands of restaurant outlets abroad.


Creative Destruction

In a dynamic economy, as older firms find they can't compete at existing levels of productivity and business-costs, labor and capital have to be reallocated into new, more dynamic industries and firms in it. All this is desirable from a national perspective, and desirable for long-term growth. It reflects what we call "creative destruction": you can't create a dynamic industrial economy based on electrification, the internal combustion engine, mass production, and new forms of financing consumer durables --- the US economy that emerged after the 1880s and prevailed until the 1970s (with a new big spurt of clustered revolutionary technologies occurring after the 1930s, such as air travel, mass travel generally, synthetics, the mass media etc) --- without reducing considerably the percentage of the work force and capital in agriculture.

The long-term results?

From 60% of the US work force around 1900, agriculture has shrunk to around 3.0% these days. In the process, it has become the most efficient in the world, and 3.0% can now feed 97.0% of the rest of us even as they export 40% of their agricultural products abroad. Similarly, US manufacturing employment has fallen from 40% in 1950 to around 13% today. (For most EU countries, the manufacturing sector is also under 20.0% of the labor force these days; in Japan, it's slightly above it, and in Germany and Italy around 24.0% --- not, I add, an advantage for these latter two, top-heavy with employment in those sectors, with more and more of the manufacturing firms simply uncompetitive internationally.) In the meantime, as occurred after WWI, the economy retains a remarkable ability to create new and well-paying jobs. Essentially, the only part of the labor force that's been hurt is low-wage, poorly educated workers, roughly the bottom 20%. Their wages actually fell each year after 1975 for two decades. But they are employed, compared especially to the EU countries; and what's more, as productivity increases kicked in and GDP growth surged after 1995, low-wage workers actually found their incomes rising faster than those of the top 20% wage-earners. The moral? The best way to raise even the incomes of poorly educated workers --- who can't easily benefit from the New Knowledge-Based Economy --- is to keep the economy growing as close to full-employment (roughly 4.0 - 4.5%) as possible.

In short, all the evidence suggests, in line with standard economic theory about the benefits of free trade and competition and the reallocation of scarce resources --- capital, managerial talent, and skilled workers --- that letting competition flourish in an economy, generated both by domestic and foreign firms and their exports to us will make for a far more flexible, dynamic, richer country in the long run. The proof? The US economy remains the richest in the world, something it has been for the last 120 years. Its per capita income today is about $36,000, compared to Japan's $25,000 and an EU average (where Germany, France, Italy, and Britain more or less are) of around $24,000.


The Counter-Examples: the EU and Japan

By the reverse token, as the last stats about per capita income indicate, all the evidence suggests that the efforts of the EU and Japan to protect key manufacturing industries over the decades have backfired. Badly.

Consider the outcome. The Japanese economy is now buried under a mountain of cumulative protection, subsidies, debt, and other forms of market inefficiencies, and its future looks bleak, especially as its population is aging rapidly and has to be supported by an ever smaller work force. It will be lucky to count itself in the front rank of industrial countries by 2020. Of the 15 EU countries, three or four small ones have been adapting decently --- not that they couldn't do better --- but all the big ones save maybe Britain struggle along with rising long-term unemployment, slow growth, stagnant population growth and rapidly aging populations, and high welfare costs, aggravated by rigid labor markets. They too, again save for Britain, are buried under (slightly smaller) mountains of self-created market inefficiencies, and their future --- according to a new French government-academic study --- is generally bleak.

Something else reinforces those problems: a cultural and social thrust, at work for decades now, that has produced a kind of learned helplessness on the part of most of the EU populations in the face of change and a willingness to accept the need for it and move and find jobs elsewhere. The problem here is really one of incentives: a lack of entrepreneurial energy, blunted and highly circumscribed risk-taking (aggravated by marked punishment for any failures, whether in creating a business or trying to change professions and get retrained or, earlier in life, dropping out of university and then coming back with a maturer outlook), and a belief that the state has a duty it will deliver on to keep you living and working your whole life in the same city or nearby region. This is doubly the case for countries like Sweden, Norway (not in the EU), and Belgium where most of the population either lives on government transfers or is in the government sector of the economy. For an excellent up-to-date study of this, see the work by Assar Lindbeck --- one of Sweden's best economists (the country has lots of good economists), and a former member of the Social Democratic party there who has been convinced, for about two decades now as he quit the party and moved to the center and moderate conservative point in the political spectrum, that Sweden and most of the EU may be near to a point of no-return in the destruction of any sense of self-responsibility and the personal incentive required for it.

The upshot? Unless the EU countries rapidly and drastically reform and find ways to increase labor-force numbers in the future, they will --- according to this study --- be a second-rate industrial bloc by mid-century, falling further and further behind North America and large parts of Asia. See a good summary of the study put out this last May in the International Herald Tribune.


What About the Laid-Off Owing to Trade Competition?

Something else that's true. Some people, laid off in industries that aren't any longer competitive fully --- as in autos and steel and parts of textiles compared to the 1980s and earlier --- never find equally good jobs. Most do, especially if they're willing to relocate and be retrained. (A good study around 1995 of the Clinton Council of Economic Advisors, which traced out what happened to downsized and laid-off workers, showed that well over half had found other, better paid work. About a quarter found equally well-paid work; the remaining quarter had to take jobs that didn't pay as well.) Three pre-conditions are essential here:

  • A willingness to accept change, something Americans are almost uniquely inclined to do.

  • A good growing job-market over the long run, again something the US economy is outstanding at doing: 50 million new jobs since the mid-1970s, with the labor force participation rate rising from 60% to 67% over the same period. (True, the big slowdown in productivity between 1973 and 1995 meant a slow increase in real wages as the US economy and work force adjusted to the big oil price hikes, new international competition, and new promising technologies for remaining competitive and increasing productivity again came into being and required a long learning process to make good use of.)

  • The willingness of the US government --- even as it maintains a commitment overall to freer trade and investment inflows and outflows --- to help workers who lose jobs to foreign competition to relocate and retrain with what's called "trade-adjustment assistance": specifically, income support for several months above and beyond unemployment insurance to encourage the workers at all levels of declining firms to move on and find other jobs.


    To Explain

    The latter comment calls for some clarification. Start with the two kinds of compensation the US government offers to laid-off workers:

    [1] Unemployment insurance --- which runs normally for 26 weeks --- has been extended another 13 weeks since 2001 (after some initial resistance from the Bush administration and some Republicans in Congress). It wouldn't hurt to increase this again, if need be, when those 13 weeks run out as they will for most workers this summer or fall. True, you have to take into account incentives. If unemployment benefits are extended too generously into the future, that lessens the incentive of people to find a suitable job and adjust their expectations accordingly. For the most part, it appears, such benefits have been too generous in the EU --- and too high, though these have been adjusted downward in most countries there for the last decade. By contrast, Americans are much more inclined to see work in positive terms than Europeans, something brought out in the far longer work year in this country than in Europe where paid vacations and holidays can produce up to 8 to 10 weeks lower work than here. To that extent, then, there's little reason to assume that an extension of benefits into the winter or spring for those whose benefits run out this summer or fall will have a dire impact.

    [2] Another government program exists that directly helps workers laid-off because of trade competition: trade adjustment assistance, which has been around in the US since the mid-1970s, with some ups and downs. More recently, it has restructured to concentrate less on job-retraining by the government itself, directly or indirectly, and much more on compensating laid-off workers for up to two years who find new jobs but at lower wages. More concretely, in those two years, the US government will pay the difference in lost wages. What's more, the new program --- a pilot one working out well, ever since it was created by the Trade Act of 2002 --- doesn't explicitly have a retraining component. Even so, better educated workers have been found to spend part of the wage-compensation for some retraining, with the rest left to the firms that employ them. Unfortunately, a problem that's been around for 25 years now ever since the manufacturing sector began to shrink, workers with less than full high-school education don't benefit as much when it comes either to finding new jobs to replace those lost to imports or to the money spent on retraining. See the highly informative article on this in the New York Times for July 28th, 2003.


    Further Evidence

    Again, save for sudden bursts of import surges (as happened after 1997 when the Asian currencies plunged and US imports of Asian manufacturing products more than doubled in one year), the evidence strongly supports these general observations.

    The main drawback of an over-strong currency of the sort the $US got stuck with after 1997 --- which was paralleled by a rise of 60% against the German DM and later the euro --- is that it encourages such import surges that no economy can fully and quickly absorb, not even the US economy. The result? Protectionist backlashes will surge too. Unfortunately, President Bush --- for political reasons largely --- put temporary protection around steel and some other industries last year (since then, moderated). The only good rationale beside political demagogy? Bush appears to be strongly in favor of free trade, not least for the Americas, and temporary relief in these hard-hit industries might have been necessary to save a free-trade coalition in Congress for the future. All the same, markets adjust eventually; and in the present case, the decline of the dollar ---- very rapid the last 18 months against the euro, much less so against the Asians --- has not only brought import relief to these industries (or will: it takes time for currency changes to show up in trade), but is hastening the relocation of Japanese and no doubt other foreign production in autos, say, to this country. That's because a cheaper dollar (about 9-10% on a trade-weighted basis) --- provided it looks like lasting a few years at least --- makes US labor less costly than before compared to foreign labor, taking into account productivity levels of the labor force in those industries.

    Finally, as for Boeing, there are essentially only two major commercial airplane manufacturers in the world; Boeing and Airbus, the latter subsidized by EU governments, the former subsidized to an extent by US defense contracts. In both cases, we're faced with monopolized forms of competition (duopoly in effect), with government playing a definite role. Then too, since air travel has plunged since 9/11, both companies are in trouble, just as the airline companies are. What follows? To the extent Boeing can remain productive by outsourcing some of its key components abroad, all the better for its long-term competitive outlook (innovation generally will be needed for decades into the future in this industry). The only possible worry that can be connected with such outsourcing is whether the components produced abroad are crucial to US air power in future wars. Japan is a friendly country, an ally that has grown closer to the US in military matters the last few years. There seems to be no reason, then, for such a worry here.


    The Specific Problem of China

    There is, it's true, too much pressure on certain US manufacturing industries --- especially textiles --- caused by the huge influx of Chinese imports, with the US trade deficit now running about $103 - $110 billion annually. In the long run, US textile firms will adapt --- exactly as they have in the past in dealing with other Asian competitors: by downsizing and upgrading their technologies. Textiles in this country, believe it or not, had a positive trade balance in the early 1990s, thanks exactly to these restructuring tendencies.

    The problem right now is the huge influx of imports, aggravated by a Yuan fixed by the Chinese government to 8.2 to the US dollar. No industry can adapt rapidly to such an influx. It needs time.

    TO BE CONTINUED (Santa Barbara time, 6:00 PM, Sunday, July 27th, 2003)