Should We Still Make Things?

Should We Still Make Things?
Dean Baker - March 11, 2009

I HAVE often thought that economists should be required to have a better grasp of simple arithmetic. It would prevent them from repeating many silly comments that pass for conventional wisdom, such as that the United States will no longer be a manufacturing country in the future.

Those who know arithmetic can quickly detect the absurdity of this assertion. The implication of course is that the United States will import nearly all of its manufactured goods. The problem is that unless we can find some country that will give us manufactured goods for free forever, we have to find some mechanism to pay for our imports.

The end of manufacturing school argues that we will pay by exporting services. This is where arithmetic is so useful. The volume of U.S. trade in goods is approximately three and half times the volume of its trade in services. If the deficit in goods trade were to continue to expand, we would need an incredible growth rate in both the volume and surplus of service trade and our surplus on this trade in order to get to anything close to balanced trade.

For example, if we lose half of our manufacturing over the next twenty years, and imported services continue to rise at the same pace as the past decade, then we would have to see exports of services rise at an average annual rate of almost 15 percent over the next two decades if we are to have balanced trade in the year 2028.

A 15 percent annual growth rate in service exports is approximately twice the rate of growth in service exports that we have seen over the last decade. It would take a very creative story to explain how we can anticipate the doubling of the growth rate of service exports on a sustained basis.

The story becomes even more fantastic on a closer examination of the services that we export. The largest single item is travel, meaning the money that foreign tourists spend in the United States. This item alone accounts for almost 20 percent of our service exports.

There is nothing wrong with tourism as an industry. However, the idea that U.S. workers are somehow too educated to be doing for manufacturing work, but instead will be making the beds, bussing the tables, and cleaning hotel toilets for foreign tourists is a bit laughable. Of course, with the right institutional structure (e.g. strong unions) these jobs can be well-paying jobs, but it is certainly not apparent that they require more skills than manufacturing.

The category “other transportation” accounts for another 10 percent of exported services. These are the fees for freight and port services that importers pay when they bring items into the United States. This service rises when our imports rise. It is effectively money taken out of our consumers’ pockets because it is included in the price of imported goods.

Royalty and licensing fees account for another 17 percent of our service exports. These are the fees that we get countries to tack onto the price of their products due to copyright and patent protection. It might become increasingly difficult to extract these fees as the spread of the Internet increasingly allows more movies, software, and recorded music to be instantly copied and exchanged at zero cost. It’s not clear that the rest of the world is prepared to use police-state tactics to collect revenue for Microsoft and Disney. The drug patent side of this equation is even more dubious. Developing countries are not eager to see their people die so that Pfizer and Merck can get high profits from their drug patents. This component of service exports is likely to come under considerable pressure in future years.

Another major category of service exports is financial services. This category accounted for approximately 10 percent of service exports in recent years. It is questionable whether this share can be maintained in the years ahead. Wall Street had been known as the gold standard of the world financial industry, with the best services and the highest professional standards. As a result of the scandals that have been exposed in the last year, Wall Street no longer has this standing in the world. After all, investors don’t have to come to New York and give their money to Bernie Madoff or Robert Rubin to be ripped off; they can be ripped off almost anywhere in the world. Perhaps the Obama administration will be able to implement reforms in the financial sector that will restore its integrity in the eye of world investors, but that will require serious work at this point.

Finally, there is the category of business and professional services, which accounts for roughly 20 percent of service exports. This is the area of real high-tech and high-end services. It includes computing and managerial consulting.

Rapid growth in this sector would mean more high-end jobs in the United States, but the notion that it could possibly expand enough to support a country without manufacturing is absurd on its face. First, even though it is a large share of service exports, it is only equal to about 0.8 percent of GDP. Even if quadrupled over the next two decades, it wouldn’t come close to covering the current trade deficit, to say nothing of the increase due to the loss of more manufacturing output.

More important, it is implausible to believe that the United States will be able to dominate this area in the decades ahead. The United States certainly has a head start in sophisticated computer technologies and in some management practices, but it is questionable how long this advantage can be maintained. There are already many world-class computer service companies in India and elsewhere in the developing world, and this number is increasing rapidly.

The computer and software engineers in these countries are every bit as qualified as their U.S. counterparts and are often prepared to work for less than one-tenth of U.S. wages. Furthermore, unlike cars and steel, which are very expensive to transport over long distances, it is costless to ship software anywhere in the world. Given the basic economics, it seems a safe bet that the United States will lose its share in this sector of the world economy. In twenty years it is quite likely that the United States will be a net importer of this category of service, unless of course wages in the United States adjust to world levels.

In short, the idea that the United States can survive without manufacturing is implausible: It implies an absurdly rapid rate of growth of service exports for which there is no historical precedent. Many economists and economic pundits asserted that house prices could keep rising forever in spite of the blatant absurdity of this position. The claim that the U.S. economy can be sustained without a sizable manufacturing sector is an equally absurd proposition.