The Open Economy and Its Enemies
The Manufacturing Fallacy
Jagdish Bhagwati
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NEW YORK – Economists long ago put to rest the error that Adam Smith made when he argued that manufacturing should be given primacy in a country’s economy. Indeed, in Book II of The Wealth of Nations, Smith condemned as unproductive the labors of “churchmen, lawyers, physicians, men of letters of all kinds; players, buffoons, musicians, opera-singers, opera-dancers, etc.” We may agree with Smith (and Shakespeare) about the uselessness of lawyers perhaps, but surely not about Olivier, Falstaff, and Pavarotti. But the manufacturing fetish recurs repeatedly, the latest manifestation being in the United States in the wake of the recent crisis.
In mid-1960’s Great Britain, Nicholas Kaldor, the world-class Cambridge economist and an influential adviser to the Labour Party, raised an alarm over “deindustrialization.” His argument was that an ongoing shift of value added from manufacturing to services was harmful, because manufactures were technologically progressive, whereas services were not. He even got a Labour Chancellor of the Exchequer, James Callaghan, to introduce in 1966 a Selective Employment Tax, which taxed employment in services more heavily than employment in manufactures – a measure that was reversed in 1973, once it was realized that it would hit the tourist industry, which generated badly needed foreign exchange.
Kaldor’s argument was based on the erroneous premise that services were technologically stagnant. This view no doubt reflected a casual empiricism based on the mom-and-pop shops and small post offices that English dons saw when going outside their Oxbridge colleges. But it was clearly at odds with the massive technical changes sweeping across the retail sector, and eventually the communications industry, which soon produced Fedex, faxes, mobile phones, and the Internet.
In fact, the dubious notion that we should select economic activities based on their presumed technical innovativeness has been carried even further, in support of the argument that we should favor semiconductor chips over potato chips. While rejection of this presumption landed Michael Boskin, Chairman of President George H.W. Bush’s Council of Economic Advisers, in rough political waters, the presumption prompted a reporter to go and check the matter for himself. It turned out that semiconductors were being fitted onto circuit boards in a mindless, primitive fashion, whereas potato chips were being produced through a highly automated process (which is how Pringles chips rest on each other perfectly).
The “semi-conductor chips versus potato chips” debate also underlined a different point. Many proponents of semiconductor chips also presumed that what you worked at determined whether, in your outlook, you would be a dunce (producing potato chips) or a “with-it” modernist (producing semiconductor chips).
I have called this presumption a quasi-Marxist fallacy. Marx emphasized the critical role of the means of production. I have argued, on the other hand, that you could produce semiconductor chips, trade them for potato chips, and then munch them while watching TV and becoming a moron. On the other hand, you could produce potato chips, trade them for semiconductor chips that you put into your PC, and become a computer wizard! In short, it is what you “consume,” not what you produce, that influences what sort of person you will be and how that affects your economy and your society.
Ignorant of the extensive “deindustrialization” debate in 1960’s Great Britain, two Berkeley academics, Stephen Cohen and John Zysman, started a similar debate in the US in 1987 with their book Manufacturing Matters, which claimed that, without manufactures, a viable service sector is untenable. But this argument is specious: one can have a vigorous transportation industry, with trucks, rail, and air cargo moving agricultural produce within and across nations, as countries such as pre-Peronist Argentina, Australia, New Zealand, and modern Chile have done very successfully.
Cohen and Zysman argued that manufactures were related to services like “the crop duster to the cotton fields, the ketchup maker to the tomato patch,” and that if you “[o]ffshore the tomato farm…you close or offshore the ketchup plant….No two ways about it.” My reaction was: “[A]s I read the profound assertion about the tomato farm and the ketchup plant, I was eating my favorite Crabtree & Evelyn vintage marmalade. It surely had not occurred to me that England grew its own oranges.”
While these episodes reflected academic obsession with manufactures and therefore died early deaths, the same cannot be said for the latest revival of the “manufactures fetish” in the US and Great Britain. The latest flirtation with supporting manufactures has come from the current crisis, especially in the financial sector, and is therefore likely to have greater prospects for survival. The fetish is particularly rampant in the US, where the Democrats in Congress have gone so far as to ally themselves with lobbyists for manufactures to pass legislation that would provide protection and subsidies to increase the share of manufactures in GDP.
Because of the financial crisis, many politicians have accepted the argument, in a virtual throwback to Adam Smith, that financial services are unproductive – even counterproductive – and need to be scaled back by governmental intervention. It is then inferred that this means that manufactures must be expanded. But this does not follow. Even if you wanted to curtail financial services, you could still focus on the multitude of non-financial services.
Diesel engines and turbines are not the only alternatives; many services, like professional therapy, nursing, and teaching are available. The case for a shift to manufacturing remains unproven, because it cannot be proved.
Jagdish Bhagwati is Professor of Economics and Law at Columbia University and Senior Fellow in International Economics at the Council on Foreign Relations.
Copyright: Project Syndicate, 2010.
www.project-syndicate.org
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aesop 04:48 04 Sep 10
This article is definitely light on analysis.
The author makes his main point and calls it a 'quasi-Marxist fallacy'. Any solid economist who has read Marx's economic works (Capital and especially, The Grundrisse) knows that Bhagwati makes a 'quasi-Bourgeois Defender fallacy'. Means of production does not only refer to physical capital goods, and so only to the manufacturing arena. Past this, Marx made the point that production conditions consumption, what you produce and how you produce it, will condition what you are able to consume. That is, how productively you produce, fairly determines what you can consume, how much, etc. Saying consumption conditions production is inaccurate: in order to eat, we must work; only after can we think. Consumption follows production. We like to think our economic votes count when we walk into the grocery store and buy our Pringles. But the producers produced that consumption, just as much as they produced that chip, for instance: "In 1983 corporations spent $100 million a year marketing to kids. By 2007 this had risen to nearly $17 billion." (“Resources: Marketing to Kids,” CBS News, May 17, 2007; Juliet Schor, Born to Buy (New York: Scribner, 2004), 21.) In this very real sense, then, consumption is "produced".
Bhagwati is a die-hard free-trader. We might as well take his advice, take down all trade barriers, relax, and play golf. He tends to ignore the success of the asian tigers whose state-assisted growth programs, along with protectionism for infant industries, allowed their respective successes. He also overlooks the international division of labor, and its historical imposition by means of military, etc. A bourgeois defender in the most classical sense, being a (weak) scholar of economic thought, he'd do well to look up the debates within Political Economy from England, circa 1820s-1830s. He seems to have skipped them (along with Marx) following Adam Smith and went straight to Alfred Marshall. He's is not a better Economist for it. More so, a hired prize fighter.
Clandestina 10:43 28 Sep 10
This piece misses the point. Even if it's true that manufacturing Pringles is more complex than assembling semi-conductors, so what? The debate about whether 'manufacturing matters' isn't about who's smarter than whom. It's about job creation and developing a sustainable economy, and this is the issue Bhagwati fails to address.
The service sector is certainly more high-tech than it used to be, but many of the advances in technology he mentions have actually been used either to eliminate service jobs which are now automated or to outsource jobs such as work in call centres and on customer help lines to India and elsewhere.
karan129 09:07 16 Nov 10
While I don't disagree with your premise, I take exception to the analogy made between semiconductor chips and potato chips. Though the contrast between something as pedestrian as potato chips and an industry that effortlessly follows Moore's law is undoubtedly attractive, I feel the analogy is specious. The reporter who "checked the matter for himself" confused "placing semiconductors" with "producing semiconductor chips". The former is is no different from fixing nuts and bolts in place, while the latter is a hugely technology intensive, and very carefully controlled process. I don't mean to nitpick but from the perspective of an electrical engineer any comparison between producing semiconductor chips and producing potato chips is laughable. Again, I am inclined to agree with your argument, just not with the analogy used to explain it.
0spinboson 06:49 27 Aug 10
A tad light on analysis.. Why do you suppose 'manufacturing' is such a powerful statement to make and stand behind?
Might I suggest this is because it results in the most tangible form of the thing that makes the supply side of capitalism work, namely 'a product'? It is true that services can also be sold as such a product, but the difference is that you can eat (or use) products, whereas services are generally only one-time transactions.
To start at the beginning, economies work because they produce and consume goods, which pays for both the consumption by the workers and the profit on the invested capital. In order to produce such goods, they often have to import materials from abroad, which have to paid for, by money which is then no longer available in the local economy. This results in slight mismatches between the amount of money available for consumption, and the money invested in production, assuming the amount of money available is more or less stable, and the amount of money created via value addition is roughly equal to the desired profits. (Thus, if wages are too low, demand will be too low; see Henry Ford.) The exported money therefore has to be compensated by imported money, lest there be a YoY shortfall that accumulates (see China), taking more and more money out of the consumption side (as the owners will find ways to 'maintain' their profits in the short term at the cost of long-term viability by underpaying their workers).
Moreover, a lot of services (nursing, hair salons, lawyering) are not, or very hard to export, and thus only serve to redistribute money around the economy. While you may well be able to sell your lawyering skills abroad, this only works when lawyers are familiar with the relevant jurisdictions, and have standing abroad, etc. They do not, on the whole, add value, however, and (in case of lawyers) can serve as a money sink, as lawyers are expensive, while keeping most of their income to themselves, as a lot of their income will be left for discretionary spending (which is a much less dependable source of demand than nondiscretionary spending is).
As such, income made from 'manufacturing' work generally goes to the middle class, which spends most of it on produced goods again, whereas money made from services will often be taken out of the equation, leading to decreased demand which then has to be compensated for. And if the economy is unable to find a new source of money (such as the extension of consumer credit to people who will be unable to pay back the principal, and who can then be sucked dry via the charging of exorbitant interest rates - which in the long run will also lead to decreased demand, but nobody ever said capitalists were especially clever) supply will have to drop, leading to a 'horrible' drop in GDP.
(PS. apologies if my post is a bit unstructured)