The Manufacturing Fallacy

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).