Manufacturing redux

In the wake of my recent criticism of economists for their misunderstanding of the importance of manufacturing, I have been flooded with e-mail criticizing me for advocating protectionism and castigating my ignorance of the wage differential between Asia (especially China) and the United States. Let me hereby try to respond and again make the case for making it in America.

First, it is clear that there is a widespread misunderstanding of the extent and significance of the wage differential in manufacturing between the United States and much of Asia and particularly between the United States and China. Many believe labor costs are a large part of the total cost of production of most manufacturing industries and that the wage differential is too large for virtually any manufacturing to be done competitively in the United States as opposed to China, Vietnam, and other parts of developing Asia. This is in fact not the case. Consider that countries like Germany, Switzerland, Sweden, and Japan have wage and benefit costs far higher than those in the United States yet they maintain manufacturing sectors twice as large as a percent of GDP as the United States.

As I write I am now watching a News Hour report on Germany. One German CEO notes that his company has switched over the past twenty years from making cuckoo clocks to tunnel boring machines. The production of tunnel boring machines is not labor intensive, but it is quite technology and capital intensive. If Germany can be the world’s largest or second largest exporter of manufactures in the face of cheap labor Chinese competition, surely the United States can do better than it is doing. In industries like semiconductors, machine tools, specialty machinery, pharmaceuticals, autos, nano technology, optical fiber, and many many more labor cost is a small part of the total cost and can easily be offset by economies of scale, transport cost, superior quality, special design, superior customer service, and lower risk and capital costs.

Most of the value in the Apple iPad for example is in parts that are not made in China. Only about $7 worth of assembly occurs in China. The parts are where the value is and they are made in Japan, South Korea, Taiwan, Germany, and even a few in the United States. Labor costs are not the reason why more of those parts are not made in America. The main reason is that the other countries have made it a matter of high national priority to assure that they produce key parts like semiconductors, digital signal processors, and electronic displays. Their industrial policies have included subsidies of various kinds, risk reducing government investments, buy national regulations, and currency manipulation.

This brings me to the second critique which is that for the U.S. government to counter these special foreign treatments would, in fact, amount to special treatment for U.S. manufacturers and constitute protectionism that would only further distort global markets. This is the position of mainstream, orthodox anglo-American economists. It is essentially a unilateral free trade view that rests on the belief that the structure of an economy and what it produces are of little significance. In effect, it holds that if you have a very competitive semiconductor industry with a large sunk capital investment that is suddenly undercut by the subsidized industry of another country, don’t respond to the subsidy that is distorting the normal market forces. Rather, let your industry die, accept the loss of the capital investment, and the loss of the hard won skills of the workers, and move on to some other industry. Hairdressing is one that Christina Romer mentioned as a possibility.

This may be a purist kind of free trade, but it is not what the founders of the World Trade Organization (WTO) and its predecessor institutions had in mind when they said free trade. The rules of these bodies provide for complaints of unfairness and distortion of markets and for the imposition of penalties aimed at off-setting and correcting the distortions. These rules exist because those distortions are not accepted as part of free trade nor is it considered special or discriminatory treatment for an industry to receive relieve from the artificially imposed distortion.  If I and my friend are walking down the street and a thief robs me but not my friend, it does not constitute a special treatment of me as compared to my friend if the police capture the thief and return what was robbed to me. In the trade game, the robbery has mostly been done so far by the mercantilists who focus on manufacturing. Stopping the robbery and restoring the stolen property is not a matter of favoring manufacturing over services. Far from protectionism it is a matter of maintaining free trade and optimizing the gains from natural comparative advantage and from trade.