A few weeks ago we penned an article on Open Source Ecology, an exciting new manufacturing concept developed by Dr. Marcin Jakubowski and his colleagues. Given its potential to create a multitude of self-reliant jobs and bring about a true manufacturing renaissance in much of the developed world, we thought that it would generate a lot of interest.
But boy were we wrong. Out of all the 77 articles that we have published since 2014 it got the lowest readings… EVER!
Now, we don’t consider ourselves to be any literary geniuses (nor we publish for “hits”), but we could never imagine that a title containing the word “manufacturing” could be so off-putting. We assume that for many of our dear readers, who for the most part live in Western countries, manufacturing is just an afterthought. The future and all the cool stuff is in services right?
Well, if this is the reason, we really need to think about how we approach manufacturing.
This is a personal topic for us. We started our career at General Electric (GE), at the time under the leadership of the legendary Jack Welch. As part of his broader risk management strategy, he bestowed an important oversight role on the finance function. Accordingly even us glorified “bean counters” were required to develop a deep understanding of our business, and particularly so in the manufacturing divisions. We even had to become conversant in Six Sigma, the art of business process improvement.
While we were busy trying to figure out the nuts and bolts of our job (literally), something else was happening at GE: Welch was transforming the company from a manufacturing giant into a services oriented powerhouse.
The core manufacturing divisions began moving into higher-margin aftersales (like maintenance contracts). More significantly, the financial services subsidiary leveraged the group’s top notch credit rating to fund an aggressive growth strategy, quickly becoming the primary source of earnings growth for the consolidated company. Consumer finance, lease providers and a plethora of other financial services companies were being acquired all over the world at breakneck speed.
Meanwhile, entire manufacturing facilities were being shut down in the US, earning the dynamic CEO the nickname “Neutron Jack” (everybody was gone when he came around, only the buildings remained).
GE turned out to be a leading indicator for the entire US economy. The same forces of globalization that were propelling Welch’s financial results were exposing other American manufacturers to cutthroat competition from emerging markets. As a consequence, they had to move upscale or offshore, or go out of business altogether.
The entire developed world was facing the same developments, with more or less the same outcomes. This offshoring is aptly illustrated in the following graph:
Percent of Value-Added in Global Manufacturing: 1980 – 2012
Source: United Nations, MAPI.
As cheaper goods imported from abroad started to reduce domestic inflation expectations, the concomitant decline in interest rates since the mid-1980s increasingly steered productive resources of developed economies towards the financial, insurance and real estate sectors (the so called FIRE economy). [Here’s an interesting punchline to our GE story: we ended up leaving the company to work… in a bank!]
For Western policymakers this was something to be encouraged, as it enabled the (partial) absorption and retraining of the increasing redundancies coming from the manufacturing sector. This is how such transition has unfolded in the US:
Monthly Employees, Seasonally Adjusted (000’s):
Jan 1950 – Mar 2016
Source: Federal Reserve Bank of St. Louis, BLS.
US manufacturing employment peaked at around twenty million in June 1979, and has steadily declined since. The latest reading is a tad above 12 million employees. On the other hand, the sum of construction and financial activity employment (as a proxy for the FIRE economy) surpassed that of manufacturing in mid-2003.
Things were chugging along, supported by copious amounts of leverage increases in both the public and private sectors, until the 2008 financial crisis exposed the fragilities of this new economic model: the gradual transition to a FIRE economy in the developed world ended up creating systemic risks that could crash the entire global economy – requiring constant vigilance by central banks to this very day in order to avoid a repeat.
Somewhat ominously, GE almost became a victim of its own successful transformation into a financial giant. Facing the inability to rollover its short term funding due to the seizure in global capital markets in 2008, without the intervention of the US government the centennial company – originated by the efforts of the great inventor (and savvy manufacturer) Thomas Edison – would have gone bust. [Here’s another personal punchline: we no longer work in a bank]
It’s not the more fickle and systemic nature of the FIRE economy that make manufacturing particularly important. It goes well beyond that.
Some very good reasons of why manufacturing matters a great deal to any economy were convincingly outlined by Prof. Vaclav Smil in his must-read book “The Rise and Retreat of American Manufacturing” (2013).
For starters, manufacturing brings together many important functions – from accounting to job training, and creates entire new ones, such as global marketing and e-sales. Accordingly, it generates the greatest positive economic multiplier (what you get out from what you put in) out of all the sectors in the “services-oriented” US economy, according to the Manufacturing Institute:
Economic Activity Generated by $1 of Sector GDP, 2012
These linkages and interdependencies require increased levels of education and intellectual capital, acting as a powerful catalyst for employee training and research and development (R&D). Manufacturing’s unique importance in this regard has also been quantified:
US Domestic R&D as % of Domestic Net Sales, 2011
Source: National Sciences Foundation.
US manufacturing R&D represented 3.9% of domestic sales in 2011, well above the 2.3% average for nonmanufacturing industries.
Stated differently, the loss of manufacturing means less skilled jobs, reduced economic multiplier effects and less innovation.
That innovation is crucial to generate sustainable economic output, more than simply expanding the pools of available capital and labor (one thing today’s proponents of open door immigration should carefully consider). Already in 1985, Edward F. Denison estimated that a staggering 55% of US economic growth between 1929 and 1982 was attributed to advances in knowledge – basically innovation, with another 16% resulting from labor shifting from farm to industry and another 18% to economies of scale. And manufacturing is needed to sustain higher rates of innovation.
We could highlight several other benefits, including on foreign trade, where in the case of the US manufacturing still accounts for the lion’s share of exports, and on more intangible yet equally important factors such as the health and vitality of many urban and suburban communities (Detroit being a notable case study on the social outcomes of the loss of manufacturing, irrespective of the underlying causes).
From this vantage point it becomes easier to understand why the US economy has struggled to generate prosperity across wider segments of the population as its manufacturing base was increasingly offshored in recent decades. On the other hand, China – today’s factory of the world – has become prosperous and a major global geopolitical player since opening its borders to foreign capital AND manufacturing practices.
Manufacturing does matter. It is time we start paying attention.