Are we kidding ourselves?

Originally posted by Dieter Adam 27 July 2023

The Economist is a British weekly newspaper with a strong focus on economics, and it is claiming to provide “authoritative global news and analysis”. This is what it came up with in its latest edition:

The article essentially argues that recent substantial government investments in or subsidies to manufacturing that have been promised, and are being made, in many ‘Western Economies’ – from Australia to North America to Europe – are a waste of taxpayers’ money. These measures are seen as an attempt to reverse a trend that started as early as the late 1960s which saw the share of manu­facturing in the economy of key manufacturing countries being approximately halved between 1970 and 2010, and remaining more or less stable after that (Fig.1).

While this trend is undeniably a fact, a couple of caveats apply. First, unlike in the graph below, the decline in manufacturing is often expressed in terms of employment data, ignoring the massive increase in automation in the period in question that meant that fewer workers could still produce the same, or a higher total output. Second, the trend is much less pronounced when using constant, rather than current price data (https://www.imf.org/external/pubs/ft/issues10/index.htm ). In the USA, for example, the share of manufacturing output in total GDP fell from 16.1% to 11.9% between 1997 and 2010 when expressed in current prices, but remained at 12.3% when expressed in constant prices (OECD Database). Constant prices (adjusted for inflation) are generally seen to be a better measure in a case like this. Finally, and rarely considered, is the outsourcing of services within the manufacturing sector (from engineering consultancy to cleaning services), which leads to a ‘statistical anomaly’ that artificially reduces the contribution of manufacturing to total economic output. For more on this, see, for example https://cepr.org/voxeu/columns/outsourcing-and-shift-manufacturing-services .

Nevertheless, de-industrialisation to various degrees occurs wherever economies be­come more advanced, and that is not a bad thing – it is a sign of increasing affluence. At some level, the explanation is quite simple – the consumption of many goods is more limited than spending on services. There is a ‘natural limit’ to how many cars, TV sets or vacuum cleaners most household will purchase – a fact that neither technology updates, nor built-in obsolescence, can completely negate. Same applies to processed foods – there are only so many yoghurts you can eat in a day.

The author of the article lists four reasons for the increased government interest in manufacturing, and then tries to knock them down one at a time:

1. Factories are a source of solid jobs that produce a bigger and more satisfied middle class.

The main counter to that is that because of high levels of automation in modern manufact-uring, the increase in job numbers when manufacturing expands will be relatively small. That argument doesn’t really apply to New Zealand, where long-run manufacturing is an exception, and an expansion of the manufacturing would likely occur where New Zealand manufacturers are most globally competitive already – short-run production of highly specialised high-value (components of) machinery and equipment. The argument also ignores the fact that for every ‘apex manufact-urer’ with high levels of automation, there is a myriad of manufacturing suppliers of both componentry and the machinery and equipment installed in such a factory. They quote the example of a modern car factory in Germany – and yet such ‘fact-ories’ really are assembly plants, with the bulk of manufacturing and value creation happening where the components that make up a car are being manufactured.

A further argument made is that in modern manufacturing, many of the high-paying jobs requiring high levels of skills are in manufacturing-related services provided by manufacturing companies. True, but these are still manufacturing jobs, and they wouldn’t exist if the goods that have value added through services weren’t made in the first place.

There is something else we need to consider here: there is a good number of people across the world who ‘just like making stuff’ – using their hands as well as their brains to produce something tangible and useful. That doesn’t just mean manufacturing, it also applies to construction and primary industries, for example. In 2022, ‘Make Stuff’ jobs in these three industries accounted for a quarter of all jobs in New Zealand, with manufacturing and construction both at around 10%. At times when job satisfaction is seen as increasingly important, reducing the opportunity for people who enjoy ‘making stuff’ to work in such jobs might not be the best way ahead.

2. Manufacturing is a driver of innovation and growth.

The authors counter this with a range of arguments, none of them compelling, or substanti­ated with clear evidence. In New Zealand, the numbers send a consistent message anyway:

3. Manufacturing is urgently needed to fuel the green transition, which will be more palatable to electorates if it delivers local jobs.

There is no doubt that a transition to a low-carbon economy will require a lot of additional manufacturing of certain types of machinery and equipment – from solar panels to heat pumps to wind turbines. The argument here is that while subsidies to attract such manufact­uring to a particular country may be effective – and the US Inflation Reduction Act certainly seems to be, for example – it is ultimately a zero-sum game. While that may be so, there will still be winners and losers, and the countries most able to fund subsidies will end up winning. This does not bode well for New Zealand, where before we even talk about a lack of funds, there is a lack of willingness to subsidise manufacturing right across the political spectrum, or at least has there been to date.

4. Tensions between America and China have pushed world leaders to reconsider which goods are strategically important, and therefore should be produced closer to home.

The counter here is that, when challenged by supply chain disruptions, countries can adopt quickly to limit the damage. The example provided was how well Europe was able to cope when Russia ceased to supply natural gas in August last year, cutting overall supplies by 40%. This ignores the fact that because of energy prices having stabilised at a much higher levels, energy-intensive production in Germany is now looking to relocate elsewhere, with the US and Canada as preferred desti-nations. It also ignores the fact that, for example, by their own admission the Chinese economy is being hit where it hurts by US and Allied sanctions not only on advanced-level semiconductors, but also on the equipment to manufacture these.

It remains true that diversification and specialisation – everyone producing what they’re best at – is the most efficient approach and produces the best outcome for all – within a country, and internationally. But at times of growing geopolitical tensions and mistrust, and pain felt already from sanctions, efficiency considera-tions often lose out to political and strategic arguments. We also need to keep in mind that – whether we like it or not – the biggest growth sector for manufacturing in the near future is most likely to be weapons and ammunition – something count-ries like to keep close. In Australia, in the five years 2016-17 to 2021-22, the defence industry’s contribution to the Australian economy grew from $6.3b to $10.6b, an increase of 67.8%. Over the same period, total economy GVA (Gross Value Added) grew by 31.7%. (https://www.abs.gov.au/statistics/economy/national-accounts/australian-defence-industry-account-experimental-estimates/latest-release ). And in the USA and Europe, the Ukraine war has triggered significant additional government investment in military manufacturing (https://www.reuters.com/world/europe/eu-plans-boost-ammunition-production-aid-ukraine-2023-05-02/ ; https://news.usni.org/2023/03/14/fy-2024-budget-pentagon-asks-for-30-6b-to-beef-up-munitions-stockpile-citing-lessons-from-ukraine-war ).

The question remains – what does all this mean for New Zealand manufacturers? (Un)Fortunately very little. As mentioned before, if policies by various governments since the days of Think Big in the 1980s are anything to go by, there will be little appetite for investing taxpayers’ money in manufact­uring sector projects, irrespect-ive of the future shape of government, and notwithstanding the $30m in the Advanced Manufacturing Industry Transformation Plan, most of which looks like it is going to government agencies anyway. And we don’t see any particular oppor-tunities (yet) for New Zealand manufacturers to benefit from the global drive to manufacture ‘green equipment’, notwithstanding new opportunities for some manufacturers. On the upside, nor have we seen any major roadblocks yet for our manufacturing exporters due to the fractioning of global supply chains.