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History lessons: Understanding the decline in manufacturing

American factory
REUTERS/Adam Fenster
U.S. industrial decline is a long-run phenomenon and will not be reversed by short-term fixes.

New ideas for reviving American manufacturing seem to appear every day. Many of these notions have merit, but most are built on a flawed premise: that the decline in U.S. factory jobs is a recent occurrence, one that can be reversed through tax cuts or trade policy.

Unfortunately, U.S. industrial decline is a long-run phenomenon and will not be reversed by short-term fixes. Let’s take a look at the trends and their implications.

The really long run

Economists traditionally classify economic activity into three sectors: agriculture (including forestry and fishing), industry (including mining, construction, and manufacturing) and services (all activities not included in either agriculture or industry.)

You probably have a story in mind about what these data will tell us. The United States was primarily an agricultural economy through the 19th century; then, industry swept the landscape in the late-19th and early 20th century — with America standing as the industrial powerhouse of the world by the 1950s. Things stayed this way until the late-1970s and 1980s, when we first lost our edge to the Japanese, then to the Chinese, and have now become a service economy that doesn’t produce stuff.

This story isn’t quite right. Let’s start with where people worked. The graph below shows the distribution of the labor force in agriculture, industry and services from 1840 to the present. The part of the story about agriculture is clearly true: Beginning in 1840 at roughly 70 percent of the labor force, agricultural employment fell to about 40 percent in 1900, 10 percent in 1950, and remains at about 2 percent today.

Next, let’s examine the service sector. Here’s where the surprises begin. In terms of employment, the second largest sector was services, not industry. In fact, service employment exceeded industrial employment throughout American history. Looking at industry, the closest that sector got to services was in 1880!

A similar story emerges when we look at output produced in agriculture, industry and services. Again, the agricultural sector originally accounted for the largest share of output, but services caught up and exceeded agriculture by the 1880s.

Industrial production kept pace until 1910, but after that services pulled ahead and never looked back. Since 1950, the share of output produced in industry has steadily declined, falling from about 40 percent of output to about 25 percent today.

The story since World War II

Let’s zero in on the period since World War II. To keep things focused, I’ll make three changes to our perspective. First, some might argue that the rise in service employment and output shown above is caused by the growth of government. I’ll focus on private-sector employment and output to see if increasing service employment and output is a product of expanded government or is the result of private-sector changes. Second, I’ll combine agriculture and industry into one goods-producing sector, and then compare that with services.

Here’s what we get in terms of employment:

Chart of private sector employment as % of total employment 1948-2010 Source: Bureau of Economic Analysis, National Income and Product Accounts

Since World War II, the share of private employment in goods production (including manufacturing) has steadily declined from just short of 50 percent to just fewer than 20 percent.

The output data look much like the employment data. Just like employment, the share of goods production (including manufacturing) in GDP has steadily declined while the share of services in GDP has steadily risen.

Chart of private sector output as % of GDP 1948-2010Source: Bureau of Economic Analysis, National Income and Product Accounts

A tale of two causes

To understand the long-run decline in industry, we need to look at the periods before and after World War II separately.

Before World War II, the service sector grew because we got richer. Think about it: From domestic servants to waiters, blacksmiths to cobblers, and barbers to bankers, Americans have always been engaged in a variety of service activities. And, as the American economy grew and average incomes increase, Americans increased their demand for meals, repairs, grooming and financial services. Thus, more and more workers were pulled into the service sector by this increasing demand.

When we look at the post-World War II data, a different story emerges. First, productivity grew rapidly in industry, faster than the demand for industrial products, while productivity grew relatively slowly in the service sector. This meant that we needed fewer industrial workers and thus many workers were pushed out of industry. At the same time, we were still getting wealthier and demanding more services, and slow productivity growth in this sector meant that to provide these services it had to pull in the workers shed by industry.

Both push and pull forces were present in both periods. But, pull factors (i.e., the increased demand for services) was the predominant cause of decreasing industrial output and employment before World War II while push factors (i.e., rapid productivity growth in industry and slow productivity growth in services) dominated after the war.

Implications for policy

The decline in manufacturing output and employment is a long-run phenomenon, not just a short-run problem. This means that policies designed to boost manufacturing need to be designed with this long-run trend in mind, and not just react to problems of the last 10 to 20 years.

Neither tax cuts nor tougher trade policy address the demand for more and varied services, nor will they address the relatively slow productivity growth in the service sector.

Sources for 1840–2010 charts:

1840–1900: Robert E. Gallman and Thomas J. Weiss. "The Service Industries in the Nineteenth Century." In Production and Productivity in the Service Industries, ed. Victor R. Fuchs, 287-352. New York: Columbia University Press (for NBER), 1969.

1900–1940: John W. Kendrick, Productivity Trends in the United States. Princeton: Princeton University Press (for NBER), 1961.

1950–2010: Bureau of Economic Analysis, National Income and Product Accounts.

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Comments (8)

The issue of the next few

The issue of the next few decades will be the global labor surplus.

Civil unrest, most recently in the Middle East, is driven by a large number of people who are under-employed with insufficient income to meet their daily needs. This is an untenable situation in a globally connected society where the most pervasive media forms are filled with images of a better life than what is possible for most of the world.

The future for gainfully employing all these people, in the world, in the US and in Minnesota, is dimming. Thanks to highly productive equipment and processes, a smaller and smaller manufacturing sector can out-produce the demands of the world. In fact, we probably have a manufacturing system that can out-produce the raw-materials of the planet.

The top end of the manufacturing employment has rising wages but represents a very small number of people who possess very specific knowledge related to running expensive, specialized machines. The other end of the manufacturing employment-- the forklift driver, the wrench-turner, and the box-packer have wages that have fallen (new hires in auto plants now make $14/hour).

That leaves the service sector which has the problem of needing to be affordable. Can you have a store like Starbucks where the customers have the same income as the server? It seems unlikely. Likewise, can you have the world most expensive health care system in a world when the patients cannot afford the cost of care and more and more cannot afford even the cost of insurance to cover a portion of the cost? How about financial services? Does a teller make more than a Starbucks employee?

The service sector ultimately dependent upon an economy that has sectors that generate more spendable income than is made within the service sector.

The problem comes down to, there is no shortage of labor, there is a shortage of jobs, a shortage of demand in excess of supply, and ultimately a shortage of raw-supplies to supply the demand.

Its a very different world than the post-WW2 world where the US was the king of the world. and the fortunes of ordinary workers in the US were rising.

Lights-out manufacturing

If you want to view the future of manufacturing, google "lights-out manufacturing". These are large, expensive pieces of machinery in specialized facilities that can run days without requiring a person other than to load the material and unload the product.

These are machines that reduce the labor input by a factor of 10 to 100, and even more. They work 24 hours a day. They never ask for a day off. They never want a vacation. Their kids don't get sick or have a ballgame. They don't require health insurance. One day, they will be paid-off but will continue to work.

That is why the purchases of highly automated manufacturing equipment is higher than ever, and will continue to grow. And that is why manufacturing employment will continue to fall.

A diverging view

I read a varied interpretation to the lines on the graphs presented here.

In the beginning years of this analysis, a wage-earner could obtain services such as "domestic servants to waiters, blacksmiths to cobblers, and barbers" simply through the provision of food to eat and a place for the worker to lay their head. Following the Civil War, the growth in the service sector indicates that wage earners had to start paying for these services.

The post WWII slowdown in the expansion of the service sector coincides with the popularity of a traditional family structure where one wage-earner provided currency while another adult(s) provided services without wages. This social structure was also facilitated psychologically by the New Deal arrangement, assuring Americans that the vulnerable would be protected, the needy provided for.

But come the late 60's, when requesting a verification of their value to society, the non-wage earning service providers were told by the courts that they in fact had no commercial value. And so the Great Disruption of the 70's tipped our society up over itself, and in doing so paid-for service jobs were created to replace the positions that were indignantly (and I think regrettably) abandoned. Note how the line on the graph takes a sharp upward slope.

Everyone finds forced labor reprehensible and counter to the nature of things. But the privatization of obligations to our families and to our communities has yet to be fully evaluated.

Potential Pitfalls

While I agree with the basic premise, that the decline in manufacturing both as a percent of total employment and GDP is a long-term trend, there are reasons to believe that there could be a reversal at some time.

I examined this on Barataria in 2009. A decline in percent of total employment in manufacturing is common throughout the developed world, but that is largely due to improvements in productivity. Developed nations have had a generally stable manufacturing share of GDP since 1990, and many through the entire postwar period. Germany, for example, is about 23% and Japan 20%. Since 1990 alone, Manufacturing as a share of US GDP has fallen from 19% to 12%.

The difference between us could come from a number of factors, but the US has the unique position of being the world's standard trade currency. Growth in global trade has fueled a strong appetite for US Dollars, generally making the Dollar worth more internationally than it should be at Purchasing Power Parity domestically.

This is important because it could change - perhaps even suddenly. China, in particular, is quite upset at having to maintain a large reserve of US Dollars and has made a lot of noise about it. Malaysia is actively promoting a standard based on Gold. Given the decline of prestige associated with both the Euro and the Yen it is hard to imagine what a new currency regime would look like at this time, but the IMF has developed a basket of currencies as an alternative.

Should the "Dollar Standard" fold we can reasonably expect that manufacturing as a share of GDP will at least stabilize - if not rebound substantially. Productivity gains probably mean that it will never rebound as a share of employment substantially, but it is worth keeping an eye on.

Percent vs. Absolute output

This post and the comments so far are all quite insightful and helpful.

The one thing I see missing from the initial post--but hinted at in some of the later posts--is that when viewed in terms of absolute output rather than as a share of the economy, manufacturing is cruising.

Here's a quote from economist Donald Boudreax: "Just before the current downturn -- in 2008 -- inflation-adjusted manufacturing output in the U.S. was 13 percent higher than it was in 2000, 52 percent higher than in 1990, 84 percent higher than in 1980, and 133 percent higher than in 1970."

And according to this graph, manufacturing has recovered quite well: http://3.bp.blogspot.com/-tqu5EdFRa7s/TZHVaChT51I/AAAAAAAAL0k/C4LyaWNybD...

You're right, of course, that manufacturing jobs are disappearing. But contrary to the oft-heard lament, "The United States doesn't make things anymore," our actual output is doing just fine. We just seen a decline in jobs in the sector due to huge bounds in productivity and a strong move toward machination, as indicated in some of the above comments. I think that's worthwhile information when considering the trajectory of U.S. manufacturing.

Decline in manufacturing

So how did FIRE (finance, insurance and real estate get to be 8% of GDP? This was not some push/pull process but, rather, a conscious power grab by Wall St banksters.

Back to basics

Thanks so much for all this valuable information.

Maybe it's time to remember that tweaking tax rates here and there is not the only tool in the government box when it comes to stimulus.

Decline in manufacturing

The thrust of the story is that services have been the mainstay of the economy since 1910. The role of manufacturing has been exaggerated and there are few prospects that manufacturing could boost the U.S. economy. Johnston offers compelling statistical plots - and his picture is widely accepted by both liberal and conservative experts as well as the media.

But there are fundamental omissions and flaws in this story, one of which Eric Hare pointed out and I'll amplify. And he misses another big one.

Johnston notes that productivity allows fewer and fewer people to make the products we need, so services inevitably must take up the slack. But just a minute. If productivity is increasing somebody is benefiting from the wealth created. And for most of our durable goods it isn't us. Guess where much of the huge Chinese growth has been coming from. And not just China. We no longer produce our own subway and railway cars which come from Finland, or Taiwan. Those sleek cruise liners come from Finland and Italy; rocket engines for space flight from Russia. Our best TV sets come from South Korea, computers and digital cameras from Japan, high-quality incinerators, book scanners, cigarette machines, machine tools, MRIs, medical microscopes and turnkey sewage treatment plants from Germany; increasing clothing from Bangladesh and Vietnam, etc. Even 85% of our seafood products are imported, though we have the world's longest ocean coastline.

We only produce advanced renewable energy equipment through federal and state subsidies. Even recent advances in hearing aids and C-pap units, a field in which the U.S. created state-of-the art equipment - have been sold to European companies (Phillips and Siemens) to manage.

Hare pointed out the major difference in the proportion of GDP occupied by manufacturing in Europe compared with the U.S. The reality is that there is a stigma on manufacturing in the U.S., created by serendipitous events of the last 50 years.

And here's the second point overlooked by Johnston. Manufacturing is the most important value-adding activity in America. It also has a generally unrecorded stimulating effect on peripheral activities through equipment or raw material suppliers, transportation, design and invention, marketing and advertising, environmental compliance, as well as tax revenues.

In contrast, health care, one of the major sources of GDP, is in large part tax free (nonprofit hospitals,Blue Cross Blue Shield and other insurance plans) and is a huge revenue sink through entitlements, rather than a producer of wealth except for specialized activities (medical equipment suppliers and the nursing, medical professions and the pharmaceutical industry.

I'm planning to publish on this general subject in the future and thank Johnston for providing me a great symbolic example for a stereotypical assumption that has done great damage to understanding the nation's economic malaise.