Abstract

The Decline Exists

For a country that once produced 90% of the goods it consumed in the 1960s, today is a stark difference when you go shopping everywhere from Walmart to Bloomingdale’s and struggle to find goods made in America. Despite manufacturing employment falling 38% since the peak in 1979 (most of which has taken place since 2000), the Federal Reserve reports that real manufacturing output rose 77% by the end of 2011. While manufacturers have upgraded their tools and machinery to remain competitive, such an increase in production seems implausible given that the U.S. barely manufactures entire industries of goods that it once dominated just 2 decades ago such as clothing and electronics. However, our eyes are not deceiving us. If not for the methodological changes made to the Consumer Price Index (CPI), conducted by the Bureau of Labor Statistics, the Fed would not be able to report real increases in manufacturing output. While each change has its justification, the new CPI is no longer an accurate barometer for the value of the dollar. For example, if today’s method was reapplied during the 1970s when consumer prices doubled, the CPI level in 1980 would only be about 8% higher than the level in 1970! It is only when output is reset to the original CPI method, do we get a more realistic reading of the state of manufacturing.

Based on the original CPI method, real output of final goods and nonindustrial supplies actually peaked in 1988 at $8,315.6 billion before falling 54.4% to $3,793.2 billion in 2011. As the graph shows, nearly all the decline took place since the turn of the century. The use of the original CPI method also contradicts the premise that real profits and wages remain at historic high levels. Under the original CPI Method, gross profits and hourly wages fell 77.3% and 73.8% respectively since both hitting their highs in 1978. Because the original CPI method was wrongly accused of grossly overstating the change in prices, this data might be seen as misleading. However, using the original CPI method is not the only way to expose the flaws of the government’s manufacturing output data.

For example, the Fed reports that annual output of automotive products supposedly increased 150% in real terms from 1980 to 2010. But during that time, the number of automobiles made in the U.S. remained relatively flat, falling 3% from 8 million to just under 7.8 million. In addition, the components of automobiles were increasingly being made abroad then shipped to the U.S. for assembly. From 1987 to 2002 alone, foreign made inputs used in the production of American automobiles surged from 16% to 29%. While automotive products account for just one industry, they represent almost 10% of all finished manufactured goods. If the government is this wrong about the real output of auto products, than how can the remaining data on manufacturing output be regarded as accurate? In the name of accuracy, the use of any CPI to determine real output of manufactured goods is inappropriate because the vast majority of manufactured goods are not consumer products, but tools, machinery, and intermediate goods used in further production. Ideally a mix between the CPI and the Producer Price Index would solve the problem, but the PPI reported by the BLS has undergone methodological changes just as the CPI and unfortunately, there is no viable alternative. While the output data presented in this study is not pin point accurate, it should be regarded as a conservative estimate since prices on producer goods historically rise more than prices on consumer goods during inflationary periods.

The decline in manufacturing employment, output, profits, and wages should not be regarded as insignificant given that the middle class owes its existence to America’s industrialization. And the deindustrialization of America prompts the ultimate questions of what is causing it, what will happen in the future, and how can America reverse course?

Causes of the Industrial Revolution

In order to understand why the manufacturing industry has suffered, it must first be understood what gave it life. While the Industrial Revolution is often marked by life changing innovations, it was the unprecedented level of economic freedom that truly distinguished this time from any other in human history. While the U.S. Constitution was not the free market’s best friend,e.g., slavery was still permitted, it did establish low taxes and protected free trade, liberty for citizens, and the people’s choice to use gold and silver. Savings is the lifeblood of manufacturing, and in 1800 the U.S. was a poor nation with little savings. But because America had a relatively high level of economic freedom, it was able to borrow heavily from Europe to expand its productive capacity. By 1900, the U.S. had surpassed England as the wealthiest nation in history.

Myths Behind the Industrial Revolution

Unfortunately, the historical tale of the economic impact of America’s freedom during the 19th century is being replaced by the argument that it was government intervention that brought prosperity. While it is true that the federal government helped finance everything from railroads to the research and development of the telegraph, federal spending on these projects was unnecessary, wasteful, and violated individual liberty. With regards to patents, a legitimate argument can be made that private property was protected when issued on the process to make a good. But Congress violated the private property of others when it issued patents on goods themselves and on a first-come first-served basis.

Causes of the Decline in Manufacturing

Just as the Constitution protected economic freedom and paved the way for the industrialization of America, the abandonment of the Constitution and its original intent has led to the downfall of the manufacturing industry. The decline in manufacturing is due to 2 main factors, the rise in regulations and the fall in savings. Union laws, the minimum wage, and safety and environmental regulations not only represent countless of lost economic freedoms, but are lethal to the manufacturing industry. Savings is the lifeblood of manufacturing, but taxes on income have diminished Americans’ ability to save, while social welfare and fiat currency have created disincentives to save.

Myths Behind the Decline in Manufacturing

Most economists believe that America’s decline in manufacturing employment is due to automation, cheap labor abroad, and even economic progress. Yet these arguments are merely fallacies. In a market free of government regulations, machines are not labor saving devices, but labor enhancing devices. With regards to the “cheap labor” theory, manufacturers are not fleeing America because wages are low in East Asia, but because the cost of labor is overpriced in the U.S. due to regulations. The reason America has lost nearly all of its jobs in manufacturing goods such as clothing is because the production of these goods are relatively more labor intensive, and thus less profitable. As regulations mounted, these producers were the first to lose money and the first to be outsourced to “cheap labor” countries. Lastly, it is impossible to claim that the fall of manufacturing and domination of the service industry represents economic progress. When people left farms and entered factories during the Industrial Revolution, their incomes increased substantially. The same cannot be said when people traded their factory jobs for those at Walmart.

The State of Manufacturing Address

Despite the dramatic decline in manufacturing, the U.S. still stands as the 2nd biggest manufacturer behind China. Yet most of the manufacturers that have survived in the U.S. have done so because of the dollar’s status as the world reserve currency. Because of the dollar’s role, the U.S. can print dollars endlessly and export them around the world to buy up industrial supplies, tools, and machinery. All of this is showing up in America’s trade deficits, which are the largest in world history. While consumer goods often highlight the trade deficit, capital goods make up the majority of imports. Unlike during the 19th century, America is not borrowing to expand its productive capacity, but merely to sustain it. Therefore, the U.S. does not have the ability to repay its creditors in goods like it did so at the end of the 19th century. When the dollar is dethroned as the world reserve currency, the manufacturing industry will follow the dollar’s descent.

The Dollar Collapse

The great mistake made by most economists in analyzing America’s participation in international trade is that they fail to understand that it is not based on voluntary trade. In order for the U.S. to be able to run massive trade deficits, foreign governments must interfere in the foreign exchange market by inflating their own currencies. So as the U.S. devalues its currency, the world must do the same. But America has raised the stakes by embarking upon the road to hyperinflation as a result of massive budget deficits caused by entitlement spending. With $118 trillion and counting in unfunded liabilities in Social Security and Medicare, budget deficits will quickly exceed $3 trillion as millions of baby boomers retire. Since most politicians refuse to put their political careers on the line and cut spending, the Fed will continue to inflate recklessly to finance budget deficits. Foreign nations will inevitably be forced to stop pegging their currencies to the dollar, and start backing them with gold in order restore stability. When the dollar collapses the U.S. will no longer have the ability to run massive trade deficits and the manufacturing industry will consequently collapse.

The Collapse of the Manufacturing

While it is impossible to pinpoint the degree of the decline, the housing collapse provided a glimpse into the future. For the first time in American history, the trade deficit collapsed in real terms, not because exports rose, but because imports fell. After a 15 year upward trend, the trade deficit fell 55% in real terms from 2006 to 2009. During this time, the decline in manufacturing output sped up rapidly, contracting 31%. For every $1 drop in the real trade deficit comprised of capital goods, the production of tangible goods suffered by a factor of $5.59. When the dollar collapses, the trade deficit will not fall by just 55%, but more than 100% as the balance of trade turns positive for the first time since 1975. And when this happens, manufacturing output will likely collapse by over 50%.

No matter the degree of the decline, the dollar collapse will not be an equal opportunity employer; some industries will be affected worse than others. The answer to which industries will suffer the most depends on three factors, sensitivity to interest rates, level of global competitiveness, and dependency on foreign inputs. Micro-economic forecasting is usually more difficult, but the outlook for certain industries is clearly evident. The U.S. capacity to refine oil will allow it to continue to import large amounts of crude oil, but only to export most of it back in the form of fuel and industrial petroleum products for consumption and further manufacturing abroad. As a result, industries that are dependent upon oil will perform poorly. Because food production and distribution is heavily dependent on oil, the output of food products will fall when oil prices spike. Given their sensitivity to interest rates, dependency on foreign capital goods, and strong competition abroad, car manufacturers will be among the worst performers when the dollar collapses.

Rebirth of Manufacturing?

Free from catering to the needs of Americans, foreigners will be free to invest more of their hard earned money in domestic manufacturers. Many foreign manufacturers will be forced to restructure or liquidate their assets to other foreign companies, but foreign economies, especially in East Asia, will quickly rebound and expand at an unbelievable rate. America’s manufacturing industry is fully capable of making a comeback, but only if Americans understand that freedom, and not government intervention, is the solution.

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