Home Economics The Problem With Dani Rodrik's Manufacturing Analysis

The Problem With Dani Rodrik’s Manufacturing Analysis

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Lots of folks tell us that we should all have more manufacturing. Some even have good reasons for insisting that more things that can be dropped on feet get made. What, for example, do we do with the sub-average male? Given the way the the measuring stick is designed there’s a significant chunk of the population with IQs of 80 and 90 and they’re not going to be doing investment banking.

There’re also those who tell us that we must have more just because that’s what’s manly, or that only making stuff produces real value or, even, that that’s where it’s easier to union organise, unions are a good thing therefore we should have more manufacturing to have more unions. That last rather fails because if people are working where they’re not fussed about having a union to protect them then they’re obviously happier than they are working in a place where they need a union to protect them.

There are also more sophisticated arguments. Like this one from Dani Rodrik:

“Manufacturing has an outsize contribution to overall innovation and productivity,” says Dani Rodrik, an economist at Harvard. He is part of a small group within the profession’s mainstream that clashed for decades with fellow economists by detailing the drawbacks of free trade and the benefits of industrial policy. A growing body of evidence on the harm done to workers by a trade agreement with China, which other economists played down at the time, has increasingly vindicated him.

This at least has the advantage of being true. It is easier to increase productivity in manufacturing. This is the flip side of Baumol’s Cost Disease – services will rise in price in relation to manufactures because it’s easier to increase productivity in manufacturing than services. But wage rates are determined by average productivity across the economy, thus the labour embedded in services – low productivity increases as above – becomes more expensive relative to the falling amount embedded in manufactures.

So, yes, we would expect to see greater productivity increases in manufacturing. Well, sorta.

Think of where the current productivity increases really are – they’re online, in software. My favourite example being WhatsApp. Some billion people gain some to all of their telecoms from this app. The production of it is a couple of hundred folks at Facebook in CA. There’s a weirdness that this is recorded in GDP as a reduction in productivity – there’s no measured output given no advertising and no charge – but there we are. It’s clearly a massive increase in productivity and it’s not in manufacturing.

But leave that aside for a moment. Think on that core idea, manufacturing is where the productivity increases are. Even if that’s not absolutely true it is still valid comparatively. We have become more efficient at making cars in a way we’ve not become in waiting tables.

OK.

So, what does that mean for the economy over time? If we’re becoming more productive in our use of labour then we will, over time, use less labour in that sector becoming more productive. This is pretty much what becoming more productive means. We’ll also see the price of manufactures fall against the price of those services where productivity doesn’t increase so much. We’re back, that is, to Baumol.

Hmm, well, what happens then? Well, clearly, by definition manufacturing employment falls as a portion of all employment. Further, we’ve already sold the pass that manufactures become cheaper relative to services. Thus manufacturing output, by value, becomes a smaller part of the total economy. These are not happenstances they’re results built into our original assumption that manufacturing has greater productivity increases than services.

So now go back to Rodrik. At least the implication of what he’s saying is that we must artificially boost the portion of the economy that is manufacturing because that’s where the productivity increases will come from. But the very productivity increases desired are exactly what shrinks manufacturing both in employment and as a sector of the economy.

In fact, we can even say – and should – that the reason for the shrinking of manufacturing is that productivity has increased there faster. So Rodrik’s policy impulse really becomes we should have more manufacturing to make up for the fact that our plan to have manufacturing has already worked.

Which isn’t, perhaps, all that great a policy idea.

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