Manufacturing, the Recovery, and What Lies Ahead

By Stormy

The big picture is always important. Today’s report of the dramatic fall of the factory index is incredibly bad news, a significant part of the that big picture:

The Federal Reserve Bank of Philadelphia’s general economic index plunged to minus 37.5 this month, less than forecast and the lowest reading since October 1990, from 3.8 in September, the bank said today. Negative readings signal contraction. The index averaged 5.1 last year.

How we respond to this fact has to be seen in a global context. We have watched one bubble burst; we are now about to confront the explosion of a negative bubble, a kind of black hole that we have been cultivating for some time: our manufacturing sector. The easy explanation is not always the correct one. Many will blame the present deep recession on just the financial crisis.

That is not the full story.

For over a decade, we have watched our manufacturing flee elsewhere; watched our largest companies outsource and offshore–with barely a peep from many economists. We have added jobs to government, health care, and service industries; manufacturing jobs have dwindled. Even many of our important service industries–in IT, medicine, and accounting–, we have outsourced, off-shored in the name of efficiency. Even Research and Development is leaving these shores.

In short, the engine for our real recovery lies littered around us, rusted, broken, unattended, and ignored. I am not going to wage my usual complaint about the WTO or our trade policies, or push once again for fair, not free, trade. Nor will I complain that globalization was too rapid, too poorly structured. It is too late for all that. What’s done is done.

What I want to do is to adumbrate the directions in which the U.S. and the world seem to be going. Then I want to offer what I see as the only hope.

The U.S. is in for a long downward slide. The fixes that are being proposed will be temporary, at best. To some extent, Europe and other developed countries will be tied to U.S. fortunes; many have sowed the same seeds that the U.S. has. But there is hope–and it may seem an unusual one to those who have understood me. That hope is China, hope that China moves as quickly as possible from an export platform to a more consumer based economy, hope that China is wise enough not to continue those policies that have drawn foreign company after company into its fold. (Those countries that can feed China’s thirst for raw materials will do well.)

The Short-term Fix

Krugman clearly states how the U.S. will respond: “Lets Get Fiscal.” Massive government spending will be the policy, regardless of U.S. indebtedness–spending to support ailing communities whose tax bases have collapsed, spending to increase unemployment insurance for our service-oriented economy and to what is left of our manufacturing industry, spending on our infrastructure to provide jobs, spending to help students no longer will be able to afford an education, spending to help those pushed over the edge by one medical crisis.

Can we do otherwise? No. But understand this is our last fix.

After it is over, we will have to pay the bill; we will have to return to that place where all ladders start. It will be a long climb. We will have to protect our people from predators, both at home and abroad; we will have to give them a safe place to work, free of medical worries, free of worries that an education is too expensive. We will have to construct policies that allow our people to compete fairly among the nations of the world. No more platitudes about being competitive; no more platitudes about freedom and democracy; no more celebrations that we are the best. Clearly, we are not gathering any laurels lately.

Competitiveness is not just one man working hard; it is a society structured so that all hard work counts.

Hard work, hard planning, hard thinking will be in order. We will have to see beyond one minute, one day, or one year. We will actually have to have some kind of vision for our future. Our government will be our collective instrument, not the whims and greed of a few important individuals. We may finally understand that democracy is hard, hard work, not the celebration of this or that personality. Then and only then will we begin that long climb upward.

China: Policies and Growth

With a population of over 1.3 billion people and with an impoverished third world economy, China’s sudden entrance onto the world stage was an enormous counterweight to the industrialized nations. No country has ever had such an impact on the world, not even Japan as it climbed from the devastation of World War II. How is China doing now, a mere seven years after its entry into the WTO?

  • Reserves: an astounding $1.7 trillion–and growing
  • GDP growth: 9.7% with projected growth around 8% next year. (IMF predicts 9.3%.)
  • Currency exchange rate: 6.8360. Recently lowered (to protect some industries)
  • Inflation rate: 4.6% (Down .3% from last month)

While its growth will slow, China seems to be weathering the storm.

How did China, a barely industrialized, impoverished nation achieve all this? Quite simply, it played perfectly its one great trump card: its 1.3 billion people. It then fashioned its playing field to exploit that advantage, by offering juicy inducements to foreign firms.

  1. It instituted a two-tier tax rate, giving the advantage to foreign firms. Foreign firms were taxed at 15%; indigenous firms, at 30%) In key industries, foreign firms were given a tax holiday if they promised to stay for ten years.
  2. It instituted no immediate provisions to protect its labor force from substandard working conditions, unscrupulous employers, or substandard pay.
  3. It used tax rebates to leverage exports on selected items. In short, no taxation for exported consumer goods. For a more complete discussion of how export tax rebates work, see data here and discussion here and here.
  4. It pegged its currency to the dollar in order to further leverage its exports.
  5. It ignored environmental degradation. (Most environmental regulations can be viewed as a hidden tax, advantaging companies that produce the pollution as well as those non-polluting companies who make use of the products that the polluting companies provide: Energy, for example.)
  6. It subsidized the cost of oil, thereby making energy cheaper for all.

In short, China combined labor, tax, and environmental arbitrage together with its immense and impoverished population to build an unrivaled export platform, an export platform that fed the Western consumer with goods produced in many instances by foreign firms from industrialized nations. The next stage–already in motion–is to cultivate its own companies. Flushed now with cash, China is in an excellent position to do so.

The Hope

As I said above, the hope is that the world–and China especially–takes a breather and reconsiders how the game has been played. There is too much at stake. We simply cannot afford the kind of arbitrage to which I have pointed. It is too dangerous for all. We have to hope that China moves from being primarily an export platform to a consumer-based society. We have to hope that China vigorously begins to levy all those hidden environmental taxes, which in turn will raise the price of goods as well as clean the environment. We have to hope that China rapidly protects its labor force from predation, that it allows real bargaining between employer and employee. We have to hope that export rebates disappear entirely. We have to hope that China provides its people with the kind of social net that some more advanced countries provide. We have to see hope that China understands that an all-too rapid climb to becoming frontier nation can have disastrous global consequences. And when all of this is done, we have to hope that then–and only then, we are ready to compete fairly in the marketplace of ideas and products.