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August 09, 2006

US Economy, War and Manufacturing
by Gerard Jackson

A great deal is being said about American military might. One common thread has it that American power will eventually decline or be superseded by another nation, probably China. This raises a vitally important question: Can America retain its superpower status without a strong manufacturing base? The unequivocal answer is no.

Let us now see why. Manufacturing consists of the material means of production that makes the projection of American military power a deadly reality for fanatical dictators. This is why America could reach into the very caves of Afghanistan in search of the murderous bin Laden, and bring down Saddam's sadistic regime in a mere three weeks.

But none of this means that American manufacturing is fundamentally strong in the sense of being able to sustain let alone successfully expand the American military if that should become necessary. Although I'm rather pessimistic about the state of US manufacturing others are cheerfully blasé, reciting such facts as manufacturing productivity averaged 3.4 per cent a year in the 1980s and that between 1981 and 1989 total output rose (in real dollars) by about 39 per cent, and so on.

It is also pointed out by optimists that the US still leads the world in the production of all types of jet aircraft, high-tech petrochemicals, telecommunications, computers, and by 1996 was producing 46 per cent of the world's semiconductors. Then there is the vast range of consumer goods being produced, as one would expect given the size of the economy. However, pessimists charge that much of what is being touted as economic success is mere floss, a view they would claim the last recession vindicated.

They cite as evidence the decline in manufacturing employment, stressing that it has fallen from 32 per cent of the workforce in 1960 to about 17 per cent today. Without a large manufacturing employment base, they argue, real wages are bound to fall as average productivity per worker declines.

Now I have to admit that this is not strictly true. In 1851 the percentage of the occupied workforce in England and Wales employed in manufacturing (including textiles) was about 33 per cent and about 37 per cent for Scotland. Today, it's about 17 per cent for the whole of Britain. But no one would argue that British living standards are below the level of 1851.

What is frequently overlooked is that the fall in manufacturing employment has been relative and not absolute, the difference being made up by massive increases in output. In addition, the US workforce has expanded enormously in the last 30-odd years. That living standards still rose as employment fell during this period is an enormous tribute to the productive power and flexibility of the American economy, despite the onerous burdens politicians have imposed on it.

The steel industry is a striking example of increased productivity. From 1980 to 1992 it shed some 400,000 jobs leaving it with less than 180,000 employees while still producing the same level of output. This amounted to a 230 per cent increase in productivity. The optimists call this an impressive performance -- and they're right.

So why my pessimism? In my opinion several things could be eating away at this rosy picture. To begin with, I'm no fan of aggregates, firmly believing that they hide more than they reveal, especially the national accounts. These accounts show that consumer spending makes up about 66 per cent of total spending.

This is completely wrong. If spending between stages of production were included consumer spending would drop significantly, perhaps falling to even 25 per cent or less of total outlays. In other words, the amount spent on producer goods -- which includes spending between the stages of production -- is what drives the economy, not consumer spending. And should the former go into a steady decline, so would living standards.

In 1928 the Dutch economist M. W. Holtrop estimated that America spent about nine times as much on producer goods as it did on consumer goods. This ratio of capital spending to consumer spending shows how massive gross savings were at the time. A ratio that made America the allies' arsenal during WWII.

So if the ratio has fallen, why haven't living standards dropped? Because of what I call the treachery of aggregates. True, the ratio has fallen but it must never be forgotten that capital is not only heterogeneous it embodies technical progress. The capital structure of 1928 is therefore not the capital structure of today, which is vastly more productive. And because capital is heterogeneous it is literally impossible to measure the capital structure.

I believe it is possible that the massive increase in the productivity of capital that has taken place during the last 70 years has concealed, with the help of Keynesian fallacies, that the growth in America's capital structure has been retarded by a combination of heavy taxation (I consider regulations a form of taxation), Keynesian inspired assaults on savings and Keynesian monetary policies, the effects of the latter being particularly pernicious.

If the capital structure has been retarded then the blame should largely rest with Keynesian pump-priming policies which involves driving interest rates down below their market clearing rates. This process could skew the economy towards consumption at the expense of a further increase in the rate at which the capital structure would otherwise expand.

Monetary manipulation not only severely distorts a country's capital structure by misdirecting production it can also lead to the currency being overvalued which in turn could induce some manufacturers to shift operations offshore when undistorted marketed conditions would have persuaded them to remain in the US.

Such a process would keep American living standards lower than they would otherwise be. This means that it would require greater sacrifices by Americans if they wish to expand and maintain a 21st century military structure. As technology progresses and becomes more complex, weapons and the means of defense become more expensive. A B1 costs a lot more in any currency than a B29.

I conclude that unless America encourages a significant increase in savings and abandons the Keynesian monetary policy of manipulating interest rates, and the Democrats' fanatical addiction to heavy taxation and burdensome regulations her ability to maintain the necessary military machine to deter attack by potential enemies in the decades to come will be severely impaired.

When Japan attacked the US in 1941 she awakened a sleeping economic giant. Let us hope that 2041 will not see an attack that will destroy what remains of what was once the envy of the world.

Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes economics editor.

Copyright © 2005-2008 Gerard Jackson

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