Manufacturing in the Intangible Economy

There is a lot of misunderstandings about the Intangible Economy (or the "dematerialized" economy or the "weightless" economy or the really misleading "services" economy). One of the greatest misunderstandings is that manufacturing has no role. Or that a national economy can survive without manufacturing. For example, a recent story in the Wall Street Journal on Michigan and the Knowledge Economy: Manufacturing won't support the middle class. The story advocates an abandonment of manufacturing for knowledge industries, which they define as "information, finance, insurance, professional services, health care and education."

There are two fallacies to that argument:
1) that "manufacturing" and "services" are completely separate and unrelated activities
2) that a large nation can export enough "services" from the knowledge industries to pay for the importation of manufactured goods.

Let's start with the first argument. One of the hallmarks of the intangible economy is the fusion of manufacturing and services. As I have noted before, even the very nomenclature manufacturing and services has become misleading. This is highlighted in a new report from the Work Foundation in the UK on Manufacturing and the Knowledge Economy. (Part of their series on the Knowledge Economy.)

The reports make a number of important points about manufacturing:

Modern manufacturing has been reshaped by exactly the same forces driving our transformation into a knowledge based economy. There are two closely related major consequences of these changes.
• Firstly, modern manufacturing invests more heavily in knowledge based intangible assets than services and provides large numbers of knowledge intensive jobs;
• Secondly, the conventional boundaries between manufacturing and services are blurring as manufacturers incorporate high value added services into the production process.

On this second point - the blurring of manufacturing and services, the classic case is Rolls-Royce as I've noted before. But not only is the business model blurring the boundaries, the jobs linkages remain strong. The Work Foundation report references a 2004 report from the EU High-Level Group Report Manufuture Technology Platform - Manufuture: A Vision for 2020. This report notes that for every job in manufacturing there were two jobs in manufacturing related services. They also cite a report to the UK Department of Trade and Industry - A Portrait of Trade in Services - that about 25 per cent of all exports of business services and between 40 and 45 per cent of trade and technical related service exports were generated by manufacturing companies.

And those manufacturing sector jobs are more knowledge intense. The Work Foundation finds that in the UK high to medium high tech manufacturing have the same level as knowledge intensive services -- around 40% of the workforce in both.

In other words, manufacturing and services are not two sides of the same coin - they are parts of the design of the face of the coin. Losing the manufacturing base means losing knowledge-intensive jobs and knowledge intensive value added.

The second part of the "let-manufacturing-go" is that we can export enough services to pay for imports of goods. That may be partial true for a very small economy -- say Singapore. However, for an economy the size for the United States, the ability to produce goods is vital for our international financial position. While manufacturing may be under 15% of GDP, it makes up a large part of our trade deficit. Even if we were self-sufficient in energy, we would be running a $300 billion trade deficit because of our deficit in manufactured goods.

Our trade surplus in services is so small relative to our deficit in goods -- as illustrated below and in my earlier posting. In addition, we need to be careful in the definition of services - since it included travel, tourism and transportation. The core of what people think of is in just two of the categories: royalties and "other business services". I label these as "intangibles" and publish that data monthly. At current levels, our intangibles surplus (business services and royalties) would have to be 6 times as large as it is now in order to offset our goods deficit.

In addition, trade in intangibles is subject to the same competitiveness pressures as trade in goods. Other nations are expanding their knowledge based service industries as well. In fact, our imports of intangibles grew faster than our exports in 7 of the last 10 years. There is no reason to believe that our exports in these sectors can grow 6 times as large in the near future.

There is one other way to look at the importance of manufacturing to the US economy. Let us undertake a thought experiment as to what would happen if manufacturing output declined. The chart below illustrates the impact on the trade deficit -- using the Federal Reserve's data on industrial production for total consumer goods and durable goods. Let us simply see how much more we would have to import if domestic production declined -- assuming consumption remained at 2008. This does not include any decline in manufacturing exports. If output of durable goods (the smallest US manufacturing sectors) were eliminated, the deficit would increase by 60%, If output of all consumer goods (durable and non-durable) were cut in half, the deficit would double. And if the entire consumer goods manufacturing base disappeared, the deficit would triple.

Now, let's also take away our exports in consumer goods. Here we have to be a little creative with the data since the categories of "consumer goods" for trade data and for industrial production are not the same. For this thought experiment, we will subtract out from the goods balance any exports of what fall into the trade categories of "automotive vehicles" "consumer goods" and "other goods". The impact is even more dramatic.

Bottom line: manufacturing still matters. But it is a different from the past - more sophisticated and knowledge intensive that ever. As such, it is an integral part of the Intangible Economy