The high-tech rebound

Posted: Sep 25, 2003 12:00 AM

An earlier column questioned recent allegations that U.S. manufacturing has suffered a long-term secular decline rather than a routine but painful cyclical recession. I received a number of critical comments, some from online bulletin boards. Many misunderstood the distinction just mentioned, between secular and cyclical trends, and nearly all the critics misunderstood the statistics.

I am certainly not claiming that all manufacturing industries are now flourishing in every state. On the contrary, industrial production in August was barely 1 percent above the cyclical trough in December of 2001. But suffering for a few years during and after a recession is a typical cyclical malady -- not a sign that manufacturing has long been fleeing the United States. Manufacturing generally grows faster than the economy during booms but also falls faster during slumps. Manufacturing often declines before recessions begin and remains distressed for quite a while after recessions end.

A couple of complaints about my earlier column were well illustrated by a thoughtful letter in The Washington Times from Michael Kirschner of San Francisco. Like several others, he sincerely believed (incorrectly) that the statistics I mentioned about GDP and industrial production confused U.S. companies with U.S. production: "Very little that HP, Dell or many other high-tech manufacturers make," wrote Kirschner, "is built in the United States."

Actually, Dell has huge award-winning manufacturing plants in Austin, Texas, and Nashville, and Hewlett Packard has manufacturing plants in 29 U.S. cities. Foreign plants of companies such as HP and Dell are mainly needed to fill foreign orders as quickly as they are filled here. Dell's factory in Ireland markets to Europe, not the United States.

Perhaps Kirschner meant to say that many parts that go into making computers are made in places like Singapore. But imported parts have nothing to do with statistics on manufacturing output within the United States. Gross Domestic Product from manufacturing is -- as the name says -- domestic product only. If a $1,000 computer contained $700 worth of imported parts, then only the $300 of value added would be counted as domestic product.

Recent controversy about manufacturing's allegedly falling share of GDP resulted from statistical mistakes. One obvious error has been to compare the figure at a cyclical peak such as 1988 with the recent recession bottom in 2001. Another error has been to rely on the nominal value of manufacturing rather than its real value or quantity.

Suppose a company produced 2 million computers in 1994 at $2,000 apiece and 3 million in 2002 at $1,000 apiece. Using nominal figures would make it look as though that company's production had gone down 25 percent, when in fact it went up by 50 percent.

I previously focused on the manufacturing component of the Fed's index of industrial production, rather than GDP, and that index also measures U.S. production only. It is constructed from physical measures, such as tons of U.S. steel, plus estimates for some industries based on their use of electric power and hours of work. Manufacturing accounts for 86.7 percent of industrial production -- mining and utilities for the rest. High-tech manufacturing of the sort typified by Silicon Valley accounts for only 7.1 percent of the index and 9.5 percent of manufacturing jobs. Yet high-tech equipment accounted for nearly half of the total growth of manufacturing growth in the '90s.

The long and strong 5.3 percent growth of manufacturing output from 1992 to 2000 would drop to only 2.7 percent if we left out huge increases in U.S. production by manufacturers of silicon chips, computers and communications equipment. The tech boom was not just in the stock market. It was quite real. And the recent rebound in tech stocks is real too: August production of computers and office equipment was up 22.2 percent from a year earlier; production of semiconductors and related components was up 19.1 percent. Manufacturers of more mundane products did not fare nearly as well as tech producers in the '90s, or in the past year.

Silicon Valley went through a classic boom-bust cycle. Some people from the area, including Kirschner, ask us to focus on the bust and ignore the preceding nine-year boom and recent rebound. It is true, however, that because of Silicon Valley's notoriously inflated cost of real estate and taxes, some of that area's plants have relocated to other states -- not to other countries -- leaving local unemployment far above the national norm.

Another common complaint concerns my use of International Labor Organization estimates that average productivity in U.S. manufacturing is 12 times larger than in China. Kirschner disputes the facts by saying Chinese plants are just as automated as ours. Because costly labor-saving machinery renders labor costs relatively insignificant, however, that claim undermines his premise that "cheap labor" (rather than proximity to millions of Asian consumers) is the main reason for being there. If cheap labor really mattered so much, then all U.S., Japanese and European factories would long ago have moved to Bangladesh and Chad.

What is missed by such anecdotal impressions about the efficiency of particular Chinese factories is that U.S. plants generally produce much more valuable products, such as cars and computers. World consumers are unwilling to pay much for, say, tiny black and white televisions regardless how efficiently they are produced. Products that can't command a high price generally can't pay a wage that would attract U.S. workers. The average productivity of all Chinese manufacturers is not determined by a few highly automated plants but rather by the sizable majority that produce inexpensive labor-intensive goods. Many of those goods are essential parts and materials that help to hold down U.S. manufacturing costs and consumer prices.

Some figures from the Federal Reserve Bank of St. Louis Review help put the unquestionably painful cyclical downturn in perspective. During the average postwar recession, industrial production fell by 7.3 percent. During the last recession, by contrast, industrial production fell by only 4.2 percent. During the average recession, imports fell by 4.5 percent -- but during the last recession, imports fell by more than 6 percent. Domestic manufacturing fared relatively well, as recessions go, while foreign exporters to the U.S. suffered more than usual.

To suggest that U.S. industries fared worse than usual during the recession of 2001 could be a mistaken impression due to short memories. But to suggest that U.S. industry went down because imports went up, as many now claim, is so far from the truth that something more devious than mere ignorance must be involved. Most likely this is just another veiled pitch for higher U.S. tariffs. But tariffs raise American manufacturers' cost of production and consumers' cost of living. Such higher costs would make us all poorer, not richer.