John Berry on the Fed's Decisions This Week
Max Sawicky Objects to a Paragraph in the Club for Growth's Petition

Barry Eichengreen: Manufacturing Doesn't Matter (Much) (Any More)

Mark Thoma sends us to Barry Eichengreen on the German economy:

Economist's View: Barry Eichengreen: The German Economy: Be Careful What You Ask For: Germans are having a hard time getting their minds around the fact that their economy is doing better.... Hans-Werner Sinn... [fears] that Germany is losing its manufacturing prowess. It is becoming a “bazaar economy” in which its celebrated consumer and producer durables are cobbled together from imported components. Professor Sinn’s favorite example is the Cayenne, Porsche’s luxury SUV. While the car is nominally assembled in Leipzig, many of the parts are sourced abroad. Even the basic assembly is done in Bratislava. Only the engine is installed in Leipzig. Domestic content is at most a third of final product.

[Sinn's] explanation is simple: expensive German labor cannot compete with equally skilled but immensely less expensive workers to the east. No wonder, then, that Porsche offshores the production of components and assembly operations. No wonder that the share of share of manufacturing jobs in German employment has been falling steadily and with it Germany’s ranking in the GDP per capita leagues.

[Sinn's] solution is equally simple. Reform labor markets so that wages are more flexible. Restructure an overly generous welfare state so that it no longer saps the incentive to work at rates that firms can afford. Germany’s manufacturing champions will then be able to survive and prosper.

There are only two problems with this story. The first one is that Germany has in fact been doing rather well recently. Growth appears to be accelerating from 2.8 per cent in 2006 to upwards of 3 per cent this year. Exports are up by nearly 50 per cent since the beginning of the decade. Even unemployment, a lagging indicator, is coming down. Inconveniently for the undertaker, the patient evidently refuses to die....

If one wants to worry about Germany’s economic prospects, then one must make a rather more subtle argument... the country may have been too successful at retaining manufacturing jobs.... [T]his traditional specialization now places it squarely in the sights of China, India and other emerging markets. These countries have immensely cheaper labor. They are already learning to use and will soon learn how to produce sophisticated machine tools themselves, just as they have learned to produce auto parts. Precisely the same thing that happened to Italy as China moved up the technology ladder into the production of more sophisticated consumer goods will happen to Germany as China moves into the production of more sophisticated producer goods.

The key to growth thus lies in getting out of the way of these behemoths and finding alternative forms of high-value-added employment. That will mean moving out of fabrication in favor of product design. It will mean moving out of industry in favor of services... figuring out how to deploy information technology to raise productivity in retailing, finance and other service sectors....

The UK has enjoyed such a successful economic run precisely because, for peculiar reasons by the name of Maggie Thatcher, it got out of manufacturing and into financial and other services at the right time. My own state, California, has similarly been able to grow and prosper because the defense build-down of the early 1990s caused industries like aerospace assembly to wind down in favor of software and systems design for a host of products manufactured elsewhere.

The real problem in Germany is not the country’s inability to retain more manufacturing employment but its failure to recognize that industry and prosperity are no longer synonymous. The challenge going forward is to adapt the country’s university system, financial system and labor market to what will have to become a post-industrial economy. Here, unfortunately, there has not been much progress. Many Germans have a visceral distaste for service sector jobs. Providing a service to someone else makes one feel like the customer’s inferior, in contrast to a solid and respectable job in manufacturing...

The first requirements for a country to be wealthy are its existing in a world with a high level of technology. The second requirements of wealth are a government strong enough and well-ordered enough to establish private property and the market sytem. The third requirements are, as Adam Smith laid them out, "peace, easy taxes and a tolerable administration of justice." The fourth requirements are a government competent and energetic enough to make the desirable investments in infrastructure and, especially, education to allow the citizens to grasp the opportunities opened by the first four.

Barry Eichengreen is worried about requirement number five: that the culture and the detailed institutions and practices of a country be such as to not penalize forms of economic activity that promise to generate large external benefits for others, and to not subsidize forms of economic activity that promise to impose external costs. Barry believes that the details of Germany's political economy give it a bias toward manufacturing--and that the time when there was a reason for a bias toward manufacturing as the driver of technology has passed.

Has it passed for the developed post-industrial economies? I don't know.