Remember the deindustrialization of America? In the 1980s, this was the supposed loss of the U.S. industrial base. There was much hand wringing over the issue at the time. Back then, we argued that the United States was the victim of a too high exchange rate, creating distress for manufacturing-a problem that industry could and would work its way through together with the likely prospect that the exchange rate would eventually decline. Subsequent events proved us correct. The foreign exchange value of the dollar fell, the economy expanded following the 1981-82 recession, and manufacturing output and employment grew.

Today, we are not hearing the phrase, "deindustrialization of America", but we are hearing much the same complaints from producers and politicians-that manufacturing production and employment is moving offshore due to the high value of the U.S. dollar and low wages abroad-as they push for protectionist measures and tax benefits. There is no question that manufacturing, after prospering in the 1990s, has faced significant obstacles over the last three years. In particular, manufacturing has had to deal with the bursting of the tech bubble, a recession, and a run up in the foreign exchange value of the dollar.

Although these have been real problems causing real pain for manufacturing, they must be kept in perspective. First, manufacturing benefited from the advances in and demand for new technology in the 1990s. It was also one of the beneficiaries of the over investment in technology. Thus, it was no surprise that manufacturing suffered with the bursting of the tech bubble. Consequently, manufacturing slipped into recession almost a year before the rest of the nation. No doubt the sector's problems contributed to the national recession. And while all manufacturing has suffered, those engaged in high tech related industries have endured the largest amount of distress.

Second, the 2001 recession, as with all recessions, hurt manufacturing. However, the recession ended almost two years ago. At the end of the recession, manufacturing did show some improvement, expanding for nine months. There was a stumble at the end of 2002, then a flattening out. In the last few months, there has been some evidence that manufacturing is once again on an upward path, though not as strong a recovery as producers would like.

Third, although the increase of the foreign exchange value of the dollar as measured by the Federal Reserve's index for the trade-weighted exchange value of the dollar was a significant 40% from the index's low in April 1995 to its peak in February 2002, it is not as great as the 52% increase from July 1980 to March 1985. Further, as of September, the index was down 17% from its February 2002 peak. While many analysts might still consider the dollar too high (especially against certain currencies, such as the Chinese Yuan), the Fed's trade-weighted index is now near the upper end of the index's value range in the early 1990s and below the index's value over most of the 1980s.

The major complaint, particularly by politicians, has been the loss of employment in manufacturing. Despite arguments to the contrary this is not an indication of the loss of industrial power in the United States (or in 1980s speak, of deindustrialization). Instead, it is the result of the maturation of manufacturing as productivity gains outstrip increased demand, reducing the need for labor.

Note that this is the same phenomenon that occurred in agriculture in the latter part of the nineteenth century and over much of the twentieth century. Today, less than 3% of the U.S. workforce is engaged in agriculture, yet the United States is a leading producer of and major exporter of agricultural products.

The shift from agricultural employment to manufacturing employment permitted the growth of the industrial sector. Today, we see a similar movement-from manufacturing employment to service employment. Contrary to modern myth, most of the new jobs are not low paying service jobs. We are not becoming a nation of hamburger flippers. Most of the growth is in the knowledge industry-everything from medical services to legal services to computer programming. These are high value added industries paying good wages.

The challenge for public policy is not how to retain our industrial base or manufacturing employment, but how to facilitate the shift in employment to the knowledge economy. It means creating programs to train (and retrain) workers for the industries with growing employment needs. It means not fighting the tide of economic forces with ill-conceived industrial programs. It means allowing manufacturing companies to make the necessary changes in their structure. Without interference, the industrial base will take care of itself and prosper.

Copyright 2003, Bernard M. Markstein III. All rights reserved. May be quoted with proper attribution.
Bernard M. Markstein III, President, Markstein Advisors
Markstein Advisors, an economic consulting firm, provides economic information and analysis to banks, portfolio managers, business managers, and owners.
"In a world full of data, we provide information."®
Phone: 610-948-6060; Fax: 610-948-1014
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