Less Manufacturing Can Indicate Economic Prosperity

The decline of US manufacturing and the rise of Chinese manufacturing has preoccupied policymakers over the past 25 years. It has resulted in the latest effort to use tariffs to try to drive domestic and foreign manufacturers back to the United States and limit trade disparities with China. This idea of bringing back manufacturing to the US is so ingrained in people’s thinking that it almost seems odd to question if that is a goal the US should pursue.

The facts are clear: Employment in the US manufacturing sector from 1965 to 2000 was fairly stable in a range between 17 million and 19 million. However, there was an abrupt shift away from manufacturing in the early 2000s, to a new lower range of 11.5 million to 13 million, which was nearly a 6 million decline, or 33 percent (see chart 1).

Importantly, these manufacturing employment figures do not take account of demographic changes over the past 80 years. We get a starkly different picture of manufacturing employment when we compare it with total employment. Manufacturing has been falling as a share of total employment since the end of WWII (see chart 2). If anything, the decline in manufacturing share has slowed since 2010.

So, what is behind this long-running decline in manufacturing share? The usual explanations for the decline in manufacturing are foreign competition and labor-saving technology. Indeed, the US has run a current account deficit since the mid-1970s and that deficit now stands at 3 percent of GDP.

Also, improvement in technology has resulted in increased manufacturing productivity. Real manufacturing output has continued to rise during that time, averaging 1.5 percent per year, despite the sharp decline in manufacturing employment starting around the year 2000. As a result, manufacturing productivity, measured as output per worker, has doubled in the past 24 years, rising at a 3.0 percent annual rate. So, less labor is needed to produce more output.

But something else is going on – tastes are changing. As nations become wealthier, they demand more services. This stands to reason, as people can become sated with goods. For instance, they can only eat so much food, they generally need only one stove or refrigerator in their house, and there is only so much need for clothing. Once these needs are met, big gains in those areas are hard to come by. On the other hand, people might still want to spend more money on healthcare, entertainment, professional services, education, etc.

There is an endless variety of services and experiences people might want to buy when means allow. Just look at US spending patterns since WWII. The share of services consistently increased over time through 2010 and has maintained a more than 60 percent high share, while the share of goods declined (see chart 3).

The important point here is that US employment and production in services has increased over time because consumer and business demand for services has risen. Similarly, the share of goods has fallen because people in the US demand a smaller share of those products. The share of manufacturing production has declined in lock step with demand – in other words, the US is producing to satisfy its own demand.

This pattern of shifting away from manufacturing and toward services is not just isolated to the United States. In every nation, consumers demand a higher share of services as the nation becomes more affluent. Let’s take a look at where the United States stands in terms of standards of living and services share (see chart 4).

The chart clearly shows a pattern of rising living standards and rising share of services across nations. The US is at the pinnacle of standard of living, as measured by per capita income. As a result, the US produces and purchases a high proportion of services, and US employment patterns reflect that shift. Notice where China is in this array of countries. In our opinion, the US is in an entirely different place developmentally and should not preoccupy itself with trying to match China’s manufacturing and trade performance.