Forget Manufacturing vs Service: The Crucial Distinction Is Tradable vs Domestic

US citizens have learned the hard way that they can not survive by selling real estate to each other. The question of what they can sell, and to whom will determine to what degree the economy can revive.

There has been considerable hand-wringing over the loss of manufacturing. The problem is that bureaucratic definitions of what constitutes manufacturing vs what constitutes service have blinded policy makers to a more significant difference; the importance of economic activities that contributes to global trade and those that are tied to domestic pursuits (eg, 'not foreign')such as home health care and food preparation.

It is the production of goods AND services that have value beyond the confines of a limited domestic area that will generate the kind of incomes that can sustain a middle class. The BRIC countries and those who are following in their wake are producing revenue both from foreign and domestic sources that have enabled the rise of a middle class. The US has lost its competitive edge due to the hollowing out of that crucial demographic.

Discriminatory immigration laws and chronic dumping complaints to the World Trade Organization will not change the dynamic. The US is dependent on global trade and must make a more sustained effort to support activities that contribute to it. JL

Free Exchange comments in The Economist:

Ed Luce in yesterday's Financial Times on America's labour market: "a growing share of whatever jobs the economy is still managing to create is in the least productive areas. Of the five occupations forecast by the Bureau of Labor Statistics to be the fastest growing between now and 2018, none requires a degree. These are registered nurses, “home health aides”, customer service representatives, food preparation workers and “personal home care aides”."

Manufacturing is nowhere in the top 20, and such jobs cannot replace the pay and conditions once typical of that sector. “The food preparation industry cannot sustain a middle class,” says Dan DiMicco, chief executive of Nucor, one of America’s two remaining big steel companies, whose company motto is “a nation that builds and makes things”.
Matt Yglesias notes that the emphasis on the importance of "manufacturing" is a bit foolish:

To understand this problem, you need to start with the fact that if I build a factory where people take fresh peas and put them in cans that's a "manufacturing" facility full of manufacturing jobs and people who "make things." But if I build a facility where people take fresh peas, mix them with some basil and a touch of mint, plus olive oil, parmigiano reggiano, and pine nuts then purée them to serve you a delicious pea pesto that's a lowly service sector employment cite that couldn't possibly generate good jobs. Similarly if I make pasta then dry it and stick it in boxes, I'm manufacturing. If I make fresh pasta and serve it to you on a plate with my pea pesto that's services. The difference between manufacturing and services is not an ontological void between making things and not making things. It's really a gap between putting things in boxes and not putting them in boxes. Like if you build a bookshelf and ship to a store and I buy it, that's manufacturing. If I hire you to come to my house and install custom built-in shelves, that's services.

I'm happy to see both Mr Yglesias and Kevin Drum note today that while the distinction between manufacturing and services is often meaningless, the distinction between tradability and non-tradability of products is most certainly not.

Tradable goods and services can, by definition, be consumed well away from the point of production. The international price of tradable products is therefore constrained within a fairly small range; you can try to sell a product for much more than its foreign equivalent, but don't expect anyone to buy it. What this suggests is that real income differences across countries are largely attributable to differences in productivities within the tradable sector. This finding is associated with what economists call the Balassa-Samuelson effect, after economists Béla Balassa and Paul Samuelson.

In order to earn a higher wage than a worker in another country producing goods that trade at a more or less equal price, an employee must be more productive. The higher wage in the tradable sector will lead to a rising wage for workers in non-tradable sectors—that is, those producing non-transportable products like haircuts for local economies—as local firms must pay a competitive wage to attract employees. An overall higher level of income in an economy, in other words, is only possible thanks to higher productivity in the production of tradables.

The trouble, as Mr Luce rightly points out, is not necessarily that America is losing jobs in manufacturing. It's that it is failing to create jobs in the tradable sector. Almost all net new job creation in America over the past 20 years has occurred in non-tradables: things like health care, for instance, or education. This is potentially a very serious issue. If America isn't creating new jobs in the tradable sector, it is presumably because creation of such jobs is economically problematic: expected returns from worker outputs are less than the expected cost of hiring the worker. Put differently, it would seem that American productivity growth has not kept up with American labour costs across the economy as a whole.

Now, this isn't necessarily the explanation for sustained high unemployment in America. Normally, we'd expect American wages to fall, either through nominal wage declines or a weakening of the exchange rate, until American labour costs are back in line with productivity and the market for labour clears. To explain unemployment, we probably need to look at a breakdown in that adjustment process. If the problem one is aiming to diagnose is one of prolonged stagnation in earnings, however, then this is an important dynamic to examine.