Magical Growth through Manufacturing Decline

September 16, 2011 at 11:45 pm 6 comments

In a data driven world, we can never get enough numbers. The market magicians and the media machines have no problem overhyping or overselling the importance of each pending data-point. With a quick economic sleight of hand, the industry pundits have converted the average investor into a frothing Pavlovian dog, begging for another market shaking statistic. One of the supposed earth-rattling data points is the monthly ISM Manufacturing Index figure, but the release of the ISM number alone isn’t enough for the audience. The real fun comes in determining whether the monthly number registers above or below a schizophrenic 50 level – a number above 50 indicates the manufacturing economy is generally expanding (August came in at 50.6).

The trick can often be surprising, but more surprising to me is the importance placed on this relatively small, disappearing segment of our economy. With the manufacturing sector now accounting for just 11-13% of GDP (see also Manufacturing – Losing Out?), shouldn’t we be focusing more on the “Services” sector of the economy, which accounts for roughly 75% of our country’s output, up from 62% in 1971 (source: Earthtrends). I believe economist Mark Perry at Carpe Diem captured this phenomenon best in his post from earlier this year (Decline of Manufacturing – The World is Much Better Off ):
The fact of the matter is that manufacturing has been declining as a percentage of GDP over the decades just as the broader economy has seen massive growth. While manufacturing got chopped in half, as a percentage of GDP, from 1970 to 2011 we have seen GDP balloon from about $1 trillion to $15 trillion. If manufacturing declined by another 50% of GDP, I’d do cartwheels to see another 15x increase in economic expansion. I acknowledge the existence of certain synergies between product development and product manufacturing, but these benefits must be weighed against higher domestic costs that could make sales potentially unviable.

Déjà Vu All Over Again

This isn’t the first time in our country’s history that we’ve experienced explosive economic growth as legacy segments of the economy decline in relative importance. Consider the share of jobs agriculture controlled in the early 1800s – a whopping 90% of jobs were tied to farms (see chart below). Today, that percentage is less than 2% in the wake of the U.S. becoming the 20th Century global superpower. History has taught us that technology can be a bitch on employment, as robots, machinery, processes, and chemistry replace the demand for human labor. As Perry points out, there is no doubt that “tractors, electricity, combines, the cotton gin, automatic milking machinery, computers, GPS, hybrid seeds, irrigation systems, herbicides, pesticides” replaced millions of farming jobs, but guess what…American ingenuity ruled the day. As it turns out, those economic resources freed up by technology and productivity were redeployed into new, expanding, job-fertile areas of the economy like, “manufacturing, health care, education, business, retail, computers, transportation, etc.”

Source: Carpe Diem

More Apples or More GMs?

The farming lobby still cries for its inefficient, growth-muffling subsidies today, but many unproductive, unionized domestic manufacturing industries are also screaming for government assistance because cheap foreign labor and new technologies are stealing manufacturing jobs by the boatloads. So at the core, the real question is do we want government and investments supporting more companies like Apple Inc. (AAPL) or more companies like General Motors Company (GM)?


As you may know, by flipping over an iPhone, any observer can clearly notice the product is “designed by Apple in California – assembled in China.” It is clear that Apple and its customers value brains over manufacturing brawn. At $371 billion and the most valuable publicly traded stock in the universe, Apple is dominating the electronics world, all the while hiring employees by the thousands. These facts beg the question of whether Apple should revamp their manufacturing supply-chain back to the U.S. to save more domestic jobs? Of course the result of a manufacturing strategy shift to a higher cost region would make Apple less competitive, force them to charge consumers higher prices for Apple products, and open the door for competitors to freely steal market share? Would this strategy create more incremental jobs, or fewer jobs? I think I’ll side with the Steve Jobs philosophy of business, which says “more profitable businesses must fill more job openings.”

If this Apple case study isn’t illustrative enough for you, maybe you should take a look at companies like GM. The U.S. automobile industry has historically been notoriously mismanaged, thanks to a horrific manufacturing cost structure, anchored by unsustainable pension and healthcare costs. Should investors be surprised that an uncompetitive, bloated cost structure leaves companies like GM less money to invest in new products and innovation? This irrational cost management contributed to decades of market share losses to foreigners. If I’m the job creation czar in the U.S., I think I’ll choose the Apple path to job creation over GM’s route.

Global Competitiveness = Jobs

With a 9.1% unemployment rate and the recent introduction of the American Jobs Act, there has been plenty of emphasis and focus on job creation. At the end of the day, what will create durable, long-term job creation is innovative, competitively priced products and services that can be sold domestically and abroad. How do we achieve this goal? We need an education system that can teach and train a workforce sufficiently to meet the discerning tastes of a global marketplace. Government, on the other hand, needs to support (not direct) the private sector by investing in strategic areas to help global competitiveness (i.e., education, energy independence, basic research, infrastructure, entrepreneurial capital for business formation, etc.), while facilitating a business environment that incentivizes growth.

Regardless of the policy mixtures, the common denominator needs to be focused on improving global competitiveness. Excessive focus on a declining manufacturing sector and the monthly ISM data will only distract decision makers from the core issues. If the economic magician’s sleight of hand diverts investor attention for too long, we may see more jobs disappear.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, and AAPL, but at the time of publishing SCM had no direct position in GM, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page

About these ads

Entry filed under: economy. Tags: , , , , , , , , .

The Political Art of Investment Commentators Mr. Market Bullying Investors

6 Comments Add your own

  • 1. Francis Larson  |  September 18, 2011 at 11:45 am

    spot on

    Reply
    • 2. sidoxia  |  September 18, 2011 at 5:46 pm

      Thanks for the comment FLarson!
      -WS

      Reply
  • 3. Brian  |  September 19, 2011 at 8:37 am

    Your logic has a fatal flaw. when we transitioned from agriculture to manufacturing we did NOT give up agriculture and start importing food!

    What happened was we became more efficient in producing Agriculture wealth with fewer workers. That is NOT what we have today, we are not simply making all the same manufactured (wealth) goods using less workers, we do no longer produce the (manufactured) wealth.

    Agriculture is in fact the largest export we have, you cant export if you dont produce. We have lost our manufacturing and it has both economic and military consequences.

    Reply
    • 4. sidoxia  |  September 19, 2011 at 3:08 pm

      Brian-
      Thanks for the response. In the 19th-20th Century agriculture era, most of the productivity improvements came from technology. In the modern manufacturing example, both technology and cheaper foreign labor are increasing productivity. Although Apple may be importing commodity modules, they are not importing finished iPhones/iPads. As I mention in the article, the iPhone/iPad may be manufactured and assembled in China, but in many instances the end-product is marked up significantly and still sold in the U.S. and recognized as part of U.S. economic growth. The profits generated from cheaper, more efficient international manufactured products allow excess capital to be invested by companies into the economy and for hiring (profitable companies hire, not uncompetitive bankrupt ones). Moreover, cheaper, more efficiently manufactured products will be more competitive globally, thereby allowing more exports to add to our economic growth. Check out how many million iPhones were sold by Apple internationally last quarter. The displaced manufacturing workers are hurt the most in the short-run and and need to be retrained to meet new growth sector demands – I’m sure the unemployed feel much the same way as displaced farmers in the early 1800s.
      ~WS

      Reply
  • 5. Sunday Link-Fest | ValueWalk.com  |  September 24, 2011 at 10:11 pm

    […] Magical Growth through Manufacturing Decline […]

    Reply
  • 6. Self-Deception | Prudent Trader  |  May 28, 2013 at 8:11 am

    […] Magical Growth through Manufacturing Decline (Wade Slome) […]

    Reply

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Trackback this post  |  Subscribe to the comments via RSS Feed


Subscribe to Blog

Meet Wade Slome, CFA, CFP®

More on Sidoxia Services

Recognition

Top Financial Advisor Blogs And Bloggers – Rankings From Nerd’s Eye View | Kitces.com

Wade on Twitter…

Share this blog

Bookmark and Share

Follow

Get every new post delivered to your Inbox.

Join 1,109 other followers

%d bloggers like this: