What’s So Special About Manufacturing?

The Bloomberg podcast Odd Lots co-hosted by Joe Weisenthal and Tracy Alloway had a recent episode that featured guests David Oks and Henry Williams on development, industrialization, and globalization. At timestamp 6:58 Weisenthal asked, “what’s so special about manufacturing?” Willaims replied, “basically when you start manufacturing, you enter a process where long term your manufacturing productivity is going to converge with the global average and with the rest of the world. And so what that means is that manufacturing can really increase your national economic productivity. But in addition to that, it also absorbs a lot of surplus labor and it drives a broader process of economic complexification density and urbanization. That means that you get these economic cores that then create richer citizens.” This a fine answer to that question and both Williams and Oks go into further detail and nuance on the role of industrialization in development contrasting mainstream neoliberal economic narratives. I highly recommend giving it a listen.

Zooming out of that podcast, manufacturing must be seen as an imperative block of a full-stack economy. Erik S. Reinert is one of the most prominent economists that has articulated its importance. He precisely defines the reason for why manufacturing is so special: “the key mechanism to wealth is not manufacturing per se, but activities subject to increasing returns, technological change, and consequent dynamic imperfect competition under high barriers to entry…in industry: an increase in production would as a general rule have reduced costs. In manufacturing, the next machine one starts up will not be less effective than the previous one, rather the opposite; the next hour worked will reduce fixed costs per unit of production. In manufacturing, increasing production leads to falling unit costs. In manufacturing, increasing market share gives you the opportunity to get ahead in the race down the learning curve; in agriculture it drives you into the wall of diminishing returns…increasing returns means that as production expands – even without technical change – the cost of production per unit falls…the key to economic development was to have a large number of different economic activities, all subject to the falling costs of increasing returns…world prosperity requires that manufacturing industries and advanced service sectors are distributed to all nations.”

Reinert explained to us that manufacturing isn’t about making stuff for the sake of making stuff. It is about focusing on productive activities that have increasing returns to scale as in when you expand production, costs fall. This means your economy has more stuff that’s cheaper to buy. An economy that deepens into one activity while also spreading into other activities has a healthy recipe for growth. This virtuous cycle enables higher output, higher incomes, and a better quality of life for citizens. Think of it like a startup. A startup doesn’t grow by increasing the number of CEOs. It grows by hiring more and more employees with specialized skills in more and more categories such as accounting, marketing, sales, engineering, research, etc. Innovations can often come from the synergies produced between these fields such as a customer support department informing the engineering department of feedback or the sales department brainstorming with the marketing department. The growth and diversification of your staff inside your business is necessary for its revenue and profit growth. Most companies don’t decide to de-diversify their staffs once they reach a certain growth milestone and similarly, countries should not do that with their economies.

Reinert also contrasted manufacturing with traditional agriculture or commodity extraction activities because as you expand production of those activities, costs rise. Additionally, Reinert is wary of over-indulgence into a service economy because a healthy advanced service economy requires a manufacturing sector to sit on top of. Without such a relationship, a stand-alone service sector is not possible. For example, Reinert used Mongolia’s 1990s experience to demonstrate what shifting from an industrial economy to a high tech service economy guided by free market liberalism can do. Rather than making computer software like many Western economists thought, Mongolia’s free market economy destroyed industry and pushed people back into traditional diminishing returns activities like herding. “In only a few years, real wages had been almost halved and unemployment was rampant. The country’s imports exceeded the value of exports by a factor of two, and the real interest rate, corrected for inflation, was 35 per cent.” In the absence of manufacturing, Mongolians were forced into worse activities. These activities produced less and didn’t have the knowledge clusters necessary to move up the value chain. Thus, investment funds, consumer demand, and infrastructure were all well below what would be necessary to produce a sophisticated software sector. Reinert wrote, “this proves…it is better to have a relatively inefficient manufacturing sector than to have none at all.” The full-stack economy can be defined as the service sector stacked on top of the manufacturing sector stacked on top of the agricultural/commodity sector. You cannot have a secure and healthy economy if your country creates holes in that stack and relies on other countries to supply them.