INSIGHTS: REGULATION’S STRANGLEHOLD ON MANUFACTURING
By Guest Columnist John Steele Gordon:
Economic historian and author of, among other works, An Empire of Wealth: The Epic History of American Economic Power.
Reprinted with permission from Commentary.
Despite the political rhetoric, it is not true that American manufacturing is declining in absolute terms. But as a new report from the Manhattan Institute shows, it is declining relative to global manufacturing. While global manufacturing has risen by $3 trillion in the last decade, American manufacturing has grown by only about $500 billion. Thus our share of global manufacturing has declined from 25 percent to about 15 percent. And we are doing this manufacturing with about 30 percent fewer workers than 20 years ago.
While many low-skill jobs in labor intensive industries, such as clothing, have moved overseas and won’t be coming back, American manufacturing remains highly competitive. Indeed, the World Economic Forum’s 2016-17 Global Competitiveness Report ranks the U.S. as the world’s third most competitive economy, after only Singapore and Switzerland. Germany was fifth, the UK seventh. The low energy prices in the U.S. are a major plus. (Natural gas—which is both a fuel and an important feedstock for chemical manufacturing—costs about half as much in the U.S. as in Europe.)
So what is holding back the growth of the U.S. Manufacturing sector? According to the report, which makes a compelling case, it is high taxes and wildly excessive regulation.
In recent years, the U.S. went from having among the lowest business taxes of the G-20 group of large economies to some of the highest. The U.S. corporate-income-tax rate (35 percent, plus many states also tax corporate profits) is the highest in the developed world.
But regulation is even worse; it’s the number-one cost pressure in manufacturing, according to the Business Roundtable. The federal government’s regulatory agencies employ 300,000 people and spend $60 billion a year overseeing manufacturing in this country. Large firms spend $20,000 per year per employee complying with federal regulations, more than twice the cost for non-manufacturing firms. For small firms, with fewer than 50 employees (and it is in small firms that most growth occurs) it is $35,000 per employee. (That’s why large firms are far less opposed to regulation—economies of scale give them a cost advantage over smaller, often nimbler competitors.)
The Dodd-Frank bank reform bill is a case in point. The big banks can live with it far more easily than small ones. That’s the main reason smaller community banks have been disappearing rapidly since Dodd-Frank became law. And it is these community banks that have traditionally been the main lenders to small firms.
At the root of the problem is the fact that bureaucrats rate their success by how big a budget they control and how many people report to them. So it is in their self-interest to promulgate ever more regulations. And self-interest is to the living world what gravity is to the physical, ineluctable and omnipresent.
The report has many good suggestions for how to reverse this tsunami of regulation, starting with President Trump’s order that two regulations must be cut for every one that’s added. In 2015, the Canadian Parliament passed a one-for-one law requiring the elimination of one regulation for every new one put in place.
The report’s bottom line is that the U.S. has so many advantages as a place in which to manufacture that it should be, as it was for well over a 100 years, the world’s first choice for manufacturing. And it makes clear that relatively modest fixes would put it back on top. The problems are not systemic and are easily reformable.
ON THE ECONOMY: JUMP THE ECONOMY
By John Dunham:
Managing Partner, John Dunham & Associates
I get up, and nothing gets me down. You got it tough? I’ve seen the toughest all around. And I know, baby, just how you feel. You’ve got to roll with the punches to get to what’s real. Oh can’t you see me standing here, I’ve got my back against the record machine. I ain’t the worst that you’ve seen. Oh can’t you see what I mean? Might as well jump. Jump! The song Jump was written by the members of the band Van Halen (Eddie Van Halen, Alex Van Halen, Michael Anthony, David Lee Roth) and released in 1983. I recall it being extremely popular when I was stationed in Fort Gordon, and in fact, it was a number one hit for the band.
There’s much scoffing in the media about President Trump’s recent budget proposal. While I tend to agree with the main-stream media that this budget is dead on arrival much like any other budget released by previous Presidents, the fact that it calls for a significant Jump in economic growth is not something that can be poo-pooed. As the blog post included in this edition of the Monthly Manifesto shows, American GDP growth fell off the rails in 2008, and has not recovered. In fact, its entire trajectory has changed leading to massive losses in economic activity and personal wealth for all Americans.
Growth rates matter. They matter a lot. Take an economy growing at 2.5 percent per year over 20 years. At this growth rate, the economy would be 63.9 percent larger in year 20 than it was at year zero. Much of that growth is due to compounding. If the economy were to grow at a straight line rate of 2.5 percent without compounding, it would be just 50 percent larger after 20 years, and if it were to grow at a simple 2.5 percent exponential rate, it would be 64.9 percent larger. At a 4 percent growth rate these figures would be 119.1 and 122.6 percent respectively. Both the rate and the functional form of the trend matter.
Over the past 9 years, the form of growth went from exponential to what is basically a linear path, and the growth rate declined from about 3.4 percent per year to 1.3 percent per year. This means that on the current track, the economy would be 30.9 percent larger after 20 years, while on the old track, it would be 97.9 percent larger. This matters – it’s equal to an economy that is $11.3 trillion larger after 20 years.
The orthodox theory of economic growth suggests that national income is a function of capital, labor, technology and accumulated human capital. In other words, all things being equal, economies grow when one adds labor, investment, and education or when exogenous technological advancements (for example, electricity, or the assembly line or the internet) enter the economy. This Mankiw–Romer–Weil augmented Solow–Swan growth model – yes economists actually use terms like this – is the standard growth model accepted by most economists. It makes sense. The more stuff you throw into the pot of stew, the more stew you have.
But as with all economic models, the assumption of ceteris paribus or other things equal is key. As we see from the blog post, all things do not always stay equal.
When pundits suggest that the economy cannot grow because the population is aging, or that higher immigration is essential for economic growth, or that we simply need to spend more, they are incorrect. There are many things that will determine how the factors of production are used to produce stuff. It’s not just the amount of labor that matters, but the type and the work ethic. It’s not just capital that matters, but how capital is employed, and it’s not just the amount of education that a population has, but how it is used. And these are the things that business, government and individuals can change.
Take labor. Even if the labor force participation rate were to begin to increase again, and even if we imported millions of workers through open immigration, if these people are not employed productively due to over-regulation or unnecessary licensing requirements, or extreme wage floors (minimum wages) then more labor will not increase growth. If capital is used to build more empty condos for Russian or Venezuelan oligarchs, or is employed to abide with safety or health care regulations that actually protect nobody, or to add unneeded labels to products, it will not increase growth. And if the education system stifles debate, and promotes political correctness over knowledge, then trillions spent in colleges and schools will not increase human capital. And if innovation is stifled by high taxes and rules that make it difficult to start a business, or if research is focused on toys like iPhones rather than real technology, then the chance that exogenous advancements will occur drops.
The economy can easily grow at the 3.5 percent trend, and it can grow even faster if policies and incentives are structured to ensure that factors of production are employed productively. These are not partisan policies, and many are common sense.
First, and most importantly, as our guest article suggests, regulation is the number-one cost pressure in manufacturing. An over regulated financial system, a government mandated health insurance system, and state licensing laws for industries like floral designing or lawn care, all extract from economic growth. Second, an education system where spending is considered an outcome and that is designed to teach a test rather than skills extracts from growth, and finally a tax system that is so complex that it costs hundreds of billions of dollars simply to comply with extracts from growth.
Fixing the American economy will not be simple. There will be winners and losers, and the partisan divide in the country will ensure that real debate is stilted, and rage and shrillness will be in the forefront. As Van Halen suggested, You’ve got to roll with the punches to get to what’s real. But this is not Venezuela, or Zimbabwe or Syria. It ain’t the worst that you’ve seen. And we can surely make this economy Jump!
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