Why NZ should avoid supporting "traditional" manufacturing

A couple of weeks ago, I pointed out that as long as we have a strong democracy we don’t have to worry about the “rise of the robots” producing things. New Zealand has seen the impact of improving technology overseas and explicit subsidies for manufacturing products over the past decade – with manufactured products becoming cheaper and cheaper, while New Zealand firms trying to compete are finding it harder and harder. However, as I aim to argue here, the solution is not to stand in the way of change – but to help New Zealander’s grab it with both hands.

It is an undeniable fact that employment in the manufacturing industry has fallen sharply in recent years. According to the linked employer-employee data provided by Statistics New Zealand, employment in the sector peaked at an annual average of 234,473 people in the 2005 calendar year and had fallen to 201,648 people by September 2011 – a 14% decline.

At first brush, we may try to explain away this shift by using our prior robot example, and say that with capital becoming more efficient we don’t need as many workers to produce the same goods. However, this is not what has happened within New Zealand – over the same period manufacturing real GDP fell 12%. As a result we can say that, a large part of the reason that manufacturers have been hiring fewer people because they have genuinely been making fewer things!

It is at this point that people jump on the exchange rate as an explanation for why manufacturers have been cutting back production – given that the New Zealand dollar has generally been at a historically high level since 2004. But when it comes to diagnosing the economic patient, pointing at the dollar is like pointing at a runny nose – it is a symptom of what is going on rather than the real cause.

To belabour an obvious point, the fundamental reason that manufacturers are shutting up shop, and are generally struggling, is that given their level of productivity they cannot make a sufficient return. They cannot get people in New Zealand or overseas to pay enough to justify creating these goods. The Global Financial Crisis exacerbated this issue – but it has been a trend for some time.

New Zealand is a sparsely populated country that is far away from most large international markets. With fuel prices going up, increasing vertical integration (when different aspects of the production process are joined together in the same firm) and the rise of just-in-time inventory management, more and more manufacturers are positioning themselves “close” to market. This trend, combined with the benefits of agglomeration in production and the improving use of technology overseas, has made manufacturing in countries like New Zealand less and less competitive.

This is tough for people who have invested time and skills in specific forms of manufacturing, but in so far as these changes are the result of changes in technology and the habits of global consumers, we cannot stand in the way of them. Instead as a society we should aim to limit the harm, and give people the opportunity to move into things that New Zealand is well suited for.

And this is the flipside – although New Zealand is comparatively bad at manufacturing things that require large scale (such as say cars) it is comparatively good at other things (producing milk). Other countries having become more productive in the export manufacturing space it actually a good thing for New Zealand as a whole – as it has driven down the price of what we buy from overseas relative to the price of what we sell! This can be seen in our terms of trade (the ratio of export prices to import prices), which has risen 10% since manufacturing activity peaked.

Many people will say that I am missing three other important drivers of what has happened: Foreign subsidises, domestic government policy, and Dutch disease.

Since 1994 China has made a concerted effort to hold down the value of its currency, and subsidise manufacturing exporters. Similar, albeit less blatant, intervention has taken place in a number of other developing countries.

It is no doubt frustrating, and unfair, when your competitor is cheating to get an edge. But when the government in New Zealand looks at introducing economic policies, it should do so in the interest of New Zealand as a whole.

If some countries are indeed taxing their citizens to make their exports cheaper and to lend money to other countries, then they are essentially taxing their own citizens and giving the goods and services that tax would pay for to us!

Following the global financial crisis, some have called the Quantitative Easing programmes in the United States and other developed countries currency manipulation. However, this isn’t the case – these countries are using these policies to meet their inflation target and secure the value of their currency, not to excessively devalue it.

On the domestic policy front, the mid-2000s saw a significant lift in local and central government spending and redistributive schemes. Working for families and interest free student loans were two of the clearest examples. The more government spends and taxes in order to reach domestic social goals, the less competitive manufacturers become – as higher taxes and spending increase labour and material costs for firms. As a society we need to accept that this trade-off exists when we set policy.

Finally, Dutch disease is a topic that has received a lot of air play in Australia and New Zealand – and if it is true, it cuts to the very heart of my previous argument. The idea behind Dutch disease is that if other countries are willing to temporarily pay more for a certain thing we sell (say dairy products), New Zealanders will respond by investing heavily in producing this good and cut back investment in other things. However, when the price drops all that investment becomes worthless, leaving the country poorer!

However, this way of thinking has three flaws: It assumes that people investing do not think about the future very much, it assumes that it is always very costly to invest in the industries that are undermined, and most of the historic examples of Dutch disease have been shown to be either false or exaggerated.

Ultimately, as a society we need to accept that there is no silver bullet for making us all wealthier. Over time, what is valuable and what is known changes. As a result what is made and created, changes. This is a reason to support people and give people the chance to excel and innovate when things change – not a reason to try and stand in the way of this change by interfering with the currency or using tax money to gamble by “picking winners”.

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