The following article is the fourth in series written by Emeritus Associate Professor W. Raymond Mills.

Adam Smith, a pioneer of political economics, saw the growth and spread of trade throughout the world as closely linked to the growth and spread of the industrial revolution throughout the world. Smith was very impressed by the increase in productivity in a factory that specialized in one particular product. But the size of the factory and the degree of specialization that could be achieved was limited by the size of the market that could be served. Smith recognized that free trade would expand the size of the market, thereby allowing for increased specialization which would create more goods and services for the entire world.

The expansion of productivity during the 19th Century demonstrated the validity of his insight. Cotton producers and brokers in the U.S. south grew wealthy by producing cotton and shipping bales of cotton to England for processing. The wealth created by planting seeds and tending land in the south was large but the size of this wealth creation was not as large as the wealth created in England where the raw material was converted into shirts and pants. The value added by manufacturing exceeded the value added by farming. Some claim that the trade surplus in England during this period (first 3/4ths of the 19th Century) averaged around 5 percent of their Gross Domestic Product.

England prospered from free trade during the era when it had the most productive manufacturing system in the world. England ceased prospering from free trade when it lost that dominance. Economists have noted the tendency of nations with large trade surpluses to favor free trade. England’s problem is that it did not change its approach to trade when it lost its dominant position in manufacturing.

The primary reality about trade in Adam Smith’s world was the fact that industrialists and brokers in England and France were persuading their respective legislators to impose import duties on the specific product the domestic producers and brokers had for sale, so as to benefit themselves, regardless of the effect on the nation as a whole. One of the most important arguments used by domestic manufacturers was that English import duties were necessary because other nations were restricting imports of English goods. Long lasting competition and hostility between England and France made such arguments irresistible to English legislators. Adam Smith cut through this Gregorian knot by proposing that England open its door to all imports, regardless of what other nations were doing. Smith had a good reason for supporting free trade, given his view that the excuse used by protectionists (we are seeking equal trade) must be eliminated – and the fact that he was a resident of the dominant manufacturing nation. But he left a legacy of overconfidence about the widespread utility of free trade that has haunted both Great Britain and the U.S. to this day.

The U.S. is suffering today because U.S. economists have not had the good sense to see the limitations of free trade for a nation that has a trade deficit.

Some would argue that manufacturing activities are no longer necessary in the U.S. We have become a service oriented economy. Let other nations do the manufacturing for us.

Here are two answers to that point:

1. We need to sell something to the rest of the world to pay for our imports. The U.S. share of world services is not growing fast enough to make up for the loss of manufacturing. The total U.S .trade deficit of 696 billion dollars in 2008 consists of a loss of 840 billion in goods and a gain of 144 billion in services.

2. Service activities do not provide employment benefits comparable to manufacturing. Not only is manufacturing pay higher than service activities (generally, except for Finance and Insurance). We also find that manufacturing requires employment in other industries to produce the intermediate inputs needed by manufacturing industries. Also, manufacturing payrolls support many service activities. Mayors and other local officials fight with outrageous subsidies to try to entice manufacturing plants to locate in their district because of the spill-over benefits to the local area.

Thirty-two percent of all the intermediate inputs used by all U.S. domestic industries in 2006 were purchased by U.S. domestic manufacturing industries. The share provided by Finance and Insurance was 8.5 percent. As recently as 1998, manufacturing purchased 38 percent of all intermediate inputs. Some other industries stepped forward to fill the gap but not finance and insurance. They purchased 7 percent of all intermediate inputs in 1998, for a gain of 1.5 percentage points compared with a loss of 6 percentage points from manufacturing.

Finance and insurance were able to create enough profits in 2006 to replace the profits no longer provided by manufacturing firms. But these profits supported a very small number of employees. The spill-over from these profits to other jobs were not sufficient to sustain U.S. employment. Now we learn that a considerable part of these profits were fictitious.

Manufacturing employment in the U.S. continues to decline for four reasons: 1. The recession, 2. Trade deficit; 3. Automation, 4. The shift to purchasing services rather than goods. The last factor is becoming less important because it is changing very slowly. Of the four, only the trade deficit lends itself to immediate correction by action of the U.S. Congress and the president.

Manufactured goods are the main item exchanged among developed nations. Continuing participation in global trade requires a viable manufacturing sector.

Click here to read the first article in this series.

Click here to read the second article in this series.

Click here to read the third article in this series.

W. Raymond Mills is an Emeritus Associate Professor of City and Regional Planning at The Ohio State University. Mills’ Ph.D was in Sociology from the U. of Michigan (in 1958), his specialty was forecasting economic and population growth in metropolitan areas in the U.S. He can be contacted via email: wrmills@wideopenwest.com

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