Friday, February 24, 2012

Why a local manufacturing base is important

This post builds from a comment I made here.  It's a reaction against the point that it's okay for a country to lose manufacturing if you have a thriving services economy.

Unless people can live on consuming services alone, buying/importing all hard goods from outside is a form of slow suicide. Imagine you, me and Mike are all the inhabitants of Consumer Republic. You cut my and Mike’s hair, I cook for you and him, he entertains the two of us. Yes, we all have a means to earn a living, and money circulates our economy. But when it comes time to buy our car, our furniture, our basic hard item necessities, we have to buy it outside, from Producer Republic.

Now imagine that Producer Republic doesn’t need to buy anything from us, they have their own domestic service providers, and they’re pretty self-sufficient when it comes to producing all their hard goods basic necessities. Meanwhile, all they get from us in return for their goods are tokens (fiat currency) that enable them to buy our services - all of which, however, they can provide themselves. What happens if they start hoarding their hard goods and stop accepting our tokens? Where and how do we get our hard goods?

This is even more worrisome if Producer Republic prefers to accept someone else’s tokens (fiat), not our own. How do we get those tokens unless we sell something besides domestic services? (And yes, markets for most services have a tendency to be domestic-focused, and hence, most countries will prefer to get their services from locals.) 

For example, if Producer Republic prefers Privilege Republic's tokens, Consumer Republic will need to sell its services to Privilege at whatever price Privilege is willing to pay for. Consumer Republic is therefore fucked, and this results in a status quo lower over-all price level of services in its country. Its inhabitants will therefore be able to buy even less hard goods imported from outside. And every time it does buy from outside, it results in an outflow of money from the economy, an outflow that, if its government compensates for by printing more money, only results in an even lower real price level. This vicious spiral will slowly eat away the economy. The only other solution would probably be to sell its patrimony to outsiders, in return for the needed token. (Just ask Greece how this feels like, since it's in the same situation of having to sell its soul to get enough of the "outside" currency, the Euro.)

This constant need to scramble for the token accepted by hard goods producing countries is probably lost on much of the population of the country that that has the "exorbitant privilege" of having the reserve currency, the unit that everyone accepts payment in. However, if this country of privilege chooses to lose all its hard goods producing capacity, because of the confidence that it can always print whatever it needs to fund all its consumption, whether of goods and services sourced from within or outside its economy, what's to prevent producer countries from eventually deciding to start hoarding their hard goods and stop accepting its tokens? Where and how will it get its hard goods, unless it starts making them itself again?

Four years ago, I advocated/predicted that both the developed and developing worlds will probably each have to become more equally divided into being both consumer and producer economies. This seems now to be actually happening. Everyone needs to have a producer economy. You can't live on consuming services alone, while buying/importing all hard goods from outside. It's a form of slow suicide. Ditto for  agriculture sector.

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Anonymous said...

But then again, the producer republic can’t forever hoard their hard goods either. At one point, the producer republic “need” to sell their hard goods to consumer republic. What is the point producing of all those hard goods in the first place? The people of producer republic might as well as turn around and become a consumer republic themselves.

In any case, such argument is a strawman. There are times, that producer republic shall seeks the consumer republic token such as vacations, medicals, conferences and etc. Nowdays, you can not live in isolation not unless you are living on planet Mars!

Rogue Economist said...

Anonymous, what is your basis for a producer needing to sell his goods? No one is force or needs to sell his goods to someone he doesn't want to sell to. What would make him?

The point of producing all those goods is to sell it for compensation of adequate value. If you're a nation that can't sell him anything he wants, why would he want to keep selling hard goods to you in exchange for your currency? What would he do with your currency?

Your argument is the straw man here. Just because a few people from producer republic will want to take vacations in consumer republic doesn't mean it will want to take them in equal value to what a production-less consumer republic wants in hard goods.

What would likely happen is that all the unemployed in the production-less consumer republic will end up willing to work for slave wages for those few from producer republic who go there for vacation fun. We already see this happening in relatively-unproductive economies. Because such economies have less income going around, it becomes a necessity for some of its people to engage in whatever services these incoming visitors from richer economies want them to provide. After all, they can only sell what they can readily provide.

I eagerly await for your refutation on this.