Predicting De-globalization: Bruce Greenwald (Part II)

History Rhymes

This is Part 2 of a two-part, high-level overview of Bruce Greenwald’s views on geopolitics and de-globalization. These articles sit within a broader series covering analysts that have been predicting de-globalization for the past several years.

We’ve covered the basic outline of how a positive productivity shock to the agricultural sector, brought about by new industrial technologies, eventually caused the demise of that whole sector as a source of demand, and launched the U.S. into the Great Depression.

But the Depression happened nearly a century ago and today most of the U.S. population no longer works on farms. Does this model of economic evolution apply to our contemporary economic environment?

According to Greenwald it absolutely does. What happened to agriculture in the early 1900s, happened to manufacturing in the late 1900s and set the stage for the financial collapse of 2008.

Saved by the B-52

By the 1930s, the collapse in demand from the agricultural sector had metastasized into an economy-wide collapse in demand. People didn’t have enough income to buy all the things being produced, which meant companies couldn’t earn enough revenue, which meant they laid off workers, which meant no one had the income to buy things. Everyone was stuck.

How did the economy get out of this funk? A common answer, which Greenwald agrees with, is that World War II rescued the American economy. The war injected a huge exogenous source of demand — the military’s need for more weapons and supplies — into the American manufacturing base. Suddenly, the factories could start hiring people. Also, several thousand men were shipped off for the war effort, tightening the labor supply at home. By the end of the war, this massive industrial policy had shifted a huge brunt of people off the farms and into factory employment, and given them the skills necessary to continue in that sector.

In one of the brutal ironies of history, the war, which was a humanitarian crisis by all accounts, ended up being a miraculous economic and industrial policy. An excerpt from their paper:

“The War represented an almost ideal industrial policy. First, it led to the relocation and retraining of a large fraction of the rural labor force either in War industries or through the military forces themselves. By doing so it greatly reduced the post-War cost of rural–urban migration. The transition from industrial production for the military to industrial production for consumers was a far easier transition than the transition from rural/agriculture to urban/industrial. Moreover, through the GI bill and other post-War programs the government absorbed the cost of retraining large fractions of the labor force, ensuring that they had the skills required for the new economy that was then emerging. Moreover, government housing programs helped absorb some of the costs of the rural-to- urban migration. Second, forced savings during the War provided the purchasing power necessary to solve the coordination problem by creating the temporary demand necessary to finance initial employment in industrial jobs in the immediate aftermath of the War.”

America transformed from an agriculture-led economy to a manufacturing-led economy. Many other countries followed the same path. The competitive process began humming along again; manufacturing firms started competing to find ways to increase output and grow market share. The cost of manufactures started to decline.

The same process which eventually caused the demise of agriculture’s “economic importance” — measured as the ability to sustain prices, revenue, and potential employment — began in manufacturing. While demand growth remained above productivity growth, manufacturers could always find buyers for their expanding output of goods. Many countries were able to grow their economies rapidly by exporting their surplus production. However, according to Greenwald, the world crossed the point several decades ago¹ where productivity growth in manufacturing began exceeding demand growth for manufactures.²

The global slowdown in demand growth relative to production growth meant that the market for manufacturing goods was no longer expanding fast enough to absorb the expanding supply. The “death of manufacturing,” as a source of employment, had begun.

“Today, the sector in terminal decline appears to be manufacturing. As was the case for agriculture in the Depression era, productivity growth has been rapid and in emerging economies like China and India, extensive new manufacturing “lands” have been brought into cultivation. At the same time, growth in global demand for manufactures has lagged as incremental income has increasingly been spent on medical care, education and financial and other services. The result has been a long- term decline in manufacturing employment and prices, and in countries like the US and the UK, the migration of most of the labor force out of manufacturing.”

Kicking the can…until 2008

Globalization is a natural outcome of productivity growth. Surplus output — production that is not bought by the domestic market — needs to find buyers somewhere. Naturally, companies will look to export. This happened with agriculture and it happened again with manufacturing.

Eventually, the global market also starts to reach a saturation point. Everyone who has the income to afford manufactures is more or less satisfied with what they have, and shift their purchase behavior towards services. Competition for market share causes firms to lower prices and seek out cost reductions because fresh markets are harder to find.

This time around, however, the U.S. was in a different position than during the Depression. After the war, America stepped into a much more central role within the global economic system. The U.S. dollar became the primary reserve currency of the world and, as Greenwald puts it, the U.S. adopted the role of “surplus buyer of last resort.”

“As a result, in the current crisis [Great Recession] — as in the Great Depression — there has been intense export competition driven primarily by exchange rate management. In the aggregate, since the sum of all international deficits and surpluses must be zero, these efforts can succeed only in transmitting the deflationary impact of manufacturing decline to other countries, especially reserve currency countries like the US with relatively little control over their exchange rates.”

He goes into more detail in this interview (around the 26-minute mark):

“There is one big global problem. When you add up, over all countries, the surpluses and the deficits have to be zero. Somebody has to eat those surpluses…Who is the deficit country of last resort? The United States because it borrows in its own currency. But there is a huge problem for the United States and you see this in the prices. Once you are running a chronic deficit of six to seven percent of GDP to accommodate the rest of the world’s surpluses, you have a huge problem sustaining full employment. And the way we did it was with a housing bubble and with a zero savings rate, which means that since the top 20% of households with 40% of the income save about 6% of GDP, the bottom 60% of households were dissaving 6% and were spending 110% of their income. This is not sustainable. When that stopped in the United States as a result of the end of the housing bubble, the ability of the world to absorb these export surpluses went away. I think we will have a continuing problem of trying to grow until the countries make the transition consciously — and they’re busy resisting it as hard as they can — out of the dying manufacturing sector.”

The U.S., as the issuer of the most desirable reserve currency in the world, had the privilege of being able to borrow copious amounts of money in its own currency. This allowed it to serve as a reliable buyer for the surplus output of the world. The U.S. consumer enjoyed low prices, in part because the highly-demanded dollar was so strong relative to the countries where the goods were being manufactured. But this rendered U.S. manufacturers deeply noncompetitive at home and abroad.

So, manufacturing jobs in the U.S. declined precipitously³. This presented a conundrum. How could the U.S. buy the surplus output of the world if so many of its people, who worked in manufacturing-related jobs, lost their income to overseas jobs? Greenwald says we solved that problem through credit and asset inflation.⁴

Credit expansion allowed the U.S. to sustain demand levels even as a major sector of its economy evaporated as a source of employment. We kicked the can of demand down the road, allowing financial asset prices to inflate, until there were no buyers left for those assets. Then the housing bubble popped. Along with it, the entire credit expansion effort seized, along with the demand it generated.

There is an additional element to this. U.S. investors were not the only ones buying overvalued U.S. financial assets. It was also a prime destination for foreign capital. A large chunk of that foreign demand was driven by a desire to engage in exchange rate management. When the U.S. bought the surplus output of manufacturing nations, those countries received dollars in exchange. If they converted those dollars to their own currency, it would strengthen their currency relative to the dollar and hurt their manufacturers’ ability to sell to Americans. The only other thing to do with those extra dollars was to buy dollar-denominated assets. And so dollars that were used to buy foreign goods were recycled into American financial assets in order to manipulate exchange rates. China’s buying of U.S. Treasuries is just one of, and likely the largest single example of this. This dynamic helped keep rates low in dollar-denominated debt, which allowed for further credit expansion, fueling demand.

Therefore, when the American financial asset values collapsed in 2008, it wasn’t only American investors who felt the pain. The whole world was invested in dollar-denominated financial assets from U.S. bonds, to equities, to mortgage-backed securities. Everyone’s balance sheets collapsed at the same time.

Here’s another excerpt from the Greenwald’s panel discussion:

“One of the things that happens in the United States is, when we run a deficit, the rest of the world has to eat the dollars. If the Chinese want to get rid of their dollars, they can either run a deficit on current account, which isn’t gonna happen in your lifetime, or they can reinvest it in the United States. When they reinvest in the United States, of course they drive interest rates down and as outside, relatively stupid investors, they create an opportunity to do what Wall Street does best — which it did to the Japanese in the 1980s — which is skin outside investors. But that seems to have been driven by the flipside of the deficits.”

Homecoming

Greenwald seems to believe that the death of manufacturing is a foregone conclusion. Productivity growth will continue to increase in the face of lower demand growth. Global manufacturing will decline in its economic importance, i.e., its ability to sustain prices, revenues, and employment.

The globalized trade paradigm that we’ve all become used to, when seen from this perspective, was effectively the result of the rapid expansion of manufacturing’s productivity and economic importance through the 20th century. What happens to this kind of globalization when manufacturing’s economic importance declines?

According to Greenwald, the real solution to the chronic deflationary problems caused by the death of manufacturing is for precise government policy, across the world, that shifts people en masse into the growing services sector.

“Today, correcting this situation will require a focused effort in managing the transition of workers on a global basis out of manufacturing into services with an impact comparable to that of World War II in moving workers off the farm.”

According to Greenwald, this has to happen, one way or the other. And when this transition does take place, the nuances of the services sector will define the new economic and trade paradigm that the world adopts.

“As robots make everything, the advantage of cheap labor…goes away. So when GM got in trouble in 1980, they had 360,000 workers. This time when they got in trouble, they had 30,000 workers and they produce half as many cars. Once that happens…nobody needs to import cars because transportation costs are not going down that much.

We used to spend nine percent of our income on clothing; six percent was making clothing and three percent was dry cleaning and wash. Today we spend six percent on clothing; three percent is still dry cleaning and laundry and three percent is making clothing. So as manufacturing becomes less and less important, it becomes all about services. And you don’t send your dry cleaning out to China. So its all about locally produced and consumed services.

So for all of those reasons, globalization is actually an early 21st century phenomenon and by the middle of the century it is going to be in retreat. And it will be all about tourism and where you want to retire, etc.” (Link)

Greenwald acknowledges that automation will change the cost-benefit equation of manufacturing to shift production closer to the end consumer market — a hypothesis we’ve explored before in our profile of T.X. Hammes’ analysis. But he adds to that the idea that services, which is set to grow in terms of economic importance in the coming decades, is largely local by nature.

Hence, according to Greenwald, the dying sector — manufacturing — is set to re-localize because of the decreasing cost of production, though it will not be a major source of employment in the long run. And the sector that will contain the most intense economic activity going forward — services — will not globalize as manufacturing had done because it is an inherently local type of activity.⁵ According to Greenwald, all arrows point home.

1. Around the 13-minute mark of the presentation, we see that Greenwald marks a manufacturing collapse in the U.S. occurring between 1979–1984. The U.S. is the first major post-war economy to experience such a collapse, as manufacturing jobs begin to leave the U.S. in search of cheaper foreign labor. The productivity shock-driven collapse then continues to roll throughout the globe. This presentation is a particularly good one to watch as Greenwald comprehensively walks through his thesis with accompanying empirical data. The conversation with Richard Koo is another good one because Greenwald is forced to distinguish his thesis for explaining the causes of the Great Recession from Koo’s compelling Balance-Sheet Recession thesis. The friction can help the listener develop a more precise understanding of the arguments, although it did get a little heated at points lol.
2. Greenwald claims that productivity growth in manufacturing has been around 5% and demand growth around 2% and that this differential cannot be changed. One thought I had that could serve as a potential counter-argument to Greenwald’s hypothesis is the possibility that there is no limit to human demand for manufactures, or at least that the limit to our demand for manufactures is much, much larger than with agricultural products. Unlike agricultural output, where people can only consume so much food before they can’t handle any more, manufacturing output can be much more varied in its application. Everything from kitchen utensils, to electronics, to infrastructure development requires various kinds of manufacturing processes. I don’t doubt Greenwald’s claim that demand growth for manufactures has stunted, but could the cause be something other than us simply reaching the limits of our desire to consume? Could a revolutionary new innovation spark a resurgence in manufacturing demand for example? What about growing demand for infrastructure development from emerging market countries?
3. Greenwald et al provide data on the job declines in U.S. manufacturing from the Bureau of Labor Statistics. Below is a quote from their paper:

“[G]rowth in global demand for manufactures has lagged as incremental
income has increasingly been spent on medical care, education and financial and other services. The result has been a long-term decline in manufacturing employment and prices, and in countries like the US and the UK, the migration of most of the labor force out of manufacturing. Consistent with our hypothesis, Autor and Dorn (2011) report “dwindling manufacturing employment and rising unemployment” (p. 9) and that “real wage growth in service occupations substantially outpaced that in other low skill occupations, averaging six percent per decade between 1980 and 2005” (p. 3). The decrease in employment in manufacturing from its peak in 1979 of 19.6 million has been (as of January 2012) about 7.7 million, i.e. a 39 percent decline. Moreover, 5.5 million manufacturing jobs have been lost since July 2000 alone, accounting for some 71 percent of the total decline since 1979. During the same period (179–2011) the number of people employed in the service sector has increased by 76 percent.”

4. How the U.S. manufactured a credit expansion to prop up demand through the 90’s and early 2000’s is a subject that has been extensively covered by many experts, and would require a separate article to delve into properly. 1) Deliberately easy central bank monetary policy along with the 2) downward pressure on rates from foreign capital investment into U.S. financial assets were contributing factors. Interestingly, if we asked Peter Zeihan, the geopolitical analyst who we profiled in a previous article, the same question, he may point to a different culprit. In the 90’s and early 2000’s, the massive Baby Boomer generation (born between 1945–1965-ish), in the U.S. and abroad, was entering into the capital rich+low expense part of their lives. Their relatively high levels of savings and desire for investment opportunities may have provided the glut of financial capital needed to keep rates lower and provide the capital needed for financing. In reality, all three of these factors (and perhaps others) likely contributed significantly to the regime of asset inflation and credit expansion that kept U.S. demand afloat while the domestic manufacturing sector bled jobs.

5. I have not heard Greenwald discuss how digital communication may effect the immunity of service jobs from globalization. While I agree that certain service sector jobs require a local presence, many can also be done from abroad. Some of the highest value “new economy” work, like software programming and various forms of knowledge work, can easily be done from anywhere in the world as long as the person has an internet connection. Moreover, educational services and even some healthcare services are also being delivered increasingly via the internet. Not to mention that many customers have been traveling to different countries to save on these services. While a significant portion of the services sector will likely remain immune to globalization, many of these jobs may be susceptible to it still. And I wonder what the implications would be if many of the highest value service sector tasks are the most susceptible to globalization.

Hope you enjoyed this article. If you have any comments or critiques, please share!