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 One of the virtues of an appreciation for economics is that it enables you to assess the root causes of common facts, fallacies, and propaganda about ideas and numbers on the declining role of manufacturing in the US. Such items often affect the markets when numbers on such things as the factory index in New York, Philadelphia, or Illinois, the industrial production figures, or the ISM manufacturing index, or the trade deficit ares announced, rumored or discussed. There is usually a pronounced immediate move in the direction of the strength or weakness in the figures, then a correction, and then if the number was weak, the propagation of various agrarian reformist fallacies relating to the declining competitiveness of the US, and if the number is weak enough hopeful arguments from chronic bears and bond bulls that a depression of the scale of 1929 is coming, especially if the stock market has gone down big on the item.

I have come across many such fallacies, and they're usually self serving things such as the leading bond funds' mismatched scale charts showing that the number of real estate agents is rising while some measure of US manufacturing is decreasing.

The economic analysis of manufacturing versus services starts with the notion that wealth consists of what people value. Trade increases the total value because both parties are benefited. Specialization enables individuals and countries that have a comparative advantage in one good or another to concentrate on what they do best without wasting resources in what others could do better. Heyne, Boettke and Prychitko summarize the fallacies in chapter 2 of their magnificent and earth clearing economics book "The economic way of thinking" nicely. "Exchange ( and the provision of services) is as much a wealth creating transformation as is manufacturing or agriculture. Exchange is just an alternative way of producing something. " As we get richer, the opportunity cost of using our money and time for purchase of domestic physical assets such as buildings, equipment, and land increases and it becomes more profitable to purchase these items from others whose opportunity cost is not as high. The principles of comparative advantage that lead to trade hold for trade between you and the supermarket, and the decisions that companies make as to whether to manufacture their goods in one state or in another country.

Such analysis gives one a rudder when the stock market declines much and the bears predict a depression. They hoped for it after the 30% 2 day decline on October 19, 1987, and they hope for it again as the financial service companies, banks,  brokerages and real estate cos. suffer in 2007. It never comes true because they don't take account of the main source of wealth, the intangible assets, knowledge, education, skills, and training that are the main repositories of wealth as they lead to people being able to make an income. Estimates of Becker put this source of wealth at 80% of the total. With the total stock of wealth in US at 40 Trillion or so, a decline of 1 trillion, caused by a 500 point drop in the DOW for example can be put in proper reasonable perspective.

All this is very well and good except that many people buy such arguments as those propagated by the bond sponsor to support his Dow 5000 predictions as well as his current tack in fixed income. If specinvestors believe that others will trade based on such faulty economic analysis, it can cause self fulfilling prices, a stampede, or herd affect.

A little testing is in order. I looked at the movements in the market in the half hour after the report of the trade deficit, the ism manufacturing report, and the beige book to see if movements in one direction were followed by reversals or continuation in the rest of the day. I found the tendency to pronounced overreaction, ie. too much pessimism or optimism to be particularly evident for the Ism announcement on the day, but particularly underreactive on the beige book days.

There are a myriad of ideas and implications that arise from consideration of the importance of manufacturing, including the relative concentration of research in manufacturing industries, the induced output that each dollar of manufacturing causes, the outsourcing of manufacturing by countries such as US and England, the German model where manufacturing is supposedly highly efficient and profitable, but highly unionized and subsumed within rigid rules and regulations, and the general more important question of whether there is such a thing as a business cycle as opposed to business fluctuations around say a random walk. I would be interested in any augmentations and ideas you have on these or related fronts. 

Ken Smith follows up in a Ricardian vein:

In Washington State two-thirds of the total economy is based on one industry, Boeing Airplane Company [Ed.: actually closer to 25%]. Another big slice is applesauce, from Eastern orchards. What remains comes from the Port of Seattle, imports from Asian producers flow down Puget Sound in container ships, unload in Seattle and Tacoma.

Many times I've read one should not put all eggs in one basket. Do not, some say, place all funds in one asset; rather it is preferable to scatter your oat seeds here and there in the hope that one or two fields will fructify, one or two out of many.

In my experience diversification of funds has diluted returns. And in the case of Washington, hereabouts, limiting investments to one or two areas has paid off handsomely.

If wealth consists of what people value it is clear people value flight and applesauce, foremost. Second, they value shipping. Hereabouts. In Kansas they gotta grow wheat and pump oil.

And that makes trade possible. Here we trade applesauce for bread, as an example. Here are up to our ears in applesauce. We can only use so much applesauce and must find ways to trade out of it.


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