Material production bolstering West

This is my Perspective column from this week’s Fund Strategy magazine.

Many experts have long argued that the developed countries, particularly America, are switching towards a “knowledge economy” and away from industrial production. The trouble is, by some measures at least, this trend seems to have at least partially reversed recently.

It is true that since the 1970s the industrial sector has generally declined as a share of both output and employment. That is not to say that America is producing less in absolute terms but services and finance have grown faster so make up a bigger proportion of the whole.

However, Joel Kotkin, a professor of urban development at Chapman University in California, has pointed to a different trend emerging since about 2000 (“The real winners of the global economy: the material boys” Forbes, 6 March 2013). Many of the world’s best performing developed economies in recent years are resource-rich nations such as Australia, Canada and Norway.

Moreover much of the developing world is making a rapid transition from old-style agriculture to industrial production. Even leaving aside China, with its rapid manufacturing-centred growth, Brazil has expanded rapidly on the basis of manufactured and food exports as well as domestic energy production.

This western trend back to material production is mirrored by developments within America. Kotkin points to the rise of four “growth corridors”, all focused on industry, to illustrate his argument (America’s Growth Corridors: the key to national revival, Manhattan Institute, February 2013). Most foreigners will know little of these places (see box). The thriving regions do not include the likes of iconic cities such as Chicago, New York and Los Angeles.

Kotkin gives several reasons for America’s shift to new centres of growth. First, a domestic energy boom, fuelled by shale oil production, has bolstered three out of the four corridors he identifies. Many others too have pointed to the beneficial effects of this development for the American economy. Oxford Economics, an economic consultancy, estimates that GDP would be 2.4% lower if there had been no shale boom since 2008. It also calculates that industrial output would be 1.8% lower and unemployment would be 1.2m higher (US Weekly Economic Briefing, 25 March 2013).

This energy renaissance has in turn bolstered manufacturing and heavy industry within these regions. Aerospace and high tech are growing rapidly too.

Finally, the economic rise of Latin America is also benefitting the four corridors. There are signs of economic links within America moving from north to south rather than east to west.

To appreciate the scale of this move back towards more material production, particularly within America, it is necessary to think back to earlier discussions. Experts have long pointed to America as the prime example of the shift away from industry. They have used many labels to encapsulate this trend: the information society, the knowledge economy, the post-industrial society and many others.

This shift away from material production was also reflected on the corporate level. Many once venerable members of the Dow Jones Industrial Average have suffered troubles or even disappeared completely. These include firms such as Eastman Kodak, which went bankrupt recently, while others such as Chrysler and General Motors, have needed government bailouts to survive.

Meanwhile, IT firms have taken their place. Some, such as Cisco and Intel, are involved in manufacturing. However, others, particularly those listed on Nasdaq, do not produce any tangible goods. These include internet giants such as Facebook and Google.

No doubt the partial swing back towards material production will also brings its corporate winners. Perhaps it will include new companies that do not yet exist or existing ones that are as yet little known. Or maybe the existing oil majors will be the greatest beneficiaries.

Of course assessing how far the move back towards production can go depends partly on working out what is driving it in the first place. No doubt the rise of China as an industrial power is an important factor.

China’s rapid economic growth has made it a voracious consumer of raw materials. I vividly remember looking through my hotel room window in Newcastle, New South Wales, a year ago and watching huge amounts of coal being shipped through the port to China (“Rulers suffer from lack of resources”, Fund Strategy, 19 March 2012).

China’s demand for energy and other types of commodities is vast. It therefore follows that if China’s growth starts to splutter then global demand for such resources could fall sharply.

Although China is by far the biggest consumer of raw materials many other emerging economies are growing rapidly too. For the time being many other countries in Africa, Latin America, the Middle East and developing Asia are also enjoying fast economic growth. As long as this continues – and it is far from guaranteed – many “material boys” are likely to prosper.

None of this is meant to suggest that the western economies are set to return to the patterns of the 1970s. Although there is substantial scope to increase manufacturing output it is unlikely that enormous armies of industrial workers will be employed once more. Industry is far more productive than it used to be back then: the amount produced by each individual worker in a given time has increased substantially.

But the partial shift back towards material production should be welcomed. It has helped cushion the impact of the economic crisis in the West and it also reflects the rising prosperity of the emerging world.