In my previous post on US trade deficits and manufacturing productivity, I discussed how US manufacturing has actually thrived, even in the last three decades while manufacturing employment was plunging. 

Such numbers might prompt one to ask how it can be, when their are abandoned, crumbling factories all around us, particularly in the old industrial cities of the Northeast and Midwest.  There are two answers.  One is that alot of manufacturing activity has moved from the unionised North to the right-to-work South and West, where factories are allowed to be run with fewer employees that cost less.

Another is that the US has been abandoning lower tech, mostly labor-intensive, manufacturing and reallocating capital to higher tech areas.  While this is no consolation to former textile workers in the US, it's the natural evolution of things.

This chart from the Economist illustrates it nicely:

Most advanced nations have been shifting away from low tech manufacturing and such manufacturing is being picked up by developing nations like China. In the US and Britain, where capital has been allocated the most freely, the trade balance is most positive in high tech manufacturing.  South Korea has also made great advances in high tech. 

I think the most interesting aspect of this chart is that Germany and Japan, the two largest advanced economies besides the US, have huge surpluses in mid-high tech but deficits in high tech.  I would argue the reason for this is that Germany and Japan have been among the most aggressive in promoting an industrial policy to build up the old mass market manufacturing economy (exemplified by autos) and have financial systems dominated by commercial banks.  They have very conservative systems that were great at building up the post World War II economy, but lack the venture capital/ IPO/ public stock/ high yield debt/ private equity culture that, for all its faults, relentlessly reallocates capital to the highest-return investments in innovative sectors.  They are also the two developed countries most manifestly in danger of being in secular decline.

I realize that sometime the US system gets its capital allocation very wrong, like with the recent housing bubble.  But I would like to bring up the fact that housing is the sector most heavily promoted by our government.  This "industrial policy" was successful for years, but eventually it got taken way too far and will be difficult to unwind, given all of the powerful constituencies that are now invested in promoting real estate speculation.

Housing in the US and the long term stagnation of Japan and Germany are warnings to those that would promote the heavy involvement of the US government in the economy to protect declining industries and to conduct industrial policy in growth sectors beyond the early R&D phase.