The Industrial Evolution

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- For decades, many U.S. investors have feared the decline of American manufacturing. Some point to manufacturing's falling share of the economy, others to the loss of U.S. manufacturing jobs. However, a close look at global data shows America remains a manufacturing powerhouse and leads a worldwide wave of productivity gains.

It's true manufacturing's share of U.S. GDP has fallen over time -- but this is in line with global trends (Exhibit 1). Moreover, it doesn't mean the US is making less. American manufacturing output has risen substantially on an absolute basis, and the US remained the world's largest manufacturer on an inflation-adjusted basis as of 2010 (Exhibit 2).

Exhibit 1: Manufacturing as a Percentage of Nominal GDP, 1970-2010

Source: United Nations Statistics Division

Exhibit 2: Real Manufacturing Output, 1970-2010

Source: United Nations Statistics Division

Over the past 40 years, U.S. manufacturing output has more than doubled -- the world's fastest growth rate outside China. But China's robust growth (or leadership in nominal output, as of 2010) needn't detract from America's output -- manufacturing isn't zero sum. Aside from the 2007-2009 recession, U.S. and Chinese manufacturing have grown in tandem -- there appears to be ample demand globally to fuel growth in both nations.

Context is also important. The U.S. and China finished 2010 in a manufacturing photo-finish, but total U.S. output, adjusted for inflation, more than tripled China's (Exhibit 3). The U.S., like most developed countries, has evolved into a more diverse, largely services-oriented economy (while still being a manufacturing powerhouse). Throughout history, economies have typically progressed from agrarian to industrial to service. China, which has evolved from agrarian to industrial since economic reforms began in the late 1970s, is less far along -- whether it, too, becomes a more services-based economy will depend on many factors, like whether its communist government continues liberalizing the economy.

Exhibit 3: Real GDP, 1970-2010

Source: United Nations Statistics Division

Of course, none of this means U.S. manufacturing workers have had it easy. Manufacturing output has increased, but the sector's share of total employment has fallen over time. This is partly because many jobs have shifted to markets where labor's cheaper -- including China, where manufacturing employment dwarfs all other nations. Yet many manufacturing jobs have stayed in the U.S., migrating to the service sector. As shown in Exhibit 4, rising service-sector employment has roughly mirrored manufacturing employment declines since 1971 -- evidence of America's economic evolution, and in line with developed nations globally (Exhibit 5).

Exhibit 4: US Service and Manufacturing Employment, 1971-2010

Source: St. Louis Fed

Exhibit 5: Developed World Service and Manufacturing Employment, 1971-2010

Source: St. Louis Fed

Exhibit 6: Annual Manufacturing Output per Employee, 1950-2010

Source: St. Louis Fed

Employment has shifted from manufacturing to services, in part, because U.S. manufacturing has largely progressed from lower-margin goods to more complex, expensive items--a sign of a healthy, evolving industry. Moreover, thanks to automation and other efficiency advancements, workers can produce more with less. This, too, is a global phenomenon (Exhibit 6). China, by contrast, focuses on smaller, lower cost goods, which typically require far more workers to sustain output. Still, China's manufacturing employment has also fallen in recent years, and productivity gains are evident there as well, but that nation is further behind the curve (Exhibit 7).

Though causing near-term dislocations that can be painful, overall productivity gains are a material net positive. Firms must adapt to a changing competitive environment and adopt better technology if they're to stay healthy -- otherwise, they lag global competitors and the industry likely legitimately fades. Higher productivity also typically means lower prices, benefiting consumers, and healthy profit margins. Profitable firms tend to invest in research, innovation, facilities, equipment and new workers as demand spurs production -- all of which boosts economic growth over time.

By no means do we downplay the impact of manufacturing job losses on those impacted. However, when assessing the health of the sector and its overall economic impact, it's important to understand U.S. manufacturing's gains in competitiveness and productivity help it remain a world leader. False impressions of a waning sector simply don't match reality.

Exhibit 7: China's Annual Manufacturing Output per Employee, 1994-2010.

Source: Thomson Reuters, United Nations Statistics Division

(This article constitutes the views, opinions, analyses and commentary of Fisher Investments as of April 2012 and should not be regarded as personal investment advice. No assurances are made Fisher Investments will continue to hold these views, which may change at any time without notice. In addition, no assurances are made regarding the accuracy of any forecast made herein. Past performance is no guarantee of future results. A risk of loss is involved with investments in stock markets.)

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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