A Retirement Home for Old Businesses

I started this post as a response to a comment on Mitch Townsend’s post on the abandoned textile mills of Massachusetts, but I thought the idea warranted its own space. Arthur Kelley said:

Textiles left Mass and went to the third world. Which, at the time, was the south. The south is no longer third world. Now, and for the same reasons, textiles are leaving the south and going to yet another third world. Textiles will always be a third world industry.

That seems true at first, but looking back to founding of the mills, it obvious that textiles were not a 3rd-world industry in the early 1800s. Back in the early 1800s, textile mills were the high-tech, cutting edge business of their day. Massachusetts was not the 3rd world in the 1800s but instead had one of the highest standards of living in the world. People built textile mills in Massachusetts for the same reason they built computers in California in the 1980s: It was the place to put a high-tech, cutting edge, highly profitable business. 

Industries don’t stay cutting edge and high profit forever. They have a life cycle in which they have high margins and big profits in the industry’s infancy but then decreasing margins and profits as the industry ages. Regions that have have infant industries can support a high tax rate, high wages and a high standard of living. Regions that have mature industries have to make do with low taxes, low wages and a lower standard of living. 

This is why protectionism will always fail to maintain a region’s standard of living. Even if industries cannot relocate or face no external competition, those industries’ profitability and the standard of living based on that profitability will inevitably decline. If a region cannot generate or attract entirely new industries to the region, the region will inevitably grow poorer over time no matter how rich it was at its zenith.  

The computer industry offers us the best recent example of an industry life cycle. For computer hardware, the 1980s were the time when the industry had the highest return on investment and the time when the great fortunes and reputations were made. Apple Computer sold the Apple II on 150% margin for several years. Other companies did almost as well. Consumers paid that premium for computers because as a new technology personal computers gave advantages that no other technology could. Relatively minor innovations evolved into major benefits that people would pay a lot for. That profitability in turn supported computer manufacturing facilities throughout California and some other regions in America. 

However, by the early ’90s, personal computer hardware had matured. Few major innovations were being made and most manufacturers concentrated on squeezing out a few additional percent of performance improvements which their competitors quickly matched. Margins and profits shrank. Manufacturers began to compete on price instead of innovation. As a result of this change, computer manufacturing moved out of high-cost California and high-cost America to low-cost Asia. 

Fortunately for California, PC software took off big-time just as computer hardware manufacturing foundered. No one noticed the collapse of hardware manufacturing because software became the new high-margin, high profit business. By the late ’90s, however, PC software had matured and margins and profits decreased. Fortunately for California, the Internet took off at that time so no one noticed the decline of profits from the PC software industry. 

California boomed in the last 30 years because it rapidly shifted from industry to industry as one industry matured and became less profitable. California could keep elevating both its standard of living and its tax base by shifting industries. Now, however, the Internet is a mature industry and there doesn’t seem to be anything on the horizon to take its place. The current budget crunch in California results in part from the reduction in the profitability of Internet-associated industry.

The computer industry does everything in fast forward but the same pattern occurs in every industry. Steel was the cutting-edge, high-profit business in the late 1800s, then railroads, then oil, then cars, then airplanes, then plastics, then electronics. Each industry starts out with high margins and high profits but eventually matures into a low-margin, low-profit industry. Even if an industry never migrates from a region and doesn’t lose market share, the region grows poorer because the industry no longer supports the standard of living it did in its heyday. 

Detroit was always doomed because it tied itself so closely to the automotive industry. The automotive industry was the young, highly profitable industry from 1910-1940. Detroit during that time had the same cachet as Silicon Valley has today. Detroit got a reprieve from the aftermath of WWII that left it the only place in the free world still building cars, but the writing was already on the wall by 1940. The number of automobile manufactures was shrinking from hundreds to dozens. By 1950, there were only a dozen and by 1960 just four. Cars were no longer cutting-edge high-margin products but commodities that competed on price. Margins and profits (measured by return on investment) shrank, and this in turn meant a lower standard of living for workers and a smaller tax base. It didn’t matter that Detroit was still building most of the cars that Americans drove, the margins just weren’t there anymore. 

Margins are important to the prosperity that an industry can support. Everyone eats and people buy food before anything else, so it would seem that agriculture would be a profitable business. But everyone from farmers to distributors finds it hard to make a living growing food. Agriculture is the most mature industry of all. Major innovations are few and far between. All this means margins and profits are thin. Communities that rely on agriculture struggle to maintain a decent standard of living because agriculture doesn’t produce the high margins and high profits that pay for good wages and high taxes. 

Detroit would be a poor place today even if we had always made it illegal to import and drive foreign cars, because cars don’t provide high margins anymore. Detroit would be nothing more than a giant farming town struggling to survive on the thin profits made by selling cars as a commodity. 

Detroit imploded because it cemented its economic and political structure around a single industry and then refused to create the conditions that would let a new high-margin, high-profit industry take its place. California could easily follow the same path if it continue its incredibly hostile attitude toward business, because then it will be stuck with a maturing, low margin, low-profit industry. The Internet boom is over and it looks like it was maybe the last boom associated with the computer industry as a whole. Even if they keep computer related jobs in the state, they won’t have the same standard of living they had before. 

Massachusetts would be impoverished had it tried to keep textile manufacturing in the state. Massachusetts thrived for two centuries and continues to manage a decent standard of living today because it made itself a good place to start new industries. Texas is booming today because the state is a good place to start new, high margin, high-profit industries. 

The flight or bankruptcy of old industries in a region shouldn’t be viewed as a problem. It’s natural to cling to what worked in the past but in the end it’s innovation that pays the bills. Regions should make economic policy based on the idea that the region should serve as an incubator for new business, not a retirement home for old ones. When a business reaches the point it can’t support an advanced standard of living through wages and taxes, it should be politely shown the door so a young, vigorous and profitable business can take its place. 

In the end, regions don’t fall into poverty because of the natural life cycle of industries. Regions fail because they cannot create new businesses. The abandoned and converted textile mills of Massachusetts are not symbols of the state’s failure but of its success. This makes the attempts to preserve old industries with subsidies and protection all the more counterproductive.

5 thoughts on “A Retirement Home for Old Businesses”

  1. “Detroit would be a poor place today even if we had always made it illegal to import and drive foreign cars because cars don’t provide high-margins anymore”..if foreign cars had been banned, then the margins might not have been so bad, given the oligopoly structure of the industry. Big-3 management & labor might have been able to extract considerable wealth from other parts of American society for a very long time.

    Eventually, the potential returns would have been so tempting that a well-capitalized someone in a different line of business would have started up an automotive venture and given the big-3 some serious competition, but it might have taken several decades.

  2. minor quibble

    Steel was the cutting-edge, high-profit business in the late 1800s, then railroads, then oil,

    railroads first powering steel, oil oft to itself doing something different

  3. The future belongs to the country with the most self control and the best educational system. Ask Spengler.

    As I wrote some years ago (American Idolatry Asia Times Online, August 29, 2006), at some time during the 20th century, the people of the West elected to identify with what is like them, rather than emulate what is above them.

    Churlish resentment of high culture comes from the slacker’s desire for reward with neither merit nor effort: the sort of artistic skill that requires years of discipline and sacrifice is a reproach to the indolence of the popular audience of the West. Better voices than Boyle’s can be found in a thousand choirs and amateur theatricals, but the crowd has embraced this late-hatching Scottish songbird as a symbol of its own aspirations.

    With no prejudice to Boyle, who seems amused rather than beguiled by her success, the fantasy-life of nations has consequences in the real world. In China, as I observed in a recent essay (China’s six-to-one advantage over the US, Asia Times Online, December 2, 2008), nearly 40 million children study classical piano, and another 15 million or so learn to play stringed instruments. Nearly 60 million young Chinese in all are learning Western classical music, and learning it the hard way, under teachers who demand mastery of technique, paid by parents who have scraped together tuition and demand regular practice. Sixty million is a big number, considering that there are only 30 million Americans aged five to 18. Of these, perhaps 5 or 6 million study piano, but few with the intensity of their Chinese counterparts.

    And vouchers have been ended in DC.

  4. Michael Kennedy,

    China will definitely be a major player in the future but I think they maybe crippled by their relatively primitive political culture and their cultural emphasis on family before all else.

    My point is that it really doesn’t matter how strong an industry’s competition is because eventually that industry will mature to the point where it no longer brings in the big bucks to the community. Eventually, it will reach the point where it is not profitable enough to support workers paid only the bare minimum needed to survive in the community. At that point it will either evaporate or migrate to a less prosperous region.

    The only way to maintain prosperity is to continually generate new industries. The fact that we face serious external competition makes this an even stronger priority.

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