Manufacturing the Future: Why Reindustrialization Is the Road to Recovery

Four and a half years after the crash, the American economy sputters along. Twenty-three million workers cannot find full-time work, and the percentage of the employed population has hardly budged since it hit bottom two and a half years ago. Republicans argue that we should reduce the deficit (a disastrous policy); Democrats urge a new stimulus (a necessary step, but not sufficient to repair our economy). Missing from our national discussions about economic revitalization—even in arguments made by many of the nation’s progressive economists—is the need to restore a badly damaged manufacturing sector.

This idea—supporting manufacturing through an industrial policy—has always had powerful enemies. Opposition from conservatives is to be expected. Industrial policy challenges the notion that a nation must make do with whatever “comparative advantage” God and history have given it. It is premised on the idea that government can shape the direction of the economy.

But even prominent Democratic economists tend to disregard the importance of manufacturing. Some believe government policy will not be effective. “Government is a crappy venture capitalist,” was how Larry Summers dismissed the Obama administration’s attempts to support clean energy manufacturing. Others believe that the decline in manufacturing jobs is not a problem, but rather a symptom of success. Robert Reich states: “What happened to manufacturing? In two words: higher productivity.” He argues that manufacturing output is strong, but it requires fewer workers to produce it. As Austan Goolsbee—former head of Obama’s National Economic Council—put it, manufacturing decline is nothing to worry about because manufacturing is going through “exactly the same process that agriculture went through.” Just as the U.S. economy shifted from agriculture to manufacturing, now we are shifting from manufacturing to a service-based economy.

This story, though widely believed, is misleading. The manufacturing decline is not similar to the jobs loss in agriculture. Unlike agriculture, the nation’s manufacturing output has declined and its job losses cannot be explained simply as productivity increases. Given this reality, and the importance of manufacturing to our economy, there are good reasons to support a robust industrial policy by strengthening the Obama administration’s plan for resuscitating manufacturing.

What Happened to Manufacturing?

The decline in manufacturing has been stunning. Having peaked at nearly twenty million in 1979, the number of manufacturing jobs has dropped to under twelve million, its lowest level since the early 1940s. The largest decline in jobs (six million) has occurred since 1998. Across the country, once bustling industrial towns shrink amidst once unimaginable decay.

Manufacturing jobs are starting to return. The Financial Times reports that “reshoring is causing great excitement in the U.S.” Business consultants at Accenture report that two-thirds of big U.S. manufacturers have moved factories in the past two years, with the most popular destinations being within the U.S.

The recent jobs gains, however, pale in comparison to the losses. In the last two years, we have gained back just under five thousand (a mere 8 percent) of the millions of manufacturing jobs lost since 1998. At this rate it would take until 2037 for the nation to regain the manufacturing jobs lost since 2000.

Is Manufacturing’s Decline Like Agriculture’s Decline?

The shift from low-productivity labor on the farm to higher-productivity, higher-paid employment in industry is precisely what economic development is all about. The same movement, supposedly, is happening with the shift out of industry and into business services and high tech. This view of economic history as an inevitable process of shifting from sector to sector—in order to shift to higher and higher levels of productivity and pay—is reassuring. However, it is also wrong and misleading.

What is currently happening to manufacturing is not what occurred with agriculture. And the difference is important. American agriculture did not go offshore. We automated agriculture and increased its output enormously by boosting productivity. Manufacturing, on the other hand, is declining because, in large part, it is moving offshore. The difference between continuing production by automating versus shifting out by offshoring makes all the difference in the world to the wealth of a nation and the composition of employment.

What Is Happening to Manufacturing Output?

Almost twenty-five years ago Lawrence Mishel, president of the Economic Policy Institute, showed that government statistics significantly overstated U.S. manufacturing output and productivity. First, he demonstrated that output was greatly exaggerated in the computers and electronics sector. Second, the increased use of cheap imported components (a consequence of offshoring) used as inputs in manufacturing production also led to overstated manufacturing productivity. Mishel’s argument, long ignored, has recently been updated and elaborated on in several important analyses of U.S. manufacturing. They all show that the trends Mishel identified in the late 1980s are more pronounced today.

Those like Reich and Goolsbee—who think manufacturing is healthy and the employment decline is due to productivity increases—point to the fact that the change in real manufacturing value added, relative to GDP, is stable. But what’s obscured is that, in 2010, thirteen of the nineteen manufacturing sectors were actually producing less than in 2000. But, more importantly, when corrected for the problems identified by Mishel—overestimation of output in the computers and electronics sector, and problems with how inputs are measured—manufacturing output actually fell over the last decade, while GDP increased by 17 percent. Employment in manufacturing is declining mainly because of reduced output.

Productivity growth, rather than being the cause of declining manufacturing employment, is the prerequisite for manufacturing employment growth. This should not be surprising. Only highly efficient factories can survive in today’s global economy. William Nordhaus has shown that, within each manufacturing industry, increases in the rate of productivity growth were associated with increases in the rate of job growth from 1948 to 2003. A Brookings Institution study extended the Nordhaus study until 2009 and concluded that “there is no evidence that productivity increases were significantly correlated with job loss.”

It is not inevitable that manufacturing will decline. Many nations with higher manufacturing wages than the United States—including Germany, the Netherlands, and Norway—have seen either stable or increasing manufacturing output as a share of GDP. Other countries—Korea, Austria, Poland, Finland, the Czech Republic, and the Slovak Republic—have actually seen their manufacturing sectors grow as a share of their economy.

Why Manufacturing Matters

Manufacturing is unique in that it is a source of good jobs for both highly educated and non-college-educated workers; manufacturing is the key driver of innovation—without manufacturing, research and design will not thrive; manufacturing is key to reducing our trade deficit; and it is the source of comparatively greater indirect employment in other economic sectors.

Manufacturing workers earn more than workers in other industries. Controlling for education, union status, and other job characteristics, manufacturing workers average an 8 percent higher pay rate than workers in non-manufacturing sectors, and are also more likely to receive benefits. A disproportionate number of less educated workers are employed in manufacturing. Yet, because of the wage advantage in manufacturing, many of these jobs provide workers with a middle-class standard of living.

Manufacturers account for roughly two-thirds of U.S. domestic company research and development (R&D) spending. In 2010, for example, manufacturing employed 35 percent of all engineers, compared with only 8.9 percent of all workers. Thus, if we lose manufacturing we also lose other jobs with a high proportion of employees with advanced degrees. “The big debate,” according to Susan Houseman of the Upjohn Institute for Employment Research, “is whether we can continue to be competitive in R&D when we are not making the stuff that we innovate. I think not; the two cannot be separated.” Or as Dow Chemical CEO Andy Liveris succinctly states: “Where manufacturing goes, innovation inevitably follows.”

A strong manufacturing sector is also needed to reduce our trade deficit. Even in its reduced state, manufacturing accounts for nearly three-quarters of U.S. exports. Even though increased exports of services and decreased imports of oil are certainly part of the solution, it is very difficult to see how the United States can balance its chronically negative current account without significant improvement to our manufacturing trade balance.

Finally, manufacturing is a key source of employment growth. The Economic Policy Institute finds that manufacturing jobs have an employment multiplier of 2.9 compared to 1.6 in business services and 1.6 in transportation.

The Administration’s Mixed Messages

A recent speech by Gene Sperling, Director of President Obama’s National Economic Council, may be the strongest case for a manufacturing policy by a U.S. administration in seventy years. It makes the case that manufacturing matters and defines a policy agenda that includes: support for advanced manufacturing initiatives, including clean energy-related technologies; giving tax breaks to domestic manufacturing firms; spending $8 billion to train workers for high-skill manufacturing jobs; and a new Interagency Trade Enforcement Center.

These are all worthwhile ideas. And, if implemented on a large enough scale, they can contribute to expanding manufacturing employment. What sectors in manufacturing are likely, with the right support, to expand? According to the Brookings Institution, the sectors best positioned for reinvestment are: computers and electronics; chemicals (including pharmaceuticals); transportation equipment (including aerospace, motor vehicles, and parts); and machinery. Each of these four industries offers the opportunity for high wages, innovation, trade deficit reductions, and environmental sustainability. Not insignificantly, the same study shows that they have gained jobs over the last two years.

But a question remains: after thirty years of surrendering markets, offshoring production, and massive trade deficits, is it enough?

One problem is the Obama administration’s failure to align its trade and industrial policies. The administration’s trade policy—and trade is one of the few areas of bipartisanship in our national politics—undercuts the positive steps it has taken on industrial policy.

The administration’s failure to put the competitiveness of the U.S. dollar at the center of a program to bring back manufacturing is a serious shortcoming. Since our current trade deficit is about 4 percent of GDP, balanced trade would have a huge impact on jobs. Yet it is inconceivable that our trade deficit can be balanced and manufacturing can rebound without a lower dollar. An international agreement to manage the exchange rates of the major currencies within target zones—similar to the Plaza Accord of the late 1980s—could help. If international cooperation efforts fail, the U.S. should consider adopting an across-the-board tariff surcharge as allowed for balance-of-payment purposes. There have also been proposals for an import certificate program, in which the right to import goods would be auctioned off or sold to companies that purchase certificates from either exporters or the government.

The administration is also negotiating the most significant trade agreement since NAFTA—the Trans-Pacific Partnership (TPP). The TPP—like NAFTA, the Permanent Normal Trade Relations for China Act, and other agreements—is being sold as a way to increase U.S. exports, reduce trade deficits, and create jobs. But like the previous agreements on which it is modeled, it will lead to rising trade deficits, the offshoring of U.S.-based production, and slower economic growth.

Given our massive trade deficit, the United States should impose a strategic pause on all trade negotiations until we reduce our trade deficit to 2 percent of GDP, improve American competitiveness, and rebuild our shattered safety net.

The two pillars of manufacturing policy are an industrial policy and a companion trade policy. They stand best when they stand together.