Manufacturing in America: Should we still make things? a symposium

Posted in The Dismal Science by distpatches on June 3, 2009

Should We Still Make Things?

Susan Helper – March 11, 2009


THE MARKET share of what used to be called the “Big Three” U.S. automakers has been shrinking for years. GM alone had over 50 percent of the U.S. market in the 1960s, but Ford, GM, and Chrysler together can now barely muster 40 percent. Since autumn, sales have been in free fall. GM lost $9.6 billion last quarter, and Chrysler has all but announced it is not viable without a foreign partner. Does the United States need an auto industry?

In the short term, the government should act to prevent a sudden collapse of the Detroit Three. Such a collapse could, due to interlinked supply chains, cause the loss of 1.5 to 3 million jobs (adding 1 to 2 percentage points to an unemployment rate already approaching double digits), and cause such chaos that even Japanese automakers support loans to keep GM and Chrysler afloat. But what about the long term? Why not let the Detroit Three continue to shrink, and allow Americans to buy the cars they prefer, whether they are U.S.-made or not?

It is true that the Detroit Three’s problems go deeper than the current dramatic fall in demand due to the economic crisis. But these problems have potentially correctable causes. The automakers have been managed with an eye to short-term financial gain rather than long-term sustainability. Public policy has also been unfavorable, in three major ways: low gas taxes, which lead to large fluctuations in the price of gas when crude oil prices change; lack of national health care, which penalizes firms responsible enough to offer it; and an insufficient public safety net for retired and laid-off employees, causing firms that shrink to be saddled with very high “legacy costs.” Another problem (primarily for the rest of manufacturing, but also for autos) is trade agreements that don’t protect labor or environmental rights.

It is important to note that the United States faces no fundamental competitive disadvantage in auto manufacturing. Competitive advantage in auto manufacturing is made, not born (in contrast to the case of, say, banana growing, where natural endowments like climate play an important role).

First, we should dispel the notion that auto manufacturing is inherently a low-wage activity. Our major competitors in auto assembly (Germany and Japan) pay wages at least as high as in the United States. Low-wage nations such as China and Mexico have made some inroads into auto supply, providing about 10 percent of the content of the average U.S.-assembled vehicle. But even here, competing with low-wage nations is not as daunting as one might think; research by the Michigan Manufacturing Technology Center suggests that most small manufacturers have costs within 20 percent of their Chinese competitors’.  Manufacturers could meet this challenge by adopting a “high-road” production process that harnesses everyone’s knowledge—that of production workers as well as top executives and investors—to achieve innovation, quality, and quick responses to unexpected situations.

Is there a public interest in reversing the industry’s undeniable failures? Why not let all the manufacturing jobs disappear and have an economy of just eBays and Googles? Because we need manufacturing expertise to cope with events that might present huge technical challenges to our habits of daily living (global warming) or leave us unable to buy from abroad (wars).

The auto industry has a critical role to play in meeting these national goals. Take the challenge of climate change. We need to radically increase the efficiency of transport, in part by making incremental changes that reduce the weight of cars, more significant changes to the internal combustion engine, and potentially revolutionary couplings of cars with “smart highways” to dramatically improve traffic flow.

Yes, we could import this technology. But it might not be apt for the U.S. context. (For example, Europe has long favored diesels for their fuel economy, but Americans have deemed diesels’ high emissions of nitrous oxides and particulates to be unacceptable).  And we’d need to export a lot of something to pay for this technology—or see continued fall in the value of the dollar, leading to a fall in living standards.

The auto industry has long been known as “the industry of industries,” since making cars absorbs much of the output of industries like machine tools, steel, electronics, even computers, and semiconductors.  Innovations pioneered for the auto industry spread to other industries as well (see this article). Thus, maintaining the industry now keeps capabilities alive that may be crucial in meeting crises we have not yet thought of.  Traditional trade theory has little room for such “irreversibility”; it assumes that if relative prices change, countries can easily re-enter businesses that they were once uncompetitive in. But, it’s very expensive to recreate the vast assemblages of suppliers, engineers, and skilled workers that go into making cars and other manufactured goods.

We should not assume that the United States will keep “high-skilled” engineering and design jobs even if we lose production jobs. In fact, the reverse may well be true.  Asian and European car companies do most of their engineering in their home countries; they manufacture here in part because of the bulkiness of cars.  Even the Detroit Three are outsourcing engineering to Europe (for small cars) and India (for computer-aided drafting). In addition, it is difficult to remain competitive for long in design when one doesn’t have the insight gained from actual manufacturing.  Another reason to save the auto industry is its role as a model of relative fairness in sharing productivity gains. Allowing a high-wage industry to fail does not guarantee that another high-wage industry will emerge to take its place—in fact, by weakening the institutions and norms that created such an industry, it becomes less likely.

So, the United States needs an auto industry, one that pays fair wages and engages in both engineering and production at a sufficient scale to keep critical industries like machine tools humming. Do “we” need a domestically owned auto industry?  This is a harder question.  Our “national champions” have not served the United States particularly well in recent decades; consumers have benefited greatly from access to Toyotas and Hondas. Yet, the demise of the Big Three may well lead to negative consequences for all of us—lower wages (since foreign automakers have been hostile to unions) and less R&D in the United States—and therefore we need to make sure we don’t create financially viable firms by sacrificing capabilities and wages. Instead, we should implement government policies, such as creating both demand and supply for fuel-efficient vehicles, and involve unions in training programs for both current and former auto workers. These policies would help create an industry that serves all its stakeholders—including taxpayers.

Susan Helper is AT&T Professor of Economics, Weatherhead School of Management, Case Western Reserve University. She is also a Research Associate at the National Bureau of Economic Research and MIT’s International Motor Vehicle Program.

Should We Still Make Things?

Dean Baker – March 11, 2009

I HAVE often thought that economists should be required to have a better grasp of simple arithmetic. It would prevent them from repeating many silly comments that pass for conventional wisdom, such as that the United States will no longer be a manufacturing country in the future.

Those who know arithmetic can quickly detect the absurdity of this assertion. The implication of course is that the United States will import nearly all of its manufactured goods. The problem is that unless we can find some country that will give us manufactured goods for free forever, we have to find some mechanism to pay for our imports.

The end of manufacturing school argues that we will pay by exporting services. This is where arithmetic is so useful. The volume of U.S. trade in goods is approximately three and half times the volume of its trade in services. If the deficit in goods trade were to continue to expand, we would need an incredible growth rate in both the volume and surplus of service trade and our surplus on this trade in order to get to anything close to balanced trade.

For example, if we lose half of our manufacturing over the next twenty years, and imported services continue to rise at the same pace as the past decade, then we would have to see exports of services rise at an average annual rate of almost 15 percent over the next two decades if we are to have balanced trade in the year 2028.

A 15 percent annual growth rate in service exports is approximately twice the rate of growth in service exports that we have seen over the last decade. It would take a very creative story to explain how we can anticipate the doubling of the growth rate of service exports on a sustained basis.

The story becomes even more fantastic on a closer examination of the services that we export. The largest single item is travel, meaning the money that foreign tourists spend in the United States. This item alone accounts for almost 20 percent of our service exports.

There is nothing wrong with tourism as an industry. However, the idea that U.S. workers are somehow too educated to be doing for manufacturing work, but instead will be making the beds, bussing the tables, and cleaning hotel toilets for foreign tourists is a bit laughable. Of course, with the right institutional structure (e.g. strong unions) these jobs can be well-paying jobs, but it is certainly not apparent that they require more skills than manufacturing.

The category “other transportation” accounts for another 10 percent of exported services. These are the fees for freight and port services that importers pay when they bring items into the United States. This service rises when our imports rise. It is effectively money taken out of our consumers’ pockets because it is included in the price of imported goods.

Royalty and licensing fees account for another 17 percent of our service exports. These are the fees that we get countries to tack onto the price of their products due to copyright and patent protection. It might become increasingly difficult to extract these fees as the spread of the Internet increasingly allows more movies, software, and recorded music to be instantly copied and exchanged at zero cost. It’s not clear that the rest of the world is prepared to use police-state tactics to collect revenue for Microsoft and Disney. The drug patent side of this equation is even more dubious. Developing countries are not eager to see their people die so that Pfizer and Merck can get high profits from their drug patents. This component of service exports is likely to come under considerable pressure in future years.

Another major category of service exports is financial services. This category accounted for approximately 10 percent of service exports in recent years. It is questionable whether this share can be maintained in the years ahead. Wall Street had been known as the gold standard of the world financial industry, with the best services and the highest professional standards. As a result of the scandals that have been exposed in the last year, Wall Street no longer has this standing in the world. After all, investors don’t have to come to New York and give their money to Bernie Madoff or Robert Rubin to be ripped off; they can be ripped off almost anywhere in the world. Perhaps the Obama administration will be able to implement reforms in the financial sector that will restore its integrity in the eye of world investors, but that will require serious work at this point.

Finally, there is the category of business and professional services, which accounts for roughly 20 percent of service exports. This is the area of real high-tech and high-end services. It includes computing and managerial consulting.

Rapid growth in this sector would mean more high-end jobs in the United States, but the notion that it could possibly expand enough to support a country without manufacturing is absurd on its face. First, even though it is a large share of service exports, it is only equal to about 0.8 percent of GDP. Even if quadrupled over the next two decades, it wouldn’t come close to covering the current trade deficit, to say nothing of the increase due to the loss of more manufacturing output.

More important, it is implausible to believe that the United States will be able to dominate this area in the decades ahead. The United States certainly has a head start in sophisticated computer technologies and in some management practices, but it is questionable how long this advantage can be maintained. There are already many world-class computer service companies in India and elsewhere in the developing world, and this number is increasing rapidly.

The computer and software engineers in these countries are every bit as qualified as their U.S. counterparts and are often prepared to work for less than one-tenth of U.S. wages. Furthermore, unlike cars and steel, which are very expensive to transport over long distances, it is costless to ship software anywhere in the world. Given the basic economics, it seems a safe bet that the United States will lose its share in this sector of the world economy. In twenty years it is quite likely that the United States will be a net importer of this category of service, unless of course wages in the United States adjust to world levels.

In short, the idea that the United States can survive without manufacturing is implausible: It implies an absurdly rapid rate of growth of service exports for which there is no historical precedent. Many economists and economic pundits asserted that house prices could keep rising forever in spite of the blatant absurdity of this position. The claim that the U.S. economy can be sustained without a sizable manufacturing sector is an equally absurd proposition.

Read the symposium introduction and contributions from Marcellus Andrews, Jeff Madrick, and Susan Helper Dean Baker is co-director of the Center for Economic and Policy Research in Washington, DC. He is the author of several books, including The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer and The United States Since 1980.

Should We Still Make Things?

Jeff Madrick – March 11, 2009

THERE ARE at least three major reasons why a nation must indeed make things to maintain its prosperity: First, making goods is on balance—with exceptions—more productive than providing services, and rising productivity is the fundamental source of prosperity; second, related to the first, making goods creates higher-paying jobs on balance—again, with a few exceptions; third, a major nation must be able to maintain a balanced current account (and trade balance) over time, and goods are far more tradeable than services. Without something to export, a nation will either become over-indebted or forced to reduce its standard of living.

The United States has looked the other way regarding these important issues for a variety of reasons, but underlying its neglect are certain narratives about how economies work that have been highly misleading. One of the more misleading narratives of recent decades involves the rapid growth of services industries when compared to the rest of the economy. It goes like this: Services will naturally replace manufacturing in an advancing economy exactly as manufacturing replaced agriculture in the 1800s. Do not be concerned. Remember how inappropriately concerned people were a century and a half ago with the rise of manufacturing? The rise in services is the best use of American resources.

Of course, within every overgeneralization lies a pit of truth.  Same here. Once we feed, clothe, house, and auto-mobilize ourselves, many economists agree that we mostly want to go to the movies or watch TV, hang out at the mall, trade stocks in our Schwab accounts, and, if financially healthy, go to the doctor a lot.  There is thus no need to be alarmed that only 8 or 9 percent of American workers are employed at a factory that makes things. To the contrary, this is proof of the economy’s sophistication and its evolution towards providing Americans with what they really want. Moreover, manufacturing’s productivity is rising rapidly—which means fewer workers are needed for the same output and the price of an equal quantity of goods falls.

A lower manufacturing share of GDP is therefore the natural course of events. In fact, productivity gains are the core reason for job loss. There are even good services jobs—finance, for example. Meantime, corporate profits rise, which is proof of the pudding and the guarantor of high levels of capital investment and the future of the nation. Not long ago, the management guru, Peter Drucker, wrote that all America had to do was learn how to more productively make services. I suppose America listened, because it has now created the remarkably productive Wal-Mart, which in turn supplied America with some of the worst jobs in the nation.

ACCORDING TO the neo-classical equilibrium theory, all of this was supposed to happen as naturally as a dolphin plies the tides. As always, there are controversies over how fast manufacturing’s share of GDP has fallen but in recent years, I don’t think there are many that argue there hasn’t been a significant drop since the late 1970s.  In addition, I don’t think many argue that the trade deficit in manufactured goods, which is pretty enormous, has virtually nothing to do with job loss.

Thus, manufacturing should have always been a focus of government policies.  But America did far worse than merely neglect it.  The decline of manufacturing has gotten a big push from the Democrats in charge in the 1990s, and from most of the Republicans since the early 1980s, in particular the hard Rightists, and increasingly most of mainstream economic academia. This push—really a shove—was the tolerance and further promotion of an overvalued U.S. dollar.

The American dollar had been high through much of the Bretton Woods period, but in 1979 it took off and rose some 60 to 75 percent, depending on the trade-weighted average used, until 1984.  High real interest rates in the early 1980s under Federal Reserve Chairman Paul Volcker attracted foreign funds while Reagan’s simultaneous Keynesian thrust of tax cuts and defense spending produced a fast-growing economy in the mid-1980s. In five years, the high dollar dramatically lifted the price of manufactured goods. Coupled with the steep recession, manufacturing was clobbered.

After the dollar declined during the run of Jim Baker’s Plaza Accord, the value of the dollar again turned up and kept rising inexorably until only a couple of year ago. Manufacturing thus did not decline as a consequence of natural causes, but was hastened to the edge of the cliff and pushed off by the high dollar.  The relevance of manufacturing was minimized by policymakers who saw an easy way to attract foreign investment and compensate for ever more borrowing, and all the while satisfy Wall Street profit seekers.

And thus America stopped making things.  American manufacturing was at an enormous disadvantage in the world. One consequence was the permanent loss of many hundreds of thousands of jobs.  But not only that.  Entire industries were decimated, needed skills lost, R&D foregone, the innovation from learning-by-doing never undertaken—and so on.

The rest of the world did not mind. American demand was the growth machine for Japan, the Tigers, and finally China. If America wanted to undermine good jobs in its own country, who were they to complain?

THE DISASTER of this policy is now clear.  Left to its own devices, the free market in currencies is probably the most devastating economic idea of our times.  Because the dollar reigned for so long as the only trustworthy reserve currency, America got a free pass to run up a big trade deficit without the concomitant rise in interest rates.  This led to self-destructive abuse. Americans didn’t have to save to finance borrowing and they could still borrow to buy what they wanted.

This led to borrowing at damaging levels.  Greenspan, for example, could push interest rates to rock bottom in the early 2000s without undermining the value of the dollar and raising inflationary fears. Meantime, the Chinese and others, intoxicated by the power of their export-led growth model, felt no pressure to raise wages at home and build a domestic market which the early rich nations of Europe and North America had long ago learned was a critical foundation—an idea that some have now forgotten.

The world’s trade and investment imbalances led directly to the current crisis.  Debt, not wages, propelled demand in America.  And not only America but international institutions invested dollars in bad American mortgages and the housing bubble.  Earlier they had done the same in the high-technology sectors.

So the extent of the decline of manufacturing in the United States was not natural.  Meantime, under this economic model, finance became America’s leading industry, accounting for more than 30 percent of profits in recent years and more than 40 percent of profits among the Standard & Poor’s 500.

If a high dollar had not been allowed to become the centerpiece of the economic model, manufacturing would have declined but to a far lesser degree.  This raises the second issue. Should we let manufacturing follow a natural, market-driven course? The answer is that we should not.  It is nonsense to think that free markets will automatically create the industries a nation needs.  The thinking that suggests it will is the result of the ascendance of simplistic free-market economic theory.

In America, we fail to develop industries for which there are few short-term incentives or that are too risky or large to be undertaken by private capital. There are gaping holes in what we make in America: no light rail or subway cars to speak of, for example, and far less agricultural equipment and almost no machine tools, once the pride and joy of our early industrial era.  We are in desperate need of money for alternative energy solutions. We spent torrentially on fiber communication lines that were unneeded. We lag in broadband coverage. We of course make almost no consumer electronics products or textiles.

We remain leaders in chip-related high technology. But it was the government that saved Intel in the 1980s, and it is the remarkable fall in the cost of computer power with Intel micro-processors that was the principal causal factor in the so-called “New Economy.” We lead in big pharmaceuticals, but that’s because the National Institutes of Health and other government agencies have so intelligently subsidized science and research at U.S. universities. We have a huge defense industry, which is a big exporter, including aircraft. (We know why.) Meantime, the nation’s overall R&D is spotty and weak. The education of engineers and scientists remains well behind our production of MBAs.

Today, to take the most straightforward measure, manufacturing final sales are 10 percentage points lower as a share of GDP than they were in the early 1980s.  That’s 1.5 trillion dollars worth.  Losing one million manufacturing jobs more than necessary has put an enormous dent in wages in America where the typical male in his thirties now makes less after inflation than the typical male in his thirties did in the 1970s.

SO HERE we are: Enormous imbalances in current accounts everywhere has put the world in a hole from which it may not climb out in the near future. The imbalances are a consequence of everyone taking the easy way out—and most doing so against the most vital long-term interests of the U.S. economy. The United States has succumbed, in particular, to the short-term interests of powerful Wall Street players.

To take one end of the spectrum, the Chinese, now in serious recession, must develop a domestic market.  At the other end is the U.S., which, until the 1970s, paid the highest wages in the world since the Colonial years. But it no longer does. It is a high productivity, low-wage nation.  Wal-Mart is the symbol of the broader demise. A major reason is the loss of manufacturing jobs.

Because the United States can no longer make many things—it doesn’t have the factories, the labor or management expertise, the new ideas or proper incentives—the trade deficit is that much harder to correct, even if the dollar falls again.  An industrial policy, such as the one partly incorporated in the new Obama stimulus package, has fewer teeth because much of the domestic spending will necessarily go to imports.

In sum, then, no nation can sustain the imbalances America has had since the late 1980s. Goods are largely what are exported.  Critically, making things also makes good jobs, it creates ideas for the future, it educates and trains workers, it has enormous multiplier effects through the purchase of goods for production and by paying high wages.  Contrary to widespread conventional wisdom, no rich nation will survive on services alone.

The United States requires an appropriate currency policy. Since it needs the cooperation of all nations, it is difficult to be optimistic. But present events may cause this to happen, and we can only hope in a stable way. The United States also requires a realistic industrial policy to support needed industry, the ongoing development of skills and products, and appropriate levels of R&D. The lack of such thinking in America—even after the crisis—is yet another failure of over-simplified, market-oriented economic theory.

Read the symposium introduction and contributions from Marcellus Andrews, Dean Baker, and Susan Helper

Jeff Madrick is editor of Challenge Magazine and director of policy research at the Schwartz Center for Economic Policy Analysis, The New School. He is the author of Taking America, The End of Affluence, and most recently The Case for Big Government.

Should We Still Make Things?

Harold Meyerson – March 12, 2009

So what kind of capitalism shall we now craft?

The Reagan-Thatcher model, which favored finance over domestic manufacturing, has collapsed after thirty years of dominance and what we need—and what we can build—is a capitalism more attuned to our national concerns. The decline of American manufacturing has saddled us not only with a seemingly permanent negative balance of trade but with a business community less and less concerned with America’s productive capacities. When manufacturing companies dominated what was still a national economy in the 1950s and 1960s, they favored and profited from improvements in America’s infrastructure and education. The interstate highway system and the G.I. Bill were good for General Motors and for the U.S.A. From 1875 to 1975, the level of schooling for the average American increased by seven years, creating a more educated workforce than any of our competitors’ had. Since 1975, however, it hasn’t increased at all. The mutually reinforcing rise of financialization and globalization broke the bond between American capitalism and America’s interests.

Manufacturing has become too global to permit the United States to revert to the level of manufacturing it had in the good old days of Keynes and Ike, but it would be a positive development if we had a capitalism that once again focused on making things rather than deals. In Germany, manufacturing still dominates finance, which is why Germany has been the world’s leader in exports. German capitalism didn’t succumb to the financialization that swept the United States and Britain in the 1980s, in part because its companies raise their capital, as ours used to, from retained earnings and banks rather than the markets. Company managers set long-term policies while market pressures for short-term profits are held in check. The focus on long-term performance over short-term gain is reinforced by Germany’s stakeholder, rather than shareholder, model of capitalism: Worker representatives sit on boards of directors, unionization remains high, income distribution is more equitable, social benefits are generous. Nonetheless, German companies are among the world’s most competitive in their financial viability and the quality of their products. Yes, Germany’s export-fueled economy is imperiled by the global collapse in consumption, but its form of capitalism has proved more sustainable than Wall Street’s.

So does Germany offer a model for the United States? Yes—up to a point. Certainly, U.S. ratios of production to consumption and wealth creation to debt creation have gotten dangerously out of whack. Certainly, the one driver and beneficiary of this epochal change—our financial sector—has to be scaled back and regulated (if not taken out and shot). Similarly, to create a business culture attuned more to investment than speculation, and with a preferential option for the United States, corporations should be made legally answerable not just to shareholders but also to stakeholders—their employees and community. That would require, among other things, changing the laws governing the composition of corporate boards.

In addition to bolstering industry, we should take a cue from Scandinavia’s social capitalism, which is less manufacturing-centered than the German model. The Scandinavians have upgraded the skills and wages of their workers in the retail and service sectors—the sectors that employ the majority of our own workforce. In consequence, fully employed impoverished workers, of which there are millions in the United States, do not exist in Scandinavia.

Making such changes here would require laws easing unionization (such as the Employee Free Choice Act, which was introduced this week in Congress) and policies that professionalize jobs in child care, elder care and private security. To be sure, this form of capitalism requires a larger public sector than we have had in recent years. But investing in more highly trained and paid teachers, nurses and child-care workers is more likely to produce sustained prosperity than investing in the asset bubbles to which Wall Street was so fatally attracted.

Would such changes reduce the dynamism of the American economy? Not necessarily, particularly since Wall Street often mistook deal-making for dynamism. Indeed, since finance eclipsed manufacturing as our dominant sector, our rates of inter-generational mobility have fallen behind those in presumably less dynamic Europe.

Wall Street’s capitalism is dying in disgrace. It’s time for a better model.

Read the symposium introduction and contributions from Marcellus Andrews, Dean Baker, Jeff Madrick, and Susan Helper Harold Meyerson is editor-at-large at the American Prospect and on the Dissent editorial board. This contribution, in a different form, appeared in the Washington Post, where Meyerson is columnist.


One Response

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  1. kars said, on June 13, 2009 at 7:43 am

    very good thanks

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