What’s the Right Path for Manufacturing?

Originally posted on IndustryWeek.

Recently, I wrote about how the 2000s were a lost decade for U.S. manufacturing. Ensuring that the 2010s are not more of the same will require a robust national manufacturing policy to help producers in America become much more productive and innovative. Unfortunately, to date, Washington has not embraced such a policy.

The key question is why?

One reason is that there are three major camps in manufacturing policy and only one puts a national innovation agenda at the top of the list.

Camp 1: Manufacturing Doesn’t Matter, So No Need for a Manufacturing Policy

These advocates have a clear policy message regarding U.S. manufacturing. Don’t do anything specifically to help manufacturing. The reason? Manufacturing doesn’t matter. The members of this camp are numerous. Kenneth Green, a resident scholar at the conservative American Enterprise Institute (AEI), writes: “As long as China is selling us the products we need, the location of manufacturing isn’t really that critical for the economy.” Meanwhile, Columbia University’s Jagdish Bhagwati dismisses anyone who says manufacturing is important as suffering from a “manufacturing fetish,” while economic columnist Robert J. Samuelson writes that any talk of manufacturing renewal being critical to solving U.S. economic problems is “make believe.”

Lest you think these are just the musings of out-of-touch academics, such views are common in government as well. President Obama’s former economic policy head Larry Summers stated: “America’s role is to feed a global economy that’s increasingly based on knowledge and services rather than on making stuff.”

In addition, Christina Romer, former chair of the Council of Economic Advisors, dismissed President Obama’s very own manufacturing policy (after she left the White House) claiming that manufacturers didn’t need “special treatment” and that any claim as to why manufacturing is different is based on “sentiment.”

As I have discussed in Innovation Economics: The Race for Global Advantage, members of this camp make such claims because, like the famous “potato chips-computer chips” view advanced by a senior economics advisor for George H.W. Bush, they believe in the “car manufacturing-car rental, what’s the difference?” theory. And unfortunately, this is not a fringe minority. In my view, this camp holds an intellectual “market share” of at least 50% in Washington.

Camp 2: Manufacturing Does Matter, But All We Need to do to Fix it is Lower Manufacturing Costs

This group recognizes that manufacturing is critical to our future, but believes that government has been the problem and that if we can just get government out of the way, by reducing or eliminating taxes and regulations on companies, then all will be well. Members of this camp point to one iconic fact to back up their claims: that the U.S. manufacturing environment is more expensive than the rest of the world.

As expressed in the 2011 MAPI and NAM Manufacturing Institute study, the 2011 Report on the Structural Cost of U.S. Manufacturing: “Because of our tax, tort, energy and regulatory policies, it is 20% more expensive to do business in the United States than it is in the countries that are our nine largest trading partners—and that excludes the cost of labor.”

However, to say that costs are the biggest problem is not supported by the facts. Despite the inference above, ITIF’s research shows that when the cost of labor is includedU.S. manufacturers actually enjoy lower costs than those in Germany, Japan, Great Britain, Canada and France. And in spite of this fact,Japan and Germany continue to outperform U.S. manufacturing.Why would we think that cutting costs a bit more would solve the problem?

Especiallywhen one considers that,as the OECD has shown,U.S. manufacturing is about 10 to 15 percentage points more concentrated in low-tech and medium-low tech industries than competitors like Germany and Japan.These nations don’t compete on cost because they know that is a no win strategy.They compete on quality, innovation, customization and productivity. The reality is that cost reduction, while it can help, is not going to solve the problem by itself.

The real problem with the Cost Camp is not that smarter regulation and lower corporate taxes wouldn’t help, it’s that this group is largely unsupportive of productivity/innovation policies that are also imperative to improve American competitiveness. We see this with NAM’s virtual silence on the Administration’s proposal to create a National Network of Manufacturing Innovation.

Furthermore, NAM’s report A Growth Agenda: Four Goals for a Manufacturing Resurgence in America talks about tax rates, regulation, health care, and legal reform, but makes no mention of programs like NIST’s Manufacturing Extension Partnershipor the Administration’s NNMI. Lowering costs without increasing innovation will not be enough to revive American industry.

Camp 3: Manufacturing Does Matter: Let’s Get the Environment Right for Innovation and Productivity

If America wants to spark a real manufacturing revival, we should seek to model Germany, which runs a large manufacturing trade surplus, has expanded, not contracted, manufacturing output and does so with costs that are at least 50 percent higher than the United States, in terms of costs per worker hour. German manufacturers win not because their costs are lower but because they compete on quality, speed, innovation, customization, and technology.

The German government has built a robust manufacturing infrastructure to help Germany’s manufacturers innovate and deploy new technologies. It has a dedicated innovation promotion agency, has expanded federal support for R&D, much of it related to manufacturing technology, and has created manufacturing-oriented Fraunhofer Institutes, which undertake applied research and are funded 70% by industry.

This is not to say that Germany has not also worked to improve its business climate. The government partnered with industrial unions to enhance wage restraint and work flexibility, while also cutting corporate tax rates from 52% to 29.8%.

This is why ITIF has argued that any effective manufacturing strategy has to include a robust “tech and talent” initiative, which would include a fully funded NNMI, a new system of “manufacturing universities” that promote training and applied research, stronger tax incentives for companies to invest in R&D, workforce training and new machinery and equipment, as well as a nationwide skill standards program for manufacturing skills.

To be sure, this need not be an either-or strategy. We need to better streamline government regulations and bureaucracy, while also lowering corporate tax rates. (ITIF has argued for bringing the rate down to 20%.) But, a cost-only, or even cost-mostly, strategy will not bring back American manufacturing. A technology-centric strategy will.