Monthly Archives: September 2011

Does Manufacturing Need Government Help?

A recent article in the New York Times by Louis Uchitelle highlights the current debate over whether manufacturing in America is in decline and, if it is, whether government subsidies would help.  Unfortunately, the article raise as many questions as it tries to answer.  There are three main facts about manufacturing that I think warrant a great deal of attention.  Each is often ignored in articles like this one.

First, the health of manufacturing depends upon how it is defined.  It is true that manufacturing’s role in the economy is undergoing a long-term relative decline similar to the one that agriculture experienced at the beginning of the last century.  When it was founded, the United States was largely an agricultural economy.  Farming accounted for a large portion of total employment and other sectors of the economy were often rudimentary and/or expensive enough so that mass consumption was unaffordable for most people.  For example, although a textile industry existed then, clothes were so expensive that most people could only afford a few items and repaired those constantly rather than buying new ones.  As other sectors of the economy, particularly manufacturing, grew and as agricultural productivity increased, agriculture as farming declined in employment even as total farming production increased.  Yet agriculture as the food industry remains a large part of our economy two centuries later and includes many sectors that are high value and innovative.

Similarly, as various service sectors grow, manufacturing is bound to decline in relative importance.  This can be seen in the long-term decline in employment (although some of the decline is due to companies outsourcing various jobs, such as janitorial services, that are then classified as service jobs).  Yet if manufacturing is defined as all of the inputs and services that go into making products that have a tangible form whether or not these are provided by the manufacturing company itself or outside service companies, there is less reason to worry about its long-term future.  Consumers are always likely to want more and better things and the task of getting them these things at a reasonable price will consume a great deal of effort.

The second major point is that manufacturing is in many ways a victim of its relative success.  Over the last several decades manufacturers have achieved impressive gains in productivity.  Many times this has allowed them to increase the quality of their products even as they reduced the price.  In static economics this is not supposed to happen.  There have been many reasons for this success.  Manufacturing is more exposed to international competition so governments have been less successful at creating domestic havens in which companies no longer need to innovate.  Original equipment manufacturers, especially in the auto industry, have been relentless in forcing their suppliers to commit to lower prices while keeping quality at least constant.  Technology such as computer aided design, 3-D printing, and inventory systems that allow just-in-time manufacturing and better quality control have also helped.  The result has been a further decline of jobs.  In a mature economy, total demand for manufactured goods rises relatively slowly and, if those goods can now be produced with fewer workers, layoffs are likely.

But characteristics of the rest of the economy act to make manufacturing appear relatively weaker than it is.  Large parts of the economy, including health care, education, government services, finance and legal services are relatively immune from productivity increases or price pressure.  In each of these government policies protect providers from the intense competition that manufacturers faced over the last 40 years.  Even worse, the structure of these markets encourages rising prices.  In part this is due to the mistaken belief that, for one reason or another, market forces cannot work in these sectors.  There is also the unstated assumption that consumers in these markets are better off being protected from competition than they would be in a dynamic market facing constant pressure to increase quality and reduce cost.  The political power of incumbents also plays a role.  But note that even if production in all sectors remains static so that producers deliver the same goods and services every year, the relative importance of manufacturing as measured by GDP will decline if it exhibits strong productivity growth while other sectors increase their prices.

Finally, it is important to remember that much of the growth in demand for manufactured goods occurs overseas.  The co-chairman of President Obama’s Advanced Manufacturing Partnership makes this same point.  Andrew N. Liveris, Chairman and CEO of Dow Chemical argues for vigorous government support similar to the government subsidies his company recently received.  Yet he also makes it clear that such support will not cause him to move manufacturing back to this country.  The article quotes him as saying: “We put things overseas because markets were growing there and we wanted to be close to them, and that will never change.”  In that case, what is the point of subsidizing production here?  To the extent that manufacturers feel the need to be in China because that is where the market is, then there may not be much we can do to stop them.  Chinese subsidies to these companies may merely transfer wealth from Chinese taxpayers to American companies and their shareholders.  And US subsidies meant to keep the companies here may ultimately be self-defeating because they lower national wealth.

We should be glad that other sectors of our economy are growing and that other countries are developing.  This is not to say that manufacturing is not important or that government policy could not be improved.  But direct government assistance to specific industries and companies is problematical.  Elsewhere in the article, Mr. Liveris says: “I would not let free markets rule without also addressing what I want manufacturing to be in 20 or 30 years from now.”  But if government agencies had spent several billion dollars in 1985, how likely would they have been to correctly foresee the changes that have occurred over the last 25 years?

Instead of trying to bet on specific industries or companies, we should concentrate on improving the general environment for creating value in this country.  That means reducing the corporate income tax, reducing trade barriers, streamlining regulation, and changing labor regulations.  Each of these changes would have a much larger and more lasting impact across a number of industries.  But because each challenges both the conceit that experts can manage society and the innate fear of unpredictable competition none are likely to occur.

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Filed under Competitiveness, Manufacturing