Manufacturing: Why We Should Help the Sector (But Not Too Much)

February 20th, 2012 at 10:40 am

For many years, policy makers and public officials have argued about whether public policy should help promote American manufacturing or whether we should leave it alone and let the market do what it will.

As usual, such stark positions have little to do with reality.  I start from the position that, like it or not, we have and will continue to have a significant industrial policy in America.  It’s just not a very smart one.

Each year we provide hundreds of billions in tax breaks for all sorts of industrial sectors, including manufacturing (tax credits for US production and accelerated depreciation of equipment alone account for $450 billion in tax breaks, 2013-2017).  But is this money well spent?  Is this ad-hoc industrial policy working?

I’d say “not so much” at least relative to better, more coordinated ideas that grow out of a close look at the sector with respect to its potential role in economic growth and global competition.  And yet, each year economists pull chins and wag fingers about how we must avoid an “industrial policy” that “picks winners.”  Meanwhile, other advanced and emerging economies, unburdened by this ideological parlor game, are crafting policy—sometimes useful, sometimes not—designed to boost their manufacturing sectors and claim global market share.

As strongly argued in a new Brookings document coming out next week (they’re having a release event there Wed AM):

…manufacturing does indeed matter to the U.S. economy and that public policy can strengthen American manufacturing.  The nation need not and should not passively accept the decline or stagnation of manufacturing jobs, wages, or production.  American manufacturing matters because it makes crucial contributions to four important national goals.

–Manufacturing provides high-wage jobs, especially for workers who would otherwise earn the lowest wages.

–Manufacturing is the major source of commercial innovation and is essential for innovation in the service sector.

–Manufacturing can make a major contribution to reducing the nation’s trade deficit.

–Manufacturing makes a disproportionately large contribution to environmental sustainability.

I’ve stressed these arguments in various posts, noting that 70% of private sector R&D comes from manufacturing, the trade surplus in services is small relative to the deficit in manufactured goods (see figure here), and, as I spoke to in Portland, OR just last week, clean energy manufacturing should be an important part of future production.

But, as my friend and wise economic thinker Christy Romer asked in a recent NYT critique of the pro-manufacturing policy position: where’s the market failure?  I was also reminded of this critical question in Zach Goldfarb’s interesting piece in the WaPo yesterday on how subsidies to an American manufacturer (Boeing) created a competitive disadvantage for another firm (Delta).

Such critiques demand a response.

First, broadly speaking, you’ve got to know your history here (as Christy does, and her position is actually closer to the Brookings folks’ view of targeted support).  There exist market barriers, unique to manufacturing, that no individual private firm can overcome by themselves.  There is no private firm that can coordinate a national smart grid, make or recoup the investment needed to move advanced battery technology from the university labs to the factory floor, penetrate export markets, and fight back against mercantilists trying to sew up market share here in clean energy manufacturing.

History also reveals—as documented in must-read detail in this book on the history of gov’t’s role in innovation–there is no transformative investment that reshaped our economy, from railroads to the internet, wherein the federal government did not partner with the private sector to overcome these barriers.  Not here, not in any other advanced economies, not even in emerging economies.   To ignore this reality in the interest of “not picking winners” or “government doesn’t create jobs” or whatever atavistic ideology you want to plug in, is to concede global competition to those unburdened by such dangerously wrongheaded thinking.

But what about Delta?  Now, that’s a tough one.  Why does a private manufacturer like Boeing need the government (in this case, the Export-Import (XM) bank) to backstop its borrowing?  If private credit markets won’t do so, isn’t that a market signal that something’s wrong here and that if anything, the taxpayer should be spared?

Again, there are market failures and risks in play here that private investors cannot adequately offset.  For one, Europe has its own consortium supporting aircraft manufacturing, Airbus, and those who oppose XM financing here have to be able to explain why it’s OK to unilaterally disarm.  Second, and unique to this industry, there’s just too much investment risk when you take a $20 billion order from Indonesia, e.g. (as in the WaPo piece); there’s currency risk, stability risk, and for private lenders to take on such uncertainty would require very high rates of interest (h/t TM on these points).

Still, and this requires more research that I’ll get to, I came away from the WaPo piece agreeing more with Christy et al in this case.  Given the risks and competitive factors just noted, we should subsidize our exporters when they need it.  But Delta has a case here.  These subsidies have grown too large—they are now more a function of the skill of your lobbyists than the need to offset the market failures.

So what should we be doing in this space?  That comes right out of the market barriers noted above:

–we should push back against the mercantilists who manage currency to tilt the playing field in uncompetitive ways—and it’s not just currency; non-tariff barriers abound.

–we should support R&D, particularly in clean energy, with great attention the “death valley” between discovery in the labs and production in the factories.

–we should ensure that workers have the technological skills that contemporary production demands.

–we should pay a lot more attention to supply chains, as that’s where most of the jobs are (Sue Helper, an author of the Brookings study, is a big promoter of this insight); that often means transitional support for, e.g., a machine shop that was making gear boxes for a Chevy to making gear boxes for a wind turbine.

–we should carefully examine the union/management/gov’t partnerships that Germany successfully implements in the interest of a stronger manufacturing presence, a point the Brookings folks also stress.

Again, I need to crunch more numbers on this, but my intuition is that we could do all this and more for less than we’re spending now on credits, tax breaks, and subsidies that we’re not adequately evaluating through the lens of market failure, innovation, and potential growth sectors.

We’ve already got a manufacturing policy.  Now let’s make it a smarter one.


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11 comments in reply to "Manufacturing: Why We Should Help the Sector (But Not Too Much)"

  1. Aly says:

    Hi Jared – I work for a safety equipment and check valves manufacturer here in Houston, TX. Manufacturing is so important to the US and global economies. We don’t have a clear policy, and as of yet, no clear way forward but at least manufacturing is back in the conversation.

    Anyhow, thanks for sharing! – Aly

  2. save_the_rustbelt says:

    Christy Romer has probably never been unemployed.

    When she gives up her tenured position and gives her job to a lower priced immigrant maybe she can talk. (SNARK, snark)

    Bill Clinton and the Robert Rubin Wall Street clique were certain we could replace manufacturing with “high value service jobs.”

    Fries with that?

    Or maybe they knew better and didn’t care what happened to blue collar workers.

  3. save_the_rustbelt says:

    “we should pay a lot more attention to supply chains, as that’s where most of the jobs are”

    Ohio has become a supply chain center, now called logistics, and it creates a lot of $9 an hour jobs with limited benefits, for the former manufacturing workers.

    Great plan.

  4. Jamison Kuhle says:

    As our economy develops and QOL indicators rise in other countries, the US has increasingly seen more manufacturing jobs re-relocate domestically. Depending on what economist you talk to, the cause for the “on-shoring” could be resultant from a wide range of stimuli, from depressed US wage levels to increased foreign working standards to a volatile fuel market to the simple leveling effect geography has on comparative advantage. At any rate, it is certainly clear that in current global markets, the US manufacturing sector continues to struggle, despite recent developments. If the US were to implement more astringent import standards, would not the playing field be leveled to a certain extent, and boost domestic manufacturing to pre-outsourcing levels, without the US government “picking winners and losers.” The most classic import restrictions of course take the form of product tariffs or, as I feel you are hinting at in your first point, currency manipulation, but these usually get the IMF, WTO, UN, and whole slew of other IOs and IGOs up in arms. Mr. Bernstein, what would you say to implementing stricter environmental standards on US imports, or labor standards, or even an import minimum wage? The third option could of course run into problems internationally by sending countries with huge labor forces but depressed wages, say China or India, into some form of inflationary spiral, but this could possibly be addressed by issuing the wage standards in some form of dyanamic PPP or inflationary measure (which might further attack currency manipulation.) At any rate, issuing higher import standards would have instant affects because at the very least, the US market is still the global monster demanding to be fed, and at the very most, could potentially raise millions out of poverty and demand a minimum human rights standard. Further, the approach would not require the US reaching in to every cookie jar on the planet and trailing crumbs every which way but loose, countries and companies would still have the option of shopping their goods wherever they pleased. Seems like a win, win, win situation. Thoughts?

    • Jared Bernstein says:

      I try to get to some of these in a forthcoming YAIA post.

    • Nhon Tran says:

      I do not wish to pre-empt what Jared will be saying, but allow me to say that the problem with the kinds of import restrictions mentioned above is not that they would get the IMF, OECD, the WTO etc up in arms but the problem is that these restrictions would hurt the American economy and people, especially those on lower income, because they would increase the cost of living and the cost of business in America. Regards.

      • Jamison Kuhle says:

        Fair enough, however, the “up-in-arms” response I postulated was a result of tariffs or currency manipulation, neither of which I advocate. In terms of whether higher import standards would cause higher prices, it could potentially, but your argument assumes only a single shift in AS. Part of my point is that AD is so great and MPC so intense for most US citizens, that there would be multiple shifts in both curves that could possibly equalize the Y-axis. If supply is decreased while demand remains the same in the short-term, competitors would certainly come out of the woodwork to advantage from the higher prices. The reverb from the supply increase settles to equilibrium, but the externality of the second supply shift is more domestic production, job production, and a rise in quality of life. If only considering where the supply shock pushes the equilibrium price, sure, there will be a higher price index. In this model, however, the final resting place of AS is in a completely separate country, and the profits associated from the equilibrium price are benefiting the same populace you would otherwise claim would suffer from higher prices. Seeing as inflation is practically nothing and domestic spending is out for recess, would not it follow that increased spending and decent, well-paying jobs for the US would be a boon?

  5. Nhon Tran says:

    Thank you. Good industry policy comprises stable and credible macroeconomic policies, world-best infrastructure, such as roads, rail, ports, intermodal linkages, broadband (America has slipped in these areas), a productive, healthy and skillful work force, a world-best education system with quality teachers (America has also slipped)and a sustainable tax system that supports a suitable safety net for the population and suitable government activities.

    President Obama’s proposal for tax incentives to firms to bring production back to America is not a smart one. It would make no difference to the location decisions of firms but it would provide relocating firms with a windfall gain, at a great cost to taxpayers.


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