Can Developed Countries Increase Manufacturing?

Stephen DeAngelis

April 26, 2011

As we all know, economies of most countries change over time. The general vector of this change is from agriculture to industry to service. This change has been more focused and accelerated since the beginning of the industrial revolution. During the colonial era, imperialist regimes sought to conquer countries that could supply the motherland with raw materials. These raw materials were used to manufacturer goods that could then be sold domestically, to other developed countries, and to their colonies. Many colonists obviously found this subservient situation intolerable and, like the United States, rebelled. My colleague Tom Barnett likes to point out that America was once an emerging market economy with a reputation much like China’s today. Workers in Europe were no happier to lose manufacturing jobs to Americans than Americans now are to lose manufacturing jobs to Chinese workers. The question is: Can this historical cycle be broken? Can developed countries staunch the flow of manufacturing jobs leaving the country? Some analysts don’t think they can and they point to the work of Joseph Schumpeter as the reason why.

 

Schumpeter was an Austrian economist and the best known proponent of the historical cycle described above. In The Process of Creative Destruction (1942), he wrote:

“The opening up of new markets and the organizational development from the craft shop and factory to such concerns as US Steel illustrate the process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one … [The process] must be seen in its role in the perennial gale of creative destruction; it cannot be understood on the hypothesis that there is a perennial lull.”

The Great Recession caused a number of analysts and policymakers to reconsider the wisdom of this “perennial gale of creative destruction.” [“How to Build Again,” by Rana Foroohar, Newsweek, 10 July 2010]. Foroohar writes:

“Ever since the financial crisis hit, policymakers around the world have been talking about how to ‘rebalance’ their national economies. In rich nations, this mostly entails reducing debt. But it also involves reassessing the mix between the service sector, which represents about 70 percent of the U.S. economy, for example, and manufacturing, which makes up just 11 percent. In the U.S. and the U.K. in particular, there’s a sense that overreliance on dodgy financial services is no way to create decent jobs for the masses or to build a more stable economy. In these and many other countries, like France and Germany, influential voices are calling for a return to the business of producing real goods.”

The question is: what do you produce? Consumers have demonstrated time and again that price trumps most other considerations (including where a good is manufactured). Since it is difficult to compete on price while producing goods also manufactured in so-called “low cost countries,” there seems to be a growing consensus that developed countries need to concentrate on creating entirely new goods to be manufactured. That is one reason that many policymakers have stressed the importance of developing strong cleantech, biotech, and nanotech sectors. Foroohar reports, “A new report issued in late June [2010] by the Council on Competitiveness and the consultants Deloitte Touche Tohmatsu should give America and some European nations like Germany reason to hope they can stay in the global game.” She explains:

“The report surveyed 400 global CEOs, tallying their views on the key factors that drive manufacturing competitiveness. The most surprising finding is that it’s innovation, not how cheap or expensive labor is, that determines whether a country will be successful in manufacturing. Contrary to conventional wisdom, manufacturing has not become a race to the bottom. That’s why the U.S. still ranks as the fourth-most competitive nation after China, India, and South Korea, despite vastly higher labor costs. Germany, Japan, and Singapore also hold positions in the top 10. The skill levels of their workers more than offset their costs (U.S. workers are twice as productive as those in the next 10 leading manufacturing economies). Skills are particularly critical in the lucrative high-end manufacturing sector, which accounts for about half of all new innovation within an economy. ‘Talent will be the oil of the 21st century,’ says Council on Competitiveness president Deborah L. Wince-Smith.”

That’s both good and bad news for countries like America. The good news is that developed countries can still compete. The bad news is that so-called “blue collar” jobs aren’t likely to return. The skills required for lucrative high-end manufacturing are only obtained through education and training — and most people agree that education is in a semi-crisis state in the United States. Foroohar says that there is other bad news for the U.S.

“Cost of energy and materials ranked third, right after talent and wages, as a determining factor in where to locate manufacturing operations. That’s bad news for America. Unlike China and many nations in Europe, the U.S. has no coherent national energy policy, and has yet to spark a green-jobs revolution. The international CEOs surveyed believed that America would drop a spot in the competitiveness rankings within five years.”

There is another side to that story. With some analysts predicting that a barrel of oil could soon cost over $170, some manufacturers now believe that the higher costs of domestic manufacturing are being offset by the higher cost of transportation. The greater the distance a good has to be moved the higher the cost. Returning the “highly-skilled worker” conundrum, Foroohar writes:

“There are measures the United States can take to shore up its position, though predictably, they aren’t easy. While it’s not politically correct to suggest that perhaps every citizen shouldn’t aspire to a university degree, high-end technical schools that can turn a $16,000-a-year dishwasher into a $60,000-a-year welder may in fact deserve as much private and public money as mediocre four-year liberal-arts colleges churning out students with relatively useless degrees. That idea has worked in Germany, though the Germans have also done a good job producing top-level engineers—another area where the United States lags. A much stronger K–12 focus on math and science would help the U.S. greatly.”

Let’s face it; in the current political climate we’re not going to see any new government plans that foster the re-skilling of workers. Foroohar concludes:

“Immigration policy can also play a key role in ensuring competitiveness. As Secretary of Commerce Gary Locke points out, ‘So many firms that we view as American icons were actually started by immigrants.’ It’s an oft-quoted fact, but one worth remembering as the Obama administration struggles to push through meaningful immigration reform. (This writer is for stapling a green card to the diploma of every foreign student who obtains a Ph.D. in the States.) After all, the most talented people in the world now have other places to seek work—namely their own countries, which will be the source of the majority of the world’s new jobs in the foreseeable future. If talent really is the new oil, it will pay to keep it here.”

Steve Minter, editor of Industry Week, doesn’t buy into Schumpeter’s creative destruction argument. [“The Case for Investing in Manufacturing,” 17 February 2010] He writes:

“Many are content to see basic industries leave the United States, assuming that there is an inevitable evolution in a developed economy toward high-tech industries. They see the drop in manufacturing employment over the past decade as a necessary byproduct of globalization and increased efficiency. The answer is to pursue new manufacturing opportunities such as electric cars and wind turbines, and to focus on the service sector. But as National Institute for Standards and Technology (NIST) economist Gregory Tassey argues in his provocative analysis of the United States’ competitive status in manufacturing, the nation must see manufacturing as a series of complex supply chains rather than individual industries and dramatically change its policies to encourage research and development.”

The most fascinating thing I find in that statement is the assertion that “the nation must see manufacturing as a series of complex supply chains rather than individual industries.” This coincides with an argument that I’ve made before that it is supply chains that compete not companies. For more on this subject read my post entitled Transforming Global Supply Chains and a column I co-wrote with colleague Thomas Barnett that was published by World Politics Review entitled “The New Rules: Managing Global Supply Chains a Key U.S. Advantage.” Minter continues:

“Tassey makes a compelling case in ‘Rationales and Mechanisms for Revitalizing U.S. Manufacturing R&D Strategies’ that the U.S. economy’s future depends on a strong manufacturing sector. He notes that ‘the high-income economy must be the high-tech economy’ and that manufacturing is a necessary element, as it supports 70% of industry R&D spending. He also points out ‘the majority of trade is still in products,’ and the United States cannot fix its huge trade deficit by relying on services. Moreover, he says international competitors are targeting high-tech services. With the advent of the Web, many of these services can be provided from Bangalore as easily as from Boston. High-tech manufacturing and services are closely tied together, and the competitiveness of one is hampered by the absence of the other.”

The most compelling argument put forth by Tassey is that the majority of trade is still in products. That shouldn’t change as globalization helps a new global middle class emerge. Those new consumers will generate a flow of money that savvy manufacturers will find a way to tap into. In many growing economies, “Made in America” still has some cachet. Commenting on Minter’s column and Tassey’s report, supply chain analyst Bob Ferrari laments that “the U.S. currently lacks a comprehensive manufacturing investment strategy, and more importantly a comprehensive supply chain strategy.” [“One More Rant – The Case for Investing in U.S. Manufacturing and Supply Chain Capability,” Supply Chain Matters, 22 February 2010] As a supply chain analyst, Ferrari zeroes in on what Tassey has to say about supply chains, which is:

“The modern global economy is therefore constructed around supply chains, whose tiers (industries) interact in complex ways. In the U.S. economy, one supply chain after another has been hollowed out by increasing foreign competition. Most of these losses have been in manufacturing. In spite of arguments to the contrary, partial domestic supply chains often have increasing trouble competing globally. This proposition is complex, varying among technologies and hence high-tech supply chain. However, it is a real phenomenon that is receiving little analysis.” [“Rationales and Mechanisms for Revitalizing U.S. Manufacturing R&D Strategies,” by Gregory Tassey, National Institute for Standards and Technology, December 2009]

Ferrari makes his frustration known about the current state of things by concluding, “If an economy doesn’t build value in the manufacture of goods, which in-turn drives the need for robust supply and value-chain capabilities, than we may as well all get in line for those few jobs left on Wall Street and the financial services sector.” In a later post [“The Shifting Tides in the Outsourcing of Manufacturing,” Supply Chain Matters, 22 November 2010], Ferrari concludes:

“Manufacturing outsourcing continues to be a delicate balance of multiple factors. Access to growing consumer-based economies, shifting and volatile currencies, higher transportation and quality control costs, and concern for intellectual property protection all interplay in the dynamics of outsourcing. From our perspective, two conclusions stand forth. First, outsourcing decisions will continue to involve dynamic factors, and the degree of flexibility and agility of manufacturing and supply chain networks will continue to be a key consideration in supporting outsourcing needs. That also implies the ability to analyze and assess all the various factors. Second, no country can claim to have an economic growth plan without consideration to the global competitiveness of its manufacturing and supply chain infrastructure.”

Germans have demonstrated that, in spite of high labor costs and a strong currency, a developed country can compete in the manufacturing sector on the global stage. As an article in The Economist reports, “Germany is the world’s largest goods exporter after China despite high labor costs and a strongish euro. It is also stuffed full of durable companies that have survived hyperinflation and two world wars.” [“Mittel-management,” 25 November 2010] I don’t claim to have any answers to this conundrum; but, two things are clear: first, manufacturing remains critical to a country’s economic health; and, second, the supply chains that support manufacturing are just as critical.