Why Does Manufacturing Matter? Which Manufacturing Matters?


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“Public policy is needed to help strengthen manufacturing and promote a high-wage, innovative, exportintensive, and environmentally sustainable manufacturing base.”

Why Does Manufacturing Matter? Which Manufacturing Matters?
A Policy Framework
Susan Helper, Timothy Krueger, and Howard Wial1
Summary
Manufacturing matters to the United States because it provides high-wage jobs, commercial innovation (the nation’s largest source), a key to trade deficit reduction, and a disproportionately large contribution to environmental sustainability. The manufacturing industries and firms that make the greatest contribution to these four objectives are also those that have the greatest potential to maintain or expand employment in the United States. Computers and electronics, chemicals (including pharmaceuticals), transportation equipment (including aerospace and motor vehicles and parts), and machinery are especially important.
Productivity and wages vary greatly within as well as between industries. In any industry, manufacturers that are not already at the top have room to improve their performance by adopting “high-road” production, in which skilled workers make innovative products that provide value for consumers and profits for owners.
American manufacturing will not realize its potential automatically. While U.S. manufacturing performs well compared to the rest of the U.S. economy, it performs poorly compared to manufacturing in other high-wage countries. American manufacturing needs strengthening in four key areas:
n R esearch and development. n L ifelong training of workers at all levels. n Improved access to finance. n A n increased role for workers and communities in creating and sharing in the gains from
innovative manufacturing. These problems can be solved with the help of public policies that do the following: n P romote high-road production. n Include a mix of policies that operate at the level of the entire economy, individual indus-
tries, and individual manufacturers. n E ncourage workers, employers, unions, and government to share responsibility for improv-
ing the nation’s manufacturing base and to share in the gains from such improvements.

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Introduction
T he United States lost 41 percent of its manufacturing jobs between June 1979, when manufacturing employment peaked and December 2009, when it reached its recent low point.2 The last decade saw the most severe manufacturing job losses in U.S. history. Manufacturing’s share of total employment fell from 13.2 percent in January 2000 to 8.9 percent in December 2009.3
During the last two years there have been some positive signs for manufacturing. The number of manufacturing jobs increased by 2.6 percent from December 2009 through September 2011, and these gains were concentrated in durable goods manufacturing, which is generally the higher-wage, more productive part of manufacturing.4 In addition, between 2009 and 2010 manufacturing output grew at more than double the rate of GDP. However, the recent manufacturing job gains pale in comparison to the losses since 2000; at the rate of manufacturing job growth that the nation has seen since December 2009, it would take until 2037 for the nation to regain all the manufacturing jobs it lost between January 2000 and December 2009.5 Moreover, inflation-adjusted hourly wages in manufacturing fell between December 2009 and September 2011, even as manufacturing employment was growing. Manufacturing wages declined more rapidly than wages in the private sector as a whole.6 Thus, even if recent job growth continues, all is not well with American manufacturing.
There has recently been renewed debate over whether, as Stephen Cohen and John Zysman argued in their 1987 classic, “manufacturing matters” to the U.S. economy.7 In the current debate, some argue that manufacturing job loss should not be a public policy concern because it results from rapid productivity growth, which is good for the national economy.8 Others contend that there is nothing special about manufacturing because many service industries can be just as productive and innovative as manufacturing.9 A final argument against a renewed policy focus on manufacturing is that U.S. manufacturing wages are too high for manufacturing to be internationally competitive.10 On the other side of the debate are those who argue that manufacturing is a crucial source of high-wage jobs and innovation and is essential if the United States is to reduce its trade deficit, maintain a strong national defense, and have a thriving service sector.11
This report argues that 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.12 This report provides new and detailed evidence in support of these arguments. The report also rebuts each of the main arguments made by those who say that the United States should allow its manufacturing sector to shrink. It shows that U.S. manufacturing job losses are not due primarily to rapid productivity growth in manufacturing. Although some service industries are highly productive and innovative, only a small share of non-manufacturing employment is more productive or innovative than the manufacturing average. Finally, American manufacturing wages are not too high for U.S. manufacturers to be internationally competitive. Unlike other reports, this report not only explains the important public purposes that manufacturing serves (“why manufacturing matters”), but also “which manufacturing matters”: which kinds of manufacturing jobs the nation has the greatest potential to retain or grow and which kinds of manufacturing firms are most likely to prosper in a way that promotes high wages, innovation, more balanced international trade, and a better environment. This report shows: ➤ The industries and firms that support the four national goals identified in this report are also
those that have the greatest potential to maintain or expand employment in the United States. Computers and electronics, chemicals (including pharmaceuticals), transportation equipment (including aerospace and motor vehicles and parts), and machinery are especially important for

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their contributions to the four national goals and their job-retention or job-creation potential. ➤ T here is dramatic variation in productivity and wages among firms in the same industry as well
as between industries. Thus, even within industries that have low productivity and wages on average, firms that are not already at the top have room to improve their performance. They can do so by adopting a “high-road” production recipe, in which skilled workers make innovative products that provide value for consumers and profits for owners. American manufacturing will not realize its potential automatically, however. While U.S. manufacturing performs well compared to the rest of the U.S. economy, it performs poorly compared to manufacturing in other high-wage countries. U.S. manufacturing wages are relatively low by international standards, the American edge in innovation and renewable energy manufacturing is slipping, and manufacturing runs a huge trade deficit (rather than a surplus, as in many other high-wage countries). Public policy is needed to help strengthen manufacturing and promote a high-wage, innovative, export-intensive, and environmentally sustainable manufacturing base. Unlike other Brookings work on manufacturing policy, this report does not suggest particular policies but frames the terms within which manufacturing policy should be designed.13 To achieve the national goals that this report emphasizes, American manufacturing needs strengthening in four key areas: ➤ R esearch and development, including that needed to solve problems common to a variety of manufacturing processes, not just that needed to develop “breakthrough” products. ➤ L ifelong training of workers at all levels, so that they are equipped to collaborate in designing and implementing innovative products and processes. ➤ Improved access to finance for firms wishing to make productive investments. ➤ M echanisms that increase the role of workers and communities in creating and sharing in the gains from innovative manufacturing. These problems can be solved with the help of public policies that do the following: ➤ P romote “high-road production,” in which firms harness the knowledge of all their workers to create innovative products and processes. ➤ Include a mix of policies that operate at the level of the entire economy, individual industries, and individual manufacturers. ➤ E ncourage workers, employers, unions, and government to share responsibility for improving the nation’s manufacturing base and to share in the gains from such improvements. Our policy framework is unabashedly but not uncritically pro-manufacturing. Manufacturing matters for public policy because it serves important public purposes, and policy should improve the extent to which it does so. Policies designed to strengthen manufacturing, or particular manufacturing industries or firms, should promote the achievement of those purposes. Not every manufacturing firm or industry is equally able to contribute to the achievement of those purposes, even with the right kinds of policy assistance. Not every manufacturing job can or should be saved. Because there are differences within as well as between industries in the extent to which manufacturers contribute to the achievement of these national goals, a national manufacturing policy requires an understanding of the advantages and challenges that different industries, as well as different firms with different “production recipes,” have in doing so. Manufacturing policy in Germany is framed in terms similar to those proposed in this report. Combining economy-wide measures with support for industry-specific institutions and assistance to individual manufacturers, German policy promotes a manufacturing sector in which highly paid, skilled workers make innovative products that provide value for consumers, profits for owners, and contributes to a better environment and a trade surplus for the nation. This report concludes with a survey of German policy, not to advocate a wholesale transfer of that policy to the United States but to show that it is possible to use our policy framework to design successful manufacturing policies.
A. Why Does Manufacturing Matter? Manufacturing serves critical public purposes that make it indispensable to the U.S. economy. It remains a source of high-wage jobs for virtually all types of workers, but especially for those who would otherwise earn the lowest wages. These high-wage jobs do not make U.S. manufacturing internationally uncompetitive; several other countries have higher manufacturing wages than the United

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States but have had less severe losses of manufacturing jobs. By increasing productivity, the United States could increase both the average wage and the number of manufacturing jobs; productivity growth is associated with gains (not losses) in manufacturing jobs. Manufacturing is the major source of commercial innovation in the United States, including innovation in the service sector. It accounts for the majority of U.S. foreign trade and is essential if the United States is to make major reductions in its trade deficit. Finally, manufacturing makes an outsized contribution to America’s “clean economy”—the goods and services that contribute to environmental sustainability. This section of the report shows the contributions that manufacturing, and individual manufacturing industries, make to these public goals.
1. Manufacturing Continues to Provide High Wage Jobs, Especially for Workers Who Would Otherwise Earn the Lowest Wages Manufacturing workers earn more than those in other industries. Weekly earnings in manufacturing during the period 2008-2010 averaged $943.06, 19.9 percent higher than the non-manufacturing average of $786.40.14
Because earnings depend on a variety of characteristics of workers and jobs, a straight comparison of earnings may not accurately reflect the difference in wages that any particular worker could expect to earn if he or she moved between manufacturing and non-manufacturing industries. Therefore, this section of the report compares earnings between manufacturing and non-manufacturing industries, using regression analysis to control for the worker and job characteristics that influence earnings.15 (See Appendix table 1 for details.) After taking those characteristics into account, manufacturing workers averaged $605.18 per week, 8.4 percent higher than the non-manufacturing average of $558.29, as shown in figure 1.
Workers at all wage levels, men and women, and those in all racial/ethnic, educational attainment, and occupational groups earned more in manufacturing than in other industries. The one exception is Hispanic workers, who earned 10 cents less per week in manufacturing than in non-manufacturing industries.16 Controlling for education and other characteristics, our data show low-wage workers benefiting the most from manufacturing jobs and high-wage workers benefiting the least, indicating that manufacturing helps reduce wage gaps between high-, middle-, and low-wage workers. Men benefited

Figure 1. Average Weekly Earnings in Manufacturing and Non-manufacturing, Controlling for Worker and Job Characteristics, 2008-2010

$800 $750 $700 $650 $600 $550 $500 $450 $400

$742.41 Petroleum Manufacturing

$699.28 Internet Publishing and Broadcasting

$489.55 Retail Bakeries
Manufacturing

$427.80 Social Assistance
Non-Manufacturing

Source: Analysis of combined Current Population Survey outgoing rotation groups for 2008-2010, conducted by Mark Price of the Keystone Research Center

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more than women, whites and Asians more than blacks, and workers with some college, high school diplomas, and bachelor’s degrees more than other educational groups. Workers in farming/fishing/forestry and sales occupations benefited the most from working in manufacturing, while those in service and transportation occupations benefited the least.17
Earnings differ among individual manufacturing industries, once again controlling for worker and job characteristics (Appendix table 2). All but 12 of the 80 manufacturing industries shown in the table pay more than the non-manufacturing average; most of those 12 are bakeries and textile and apparel industries, and together they employ relatively few workers.18 The highest-paying manufacturing industries are either technologically cutting-edge (e.g., aerospace; computer and electronics industries) or very capital-intensive (e.g., petroleum refining, tobacco), or both (e.g., pharmaceuticals), while the lowest-paying industries are neither. A wide range of manufacturing industries, mostly durable goods industries that are somewhat capital- and/or technology-intensive but not as much so as the highest-paying industries, pay more than the overall manufacturing average; among these are appliances, motor vehicles, and iron and steel.
While nearly all manufacturing industries pay more than the non-manufacturing average, only a few non-manufacturing industries pay more than the manufacturing average, controlling for worker and job characteristics. The latter include mining, utilities, Internet publishing and broadcasting, telecommunications, finance, insurance, professional and technical services, management of companies and enterprises, hospitals, and public administration.19 Together these industries employ only a­­ bout 21 percent of the nation’s 116.3 million non-manufacturing workers.20
Manufacturing not only pays high wages; it is also more likely than non-manufacturing industries to provide employee benefits. Workers in goods-producing industries, of which manufacturing accounts for 65 percent of all jobs, are more likely than private sector workers as a whole to participate in some of the most common employee benefits, including both defined benefit and defined contribution retirement plans, paid holidays, life insurance, health insurance, and paid vacations (Appendix table 3).
Research indicates that the main reason why manufacturing wages and benefits are higher than those outside of manufacturing is that manufacturers need to pay higher wages to ensure that their workers are appropriately skilled and motivated.21 Two dimensions of skill and motivation especially matter for manufacturers. First, manufacturers face higher costs of downtime, in part because they are more capital-intensive than other businesses.22 To obtain qualified, motivated workers who will work to avoid this downtime, employers pay higher wages. Second, factories on average are larger than most other business establishments. This makes it more difficult and costly for factory managers to control the work process. To induce workers to take responsibility and, to some extent, manage themselves, manufacturers pay higher wages.23
This need for skilled and motivated workers across all occupations will remain a core feature of U.S. manufacturing. In fact, the policy approach advocated in this report (of increasing manufacturing productivity by encouraging firms to adopt the “high-road” strategy described below) would lead to increased reliance on skilled and motivated workers, thus leading to higher wages.24
Finally, manufacturing provides a disproportionately high number of jobs for less-educated workers. About 48 percent of manufacturing workers, but only 37 percent of non-manufacturing workers, have no formal education beyond high school.25 Manufacturing’s larger share of jobs for less-educated workers, along with the substantial wage advantage that it offers to those workers, make it an engine for boosting those workers into the middle class.
2. Manufacturing Continues to Be the Major Source of Commercial Innovation and Is Essential for Innovation in the Service Sector Manufacturing firms are far more likely than non-manufacturing firms to introduce new products and new production or business processes. According to the National Science Foundation’s 2008 Business R&D and Innovation Survey, 22 percent of manufacturing companies but only 8 percent of non-manufacturing companies introduced a new or significantly improved good or service between 2006 and 2008. The same percentages applied to manufacturing and non-manufacturing companies’ use of new production, distribution, and support activity processes during that time. All manufacturing industries, including such reputedly “low technology” ones as wood products, furniture, and textiles, exceeded the non-manufacturing averages for both product and process introductions, while only a few science-

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and information technology-intensive non-manufacturing industries (software, telecommunications/ Internet service/Web search/data processing, computer systems design and related services, and scientific R&D services) equaled or exceeded the manufacturing averages.26
Although all manufacturing industries surpass the non-manufacturing averages, some are more likely than others to be product or process innovators. The most innovative manufacturing industries, measured by either product or process introductions, were several computer and communications industries and the pharmaceutical industry (Appendix table 4). Chemicals and the majority of durable goods industries, including autos, aerospace, and machinery, also equaled or exceeded the averages for all of manufacturing. The manufacturing industries in which both product and process introductions fell short of the manufacturing averages were wood products, nonmetallic mineral products, furniture, primary metals, beverages, food, and textiles and apparel. Although manufacturing makes up only about 11 percent of GDP, it is responsible for the overwhelming majority of domestic research and development spending by companies, a key input into innovation. Manufacturers account for 68 percent of U.S. domestic company R&D spending.27 The manufacturing industries that each account for at least 5 percent of the nation’s domestic company R&D are pharmaceuticals (which alone accounts for 18 percent), transportation equipment, communications equipment, and semiconductors. The only non-manufacturing industries in which companies perform this much R&D domestically are software and professional/scientific/technical services (figure 2).
A similar picture emerges when examining R&D intensity (R&D spending as a percentage of sales), a measure of R&D effort that standardizes for the size of each industry. Domestic company R&D spending is 3.6 percent of domestic manufacturing sales, compared to 2.4 percent of domestic nonmanufacturing sales. Among manufacturing industries, R&D intensity is highest in the computer and electronics industries and pharmaceuticals. It also exceeds the non-manufacturing average in machinery, aerospace, motor vehicles/trailers/parts, and electrical equipment/appliances/components but is below the non-manufacturing average in all other manufacturing industries (Appendix table 5).
Engineers are an essential input into technological innovation. In 2010, manufacturing employed 35.2 percent of all engineers, compared with only 8.9 percent of all workers.28 The percentage of employment accounted for by architecture and engineering occupations (a combined category that is comparable across industries and that, in manufacturing, is 71 percent engineers) differed among
Figure 2. Industry Share of Domestic Company R&D Spending, 2006-2008

Other Non Manufacturing 10%
Professional/scientific/ technical services 10%
Software publishers 12%
Other Manufacturing 26%

Pharmaceuticals/ medicines 18%
Communications equipment 5%
Semiconductor/other electronic components 19%
Transportation equipment 10%

Note: Domestic company R&D spending includes all spending on R&D performed by companies in the United States and paid for by the company that performs it. Source: Authors’ analysis of National Science Foundation, Division of Science Resources Statistics, Business R&D and Innovation Survey, 2008.

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Box 1. Why Official U.S. Productivity Statistics Overstate Manufacturing Productivity Growth
Mounting evidence suggests that official U.S. government statistics on productivity (from the Bureau of Labor Statistics and Bureau of Economic Analysis) overstate recent productivity growth in manufacturing. There are three reasons why they do so.
Quality improvements in computers and electronics strongly influence the growth of overall manufacturing output and productivity. According to official statistics, annual manufacturing productivity growth between 1997 and 2007 averaged 5.4 percent per year if computers and electronics are included, but only 3.2 percent if they are excluded. Computers and electronics make such a big difference because their officially measured output grew at an annual average of 22.7 percent and their productivity grew at an annual average of 26.8 percent.29 These measured gains do not indicate that America was producing 22.7 percent more computers and electronics each year. Instead, they reflect the assumption that the quality of those products improved dramatically. This assumption is based on the fact that those products included technological advances that made them significantly more valuable.30
The official statistics confuse the growth of offshoring with productivity growth.31 When people think of labor productivity increasing by 10 percent, they usually think, for example, that Joe Machinist figured out how to make 110 parts in an hour instead of 100. Instead, what has increasingly happened in the last decade is that Joe’s boss offshored some production to China and fired Joe. Thus, Joe’s boss is now getting 100 parts with 10 workers rather than 11, but only because of an increase in imported inputs, not because of domestic productivity growth.
The root of the problem is that value added is measured as “sales minus the cost of materials” but there are no data comparing the costs of inputs imported from different places. Without these data, there is no way to tell whether an increase in measured productivity actually reflects a value-adding change an American firm made or whether the cost of inputs simply decreased. Economist Susan Houseman and co-authors estimated that failures to capture cheaper input prices have likely accounted for 20 percent to 50 percent of manufacturing’s measured growth in inflation-adjusted value added between 1997 and 2007.32
The official statistics confuse the growth in manufacturers’ use of temporary help services with productivity growth. Since the late 1980s manufacturers have increasingly used workers employed by temporary help services to work in their factories. Although they work in factories alongside manufacturers’ employees, these workers do not count as manufacturing workers in the official statistics. Yet the goods that they help produce count as manufacturing output. For this reason, manufacturers’ productivity is overstated when they use temporary help services. Moreover, the growth in manufacturers’ use of temporary help services means that this overstatement has become larger over time, so that the growth of manufacturing productivity is also overstated. Houseman and co-authors estimate that, in 2004, counting employment services workers as part of the manufacturing workforce would have added 8.7 percent to direct-hire manufacturing employment, compared to just 2.3 percent in 1989. As a result, they estimate, the growth of manufacturing productivity was overstated by 0.5 percentage points between 1989 and 2000 and between 2001 and 2004.33
Correcting for these three sources of overstated manufacturing productivity growth reduces the officially reported 5.4 percent annual productivity growth between 1997 and 2007 considerably. After adjusting for increased offshoring, manufacturing productivity growth falls to 4.8 percent annually. In addition to this, removing computers and electronics from the manufacturing total reduces productivity growth to 2.8 percent. Adding an adjustment for the increased use of temporary workers reduces it further, to 2.3 percent. However, this remains above the 1.8 percent productivity growth rate for all private business.

manufacturing industries. The transportation equipment industries (aerospace, motor vehicles and parts, and other transportation equipment), computers and electronics, machinery, electrical equipment, and petroleum and coal products had the highest percentages of their jobs in architecture and engineering occupations (Appendix table 6). These occupations made up the smallest percentages of employment (at or below the economy-wide average of 1.8 percent) in nondurable goods industries. Notably, engineers and related occupations account for a relatively small share of jobs in the pharmaceutical industry, where, unlike in other manufacturing industries, scientists are much more important than engineers in developing new products.
Patents are an indicator of invention, a key input into innovation. The U.S. Patent and Trademark Office provides industry-level patent data only for manufacturing industries, making it impossible to compare patenting rates in manufacturing to those in the rest of the economy. However, there are large differences in patenting activity among manufacturing industries (Appendix table 7). These

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differences reflect a combination of the extent of invention and the importance of patenting as a means of creating intellectual property rights in invention. Computers and electronics industries are the top four patenting industries; together they account for just over half of all patents of U.S. origin. Machinery, chemicals other than pharmaceuticals, and electrical equipment also accounted for more than 5 percent of all patents apiece. Nondurable goods (other than chemicals), nonmetallic mineral products, and non-automotive transportation equipment (including aerospace, which ranks high in employment of engineers) account for the fewest patents, less than 1 percent each.
Finally, labor productivity growth is a broad measure of innovation that combines the impacts of incremental and radical changes in production processes.34 The official statistics overstate productivity growth because they do not properly account for the role of offshoring and manufacturers’ use of temporary help services. They also include the computers and electronics industry, whose extremely high productivity growth rate has an outsized impact on overall manufacturing productivity growth. However, even after correcting for these factors manufacturing still has higher productivity growth than the private sector as a whole (Box 1).35 As with other innovation measures, productivity growth in individual manufacturing industries varies greatly (Appendix table 8). Computers and electronics had by far the fastest productivity growth of any manufacturing industry. Motor vehicles and parts also had productivity growth above the manufacturing average, while miscellaneous manufacturing and apparel and leather products had productivity growth near the manufacturing average. At the other extreme, productivity growth was below the average for all private business in many nondurable goods industries, nonmetallic mineral products, and fabricated metal products. Productivity actually declined in petroleum and coal products.
These findings show that manufacturing industries contribute to innovation in very different ways. Computers and electronic products is a highly innovative industry on all the dimensions of innovation highlighted in this section, while food, beverages, and tobacco rank low on all dimensions. However, there are other industries that are high innovators on some dimensions and low innovators on others (e.g., motor vehicles and parts). In addition, because manufacturing industries on average are more innovative than the rest of the economy on every dimension discussed here, even industries that perform at or near the manufacturing average on all dimensions should be regarded as very innovative.
The high level of innovation that characterizes so much of U.S. manufacturing depends in large part on the co-location of production and R&D. Some argue that the United States can build its manufacturing economy around innovation and R&D while locating production elsewhere.36 Yet studies of the relationship between production and innovation indicate that the location of production is an important determinant of which countries lead current and future technology cycles.
America’s track record of offshoring reveals that the loss of industrial production capability often leads to later loss of R&D capability. The reason is that making products exposes engineers to both the problems and the capabilities of existing technology, generating ideas both for improved processes and for applications of a given technology to new markets. Losing this exposure makes it harder to come up with innovative ideas. For instance, U.S. firms decided to offshore battery and electronics production to East Asian countries a decade ago. Now, East Asian countries have a significant production advantage in this area, which is in part feeding their innovation advantage in the race to develop vehicles with better rechargeable batteries.37
Similarly, movement of semiconductor production to Asia has led to a sharp decline in thin-filmdeposition production in United States. Now that thin-film-deposition has turned out to be important for manufacturing solar panels, those past decisions are causing the United States to fall behind in the quickly growing solar industry.38
Offshoring production stymied later innovation in the rare-earth technology industry as well.39 The U.S. rare-earth technology industry began importing key inputs in 1975, and China replaced the United States as the main producer of rare-earth element materials by 1990. The patent application rate in the U.S. rare-earth technology industry has since dropped, indicating that innovation in this field is less likely to come from American firms. The case of rare earth metals is important because those metals have a key role in many cutting-edge products. In addition, the case is important because it is one in which it is easy to show that offshoring caused innovation to decline. As discussed above, in many industries a rise in offshoring happened at the same time that innovation capability in the United States declined. However, in many of these industries, it is difficult to show that offshoring was

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responsible for the drop-off in innovation; it may be that offshoring became attractive because capabilities were lagging. In the rare earth case, the latter possibility can be ruled out, because the decline of mining in the United States was due to exhaustion of deposits and environmental regulations, neither of which was related to the innovative capabilities of downstream operations.
Production of manufactured goods is also essential for innovation in America’s service sector. Hightechnology services such as Internet services, telecommunications, computer systems design, and scientific research are closely linked to industry-funded R&D. Because America’s manufacturing sector provides the overwhelming majority of the nation’s industry-funded R&D and employs an outsized percentage of engineers and scientists, economist Gregory Tassey explains:
The ability of the domestic economy to be competitive in high-tech services will continue to require close interactions with the creators and suppliers of technologically advanced hardware and software. . . . Under a “service-sector-only” growth scenario, the skilled pool of researchers would be unavailable to the developers of high-tech services.40
Even in instances when U.S. firms do maintain the technological edge without manufacturing products in the United States, this alone is not always enough to produce substantial profits. E-ink, a Massachusetts-based firm, designed and manufactured the electronic “ink” that represents the Kindle’s key innovative element.41 Because the firm was geographically located so far away from its Asian suppliers, it had trouble finding new markets for its products because its engineers were not able to interact on a daily basis with other firms in the supply chain that are inventing new products. The situation is similar throughout the rest of the LCD flat-panel-display industry. Harvard Business School Professor Willy Shih estimates that, because the United States has offshored much of its production capacity in this industry, U.S. firms capture only about 24 percent of the profits from manufacturing the Kindle.42
In short, the interdependence between production and innovation is apparent in many industries, and policymakers ignore this fact at the peril of eroding America’s competitive edge in both current and future industries and in services as well as manufacturing. Because of the strong links between manufacturing capacity and high-tech innovation, even those who believe much of America’s economic future rests in the service sector should not support offshoring production.
Some argue that increasing the rate of innovation in the United States could be counterproductive to manufacturing employment.43 If technological progress means that fewer workers can produce the same amount of goods, then, the argument goes, that progress must reduce the number of manufacturing jobs. Both economic theory and evidence, however, contradict this argument. In fact, the evidence suggests just the opposite: that productivity growth leads to job gains rather than job losses in manufacturing. (See Box 2.)

Box 2. Manufacturing Job Losses Are Not the Result of Rapid Productivity Growth

Some argue that strong productivity growth has caused much of America’s manufacturing job loss, especially in the last

decade.44 This theory, which contends that technology is replacing workers, stems from the observation that apparent produc-

tivity gains have coincided with manufacturing job loss in the 1990’s and 2000’s. Yet there is no economic reason why increased

productivity must lead to job loss. Even though a productivity increase means that fewer workers are needed to produce a given

quantity of output, the productivity increase also allows product prices to be lower, increasing the size of the product market.

The bigger market means that firms will need to hire more workers. The additional hiring needed to produce for a bigger prod-

uct market usually offsets the initial labor-saving impact of the productivity increase. Therefore, the overall impact of a produc-

tivity increase is usually to expand employment rather than reduce it.

Recent trends in manufacturing productivity and employment support this theoretical explanation. Comparing job losses to

productivity gains shows that major losses of manufacturing jobs are very difficult to attribute to productivity gains. Nearly

three fourths of the decline in U.S. manufacturing employment occurred between 2000 and 2010. From the 1990s to the first

decade of the 21st century, the rate of job loss accelerated more than 1000 percent. This was true

continued ➤

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continued ➤

even before the onset of the Great Recession: manufacturing employment shrank by 3.4 million from 2000 to 2007 alone.45

If productivity gains drove this trend, a sharp rise in the rate of productivity growth would be expected from the 1990s to the

2000-2007 period. Yet as figure 3 shows, the rate of productivity gains did not grow between these two time periods; in fact the

rate of growth slowed slightly.

A more detailed examination by economist William Nordhaus shows that within each manufacturing industry, increases in the

rate of productivity growth were associated with increases in the rate of job growth (or decreases in the rate of job loss) during

the 1948-2003 time period. Replicating Nordhaus’ study with Bureau of Labor Statistics data for the years from 2001 through

2009 shows that the positive effect of productivity growth on manufacturing job growth was weaker than before. However,

there is no evidence that productivity increases

were significantly correlated with job loss.46

Countries differ in whether productivity growth in manufacturing coincides with employment growth or decline, and by how much. Canada and

Figure 3. Productivity and Employment Change in U.S. Manufacturing, 1990-2000 and 2000-2007

Italy show modest rates of annual manufacturing productivity growth during the 1990’s (3.6 percent and 2.6 percent, respectively), while the two countries grew their manufacturing employment by 9.4 percent and 4.0 percent during the same decade. Meanwhile the Netherlands and Japan had annual productivity gains within the same range (averaging 3.5 percent and 3.4 percent, respec-

5%

4.1%

4%

3%

2%

1%

0%

-1%

-0.2%

-2%

-3%

-4% 1990–2000

3.9%
-3.0% 2000–2007

tively), while their manufacturing employment

■ Average Annual Change in Productivity ■ Average Annual Change in Empoloyment

shrank by 4.1 percent and 12.2 percent in the 1990’s.47
Our finding that even in recent years there is

Source: Authors’ analysis of Bureau of Labor Statistics Major Sector Productivity and Costs data (productivity) and Current Employment Statistics data (employment).

no relationship between U.S. productivity growth

and manufacturing job loss is remarkable because

official productivity statistics overstate recent productivity growth in manufacturing, as explained in Box 1. Overstated recent

productivity growth, combined with the huge recent losses of manufacturing jobs, would be expected to lead analysts to find

that productivity growth is associated with job loss in manufacturing. Yet, even studies that use the official data do not find that

productivity growth causes manufacturing job loss.

The argument that productivity growth leads to reduced manufacturing employment rests on two assumptions, both of which

are faulty. First, it assumes that the quantity of manufactured goods demanded by consumers does not rise much when prices

fall relative to incomes. This is simply not true for the world taken as a whole. Second, it assumes that workers whose skills are

currently low cannot be taught to use information technology to make them more productive. Again, this assumption is false. A

2011 Case Western Reserve University survey of automotive suppliers asked plant managers about their use of information tech-

nology.48 It found that 84 percent of respondents had information technology on the shop floor and that only 8 percent of those

respondents agreed with the statement, “We have found that use of Information Technology (IT) reduces the need for shop-floor

workers to have analytical skill.”

In short, the effects of productivity on American manufacturing employment likely are still positive. Although domestic manu-

facturing employment has decreased in recent decades, Nordhaus’ work suggests that employment loss would have been worse

were it not for continued productivity gains. Much of what is measured as productivity growth is actually increased offshoring,

or quality improvement in computers. Thus, correctly measured, productivity gains in most of manufacturing have in fact been

relatively modest. If anything, it is our lack of sufficient productivity growth—not the growth that did occur—that helps explain

recent U.S. manufacturing job loss. Because manufacturing competition is global, individual countries can grow their share of

the total work even when aggregate demand does not grow, or as new competitors emerge.49 Productivity is an important front

on which this competition occurs. If the United States had experienced stronger productivity growth in sectors besides comput-

ers and electronics in the past decade, the U.S. manufacturing sector likely would have hemorrhaged less work.

10

BROOKINGS | February 2012

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Why Does Manufacturing Matter? Which Manufacturing Matters?