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Is There A Manufacturing Crisis After All?

Editor’s Note: This essay is part of Advanced Manufacturing: A Law and Liberty Symposium

One must give William B. Bonvillian and Peter L. Singer a certain amount of credit for writing Advanced Manufacturing: The New American Innovation Policies. In it they accomplish a rare economic trifecta: They mischaracterize the symptoms of a problem, misdiagnose the underlying “disease,” and then botch the prescription for a cure. On the other hand, they are making an argument that most Americans believe, and the solution they offer is one that many politicians favor, so the book should be taken seriously.

The book addresses the “decline of manufacturing,” toward which the authors take a now-standard line of collapse and crisis. But one might object that the starting premise is mistaken, because there has been no decline in manufacturing. When you get down in the weeds, you see that what we really have is a decline in the rate of growth of manufacturing. Seriously, the problem is that manufacturing isn’t growing as fast as the authors think it should, not that it’s shrinking. Manufacturing is by far the largest sector of the U.S. economy, accounting for more than $6 trillion in new value. Further, the value of products manufactured in the United States  has more than doubled since 1974, the year many people use to date the beginning of the “great manufacturing decline.”

As you can see from Table 1, there has been a flattening of manufacturing output, and the Great Recession of late 2007 to 2009 did indeed do a lot of damage. But to call this a “decline in manufacturing” is just a mischaracterization of basic facts. Manufacturing has continued to grow at something quite close to its long-run trend growth rate, between 1.5 percent and 2 percent per year.

Table 1: U.S. Manufacturing, 1919-2015

Source: Federal Reserve Board, Series G.17, Historical. Author’s Representation

It is true enough that in 2010, China passed the United States as the Number 1 manufacturing nation. It’s not clear, however, why anyone ought to conclude that if the United States is not the largest manufacturing economy, it does no manufacturing at all. But the comparison is nonsensical even on its own terms. China has a population of 1.379 billion. The United States,  with a population of 325 million, has a manufacturing output per capita of more than $6,700; China’s is less than a third of that, $2,200 per capita.

Further, as Table 2 (from a Congressional Research Service report released early this year) shows, even making the comparison on total size alone, the United States continues to stand out. U.S. total manufacturing is still larger than the next three economies—Japan, Germany, and South Korea—combined. It is simply not true that American manufacturing is declining.

The authors also make a criticism regarding the slow growth of U.S. productivity. But growth can be misleading due to the “index number” problem. According to the Organization for Economic Cooperation and Development, the United States is one of the top six most productive economies, with output of more than $70 per hour worked. If productivity increases by $1 per hour, that’s only a 1.4 percent increase. China has less than one-fifth that level of productivity; a $1 increase is 7 percent growth. Further, China’s growth and productivity “miracle” seems to be foundering.

Table 2:  Leading Countries, Value Added in Manufacturing, Billions of 2016 $

Diagnosis

Make no mistake, there has a been a dramatic decline in manufacturing employment in this country, particularly as a proportion of the total U.S. work force. Some of this results from increases in productivity, but it is also true that many of the products Americans now use were made elsewhere and shipped here. America, facing the “make or buy” decision in dozens of industries, has found that “buy” is cheaper—often much cheaper. The economist David Autor, otherwise solidly a free trader, has concluded that there is something different about the current slump in manufacturing, which he and coauthors David Dorn and Gordon H. Hanson have called “The China Shock.”

So, let’s say for the sake of argument that there is a problem, and that the decline in manufacturing employment is something to worry about. In my recent book Tomorrow 3.0, I claimed that there is a general long-term trend in the direction of less manufacturing, at least of durable items. To call something a “problem,” however, is to go much further, since it means “we” believe that some political solution is required. If there’s a problem, we have to do something. Worse, the idea that we are somehow losing to China suggests that we should try to be more like China—which would mean centralizing industrial planning and giving government more control over the direction of investment growth and expansion of capacity.

It seems there is always some other nation that we should be more “like.” In 1988, I had the chance to interview for a position at a top U.S. business school, an Ivy League university. During the interview, one of the faculty asked me how I would integrate into my courses teaching about “being more like Japan.” We don’t need to be more like Japan, I politely (or perhaps not so politely) responded. That nation, I said, is on a path to economic stagnation. Its leaders’ taste for centralized planning, and the problems with its financial system, combined with the enormous debt the Japanese are building up with a purely export-oriented growth strategy, are going to lead to disaster, I wound up.

There was a long, shocked, silence.

Of course, I didn’t get the job—because everyone knew that planning and government investment were the keys to growth. At the time I made my prediction, Japan was growing at a 10 percent annual rate. Within five years its economy had tanked and nobody wanted to be “like” Japan anymore.

The idea itself has not gone away—that is, that the United States can centralize, direct, and plan its way to higher growth and the restoration of manufacturing to its economic pride of place as the dominant animator of GDP growth. Bonvillian and Singer diagnose the problems America  faces as a combination of market imperfections and system failures. The “market imperfections” include 1) network economy problems; 2) split incentives (essentially, positive externalities, where the benefits to new technology can be fully captured by the innovators); and 3) governmental institutional problems, that is, what the authors see as a lack of political will, with government “unprepared to take on the public-private organization of an innovation challenge of the complexity of a major sector such as manufacturing.”

That last one is impressive. Bonvillian and Singer believe it is quite obvious what should be done; all that’s required is a government willing to do it. Perhaps there’s still time to be more “like Japan,” after all.

They also present what they claim are the five “basic models” of innovation, derived from an earlier book that Bonvillian coauthored with Charles Weiss. Bonvillian argues, in that 2015 work, in the current work with Singer, and in other places, that economists don’t have a very good handle on innovation, where it comes from, and how it affects the economy. He is absolutely right about that, of course. But the crude cladistical set of categories of “types” of innovation and the associated means of spurring new processes is not a step forward.

The “pipeline” model, in which invention derives from an intentional “push” by government, is politically hard to sustain and economically hard to justify. So is the “induced innovation” model, where a firm or entrepreneur sees an opportunity or potential connection and creates a new product or process, after raising capital from people willing to take a risk. This kind of innovation may take place within an existing firm (though “legacy” firms may have trouble changing directions), or in a new economic entity that matures and becomes a firm.

According to the authors, the chief problem we face is a lack of another type of innovation, namely the “manufacturing-led” variety. These are

innovations in production technologies, process, and products that emerge from expertise informed by experience in manufacturing. This is augmented by applied research and development that is integrated with the production process. It is typically industry led but often with strong government industrial support. While countries such as Germany, Japan, Taiwan, Korea and now China have organized their economies around ‘manufacturing-led’ innovation systems, the United Stats in the postwar period has not. It is a major gap in the U.S. innovation system.

Bonvillian and Singer conclude that there is an “innovation irony” taking place even among the successful nations such as Taiwan, Korea, and Japan (always Japan, as if it were a success): these nations “now see that this must be complemented by stronger front-end, Research and Development-based innovation.”

Yet they adduce very little evidence here that would support the notion that having political leaders take a central role in dictating the directions of investment and innovation would do anything other than expand the corrupt, pork-barrel allocation of contracts that now hamstrings  our defense-procurement process. Even if it were true that an omniscient bureaucrat could divine the best future technologies for innovative investment, there is no reason to expect that actual political incentives would lead elected officials to act on that information. Oh and by the way, the information doesn’t actually exist.

Prescription

The central prescription for the problems the book seeks to identify and diagnose is “new production paradigms.” The examples listed include the use of steam power in England, and the “quality” revolution led by Edward Deming in . . . you guessed it, Japan. This is simply sampling on the dependent variable. Given all the failed attempts at industrial planning—Japan’s MITI ordered Honda to stop making cars, to preserve economies of scale for Nissan and Toyota, and was only thwarted by Honda’s unwillingness to give in to government orders—this kind of top-down innovation has left a record that is dreary and unencouraging.

It should be said that a number of the issues highlighted by Advanced Manufacturing are real and deserve close attention. The core claim of the book, that mainstream economics has botched its understanding of innovation and failed to make a serious effort even to understand the importance of innovation in fostering growth, is spot on. Further, the related but distinct problems that figure prominently here—network economies and scale-up barriers—are central to the question of how to preserve a dynamic economy.

When all is said and done, I learned a great deal, both in terms of history and industrial organization, from this book. While I have been critical of what I see as its credulous acceptance of an idealized conception of the “state,” Advanced Manufacturing has much to recommend it.

Reader Discussion

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on September 06, 2018 at 12:50:50 pm

It is always interesting to speculate as to what is "missing" from data provided in support of an argument. As an example, does the figure for US manufacturing output include all the worthless mailers, ads and other frivolous "products" *manufactured* within the US?

Munger asserts that there may have been no decline in manufacturing but then goes on to admit of a significant decline in the manufacture of durable goods. I am one who characterize the decline in durable goods output as a DECLINE in manufacturing - both in gross output, the quality of said output AND the decline of all those related skills required to foster, sustain and create NEW products and innovation. Particularly affected are those manufacturing skills necessary to conceive, devise, develop and bring into common use new products, technologies AND processes that are essential to innovation.

Much of this is our own doing. The need to respond to Wall Streets demand for positive quarterly earnings statements has a rather interesting effect on corporate decisions regarding investment in plant, equipment AND on NEW product development efforts such that the corporate accounting overseers interests and initiatives take precedence over the engineering and product development initiatives.

Consider GE, now booted off the Dow 500. In the 1980's under Jack Welch we observed the transformation from a first rate manufacturing AND product development company into one that derived the principal share of its profits from FINANCE. Within 15 years, many of GE's medical products were either sold off or outsourced. As a competitor, one could welcome such an outcome; as an impartial observer, one was taken aback by the willingness of this once great corporate leader to commit manufacturing suicide.

But Munger is surely correct however when he cautions against "centralized" innovation / manufacturing planning. No good will, nor has it ever come from such a scheme. Can you imagine how *involved* will be each and every one of our 535 elected representatives in assuring that their State / District receives its fair share. Look to any DOD procurement effort. "Well, I think the right wing ought to go to the State of Missouri; the left wing to Arkansas and the tail stabilizer for this wondrous new attack aircraft should go to Mississippi." (BTW: That is not a joke; this is what happens) while this may be politically satisfying, it adds undue costs, times and complexity to any development and manufacturing effort.

Moreover the knowledge required to make such complex informed decisions DOES NOT exist within the mind of any one individual within the government. It is not obvious that it even exists within the corporation(s) tasked with providing the new technologies / products as evidenced by the innumerable delays and costs overruns. And Bonvillian and Singer would have us embark upon such an *enlightened* approach.

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gabe
on September 06, 2018 at 17:19:27 pm

H.L. Mencken would admire the commentator's sarcasm in describing "Advanced Manufacturing: The New American Innovation Policies" as a book whose authors "mischaracterize the symptoms of a problem, misdiagnose the underlying 'disease,' and then botch the prescription for a cure."

A friend professes about such matters (mostly to avid students from India and Red China) from the podium of a leading MBA school. He also writes about such matters in MBA journals that I doubt few read except other MBA professors and their ardent, mostly Red Chinese and Asian- Indian students.

In deference to the brevity of life I read very little MBA stuff. Hence I can offer nothing except the following admonitions derived from history and political philosophy: 1) I would recommend that no one read anything that is recommended (as is this book) by a descendant of the Kennedy Clan, since JFK and his very rich father seem to have been the end of the line as far as that family's capacity to understand economics and business; 2) if one is hell-bent on reading "Advanced Manufacturing etc" I suggest that one also read "The Constitution of Liberty" for its brilliant understanding of the foundation of innovation, the spontaneous order, the understanding of which is a strong refutation of "Advanced Manufacturing etc's" notion that it would be a good thing for political leaders to take a central role in dictating the directions of investment and innovation; and 3) the Great Depression ended and World War II was won not by dirigisme but only after FDR and Democrat political leaders belatedly gained the wisdom to assign the tasks of investing and innovating for victory to business entrepreneurs not politicians.

In organizing and innovating for victory over our Red Chinese enemies let's keep that model uppermost in mind, and let's get rid of the charlatans of business leadership, the Jeffrey Immelt's of the business class who are crony capitalist intruders on the model's implementation.

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Image of Pukka Luftmensch
Pukka Luftmensch
on September 06, 2018 at 17:41:14 pm

Yep, and poor stupid me arguing all these years that the increases in productivity in the manufacture of advertising mailers, plastic straws (Oops can't do that sh*t anymore), Starbucks coffee cups, video games and other disposable goods does not make for a sound manufacturing base; nor will it provide for a readily convertible industrial machine, as was done, once FDR got his tired arse out of the way, in an effort to properly arm the nation in WWII.

I can imagine the ChiComms response, if we ever have a military confrontation with "free trade" regime, when we ask them, sotto voce, of course, if they "could, please, pretty please, keep sending those container ships with both the industrial goods and the raw materials needed by the US to manufacture proper weaponry.

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Image of gabe
gabe

Law & Liberty welcomes civil and lively discussion of its articles. Abusive comments will not be tolerated. We reserve the right to delete comments - or ban users - without notification or explanation.