Finance and Assets

Should We Really “Forget Factories?”

April 12, 2012

Two widely read sources weighed in yesterday on the debate about how much America should focus on reviving the manufacturing sector. Both Matt Yglesias’ “Forget the Factories” and Catherine Rampell’s “Never Mind Factories. Think Services” argue that the recent promotion of the “factory sector” is wrong-headed and potentially counterproductive. Rampell claims such a trend shifts attention away from the services sector, which has “larger comparative advantage in high-skilled services like engineering, law and finance than in lower-skilled manufacturing jobs that rely on cheap labor.” Yglesias wants to link our economic future to the information technology (IT) sector, saying: “It should be obvious that the path forward for America is to focus on our strengths in information technology and media, and not compete with the Chinese for manufacturing supremacy.”

There are at least two major problems with these lines of argument: They overstate the case for services as the primary engine for growth and improvements in America’s competitive position, and more importantly, they misrepresent what modern American manufacturing really does. On the first point, Yglesias cites the recent $1 billion acquisition of Instagram by Facebook as a prime example of IT as the engine of prosperity. As one who recalls the dot-com boom of the 1990s, I can only wish Facebook the best in its investment in a company with good technology that nevertheless lacks any real income or business plan. This is not to deny the importance of IT, as millions of jobs have been created in this sector and numerous fortunes amassed, but only to suggest that we curb our enthusiasm until a solid record for this particular transaction (and other new startups) reveals itself over time. Google has certainly proven its worth in the market and has proven staying power, but it recently bought a major manufacturer, Motorola Mobility, perhaps because of a symbiotic link between hardware and software. Some of the other poster children of the IT sector—Apple and Qualcomm, to name two—clearly are manufacturing leaders.

Rampell would have us rely on the services sector to increase jobs (which is accomplished partly by relatively low productivity levels), expand exports, and rebalance international trade accounts. Overall, the services sector accounts for some 70 percent of the U.S. economy, compared to 12 percent for manufacturing, yet the ratio of goods exports to that of services is about three to one. Although America already does well in exporting business services, it is an open question whether we have such a large comparative advantage in engineering as Rampbell suggests, especially since a large proportion of advanced engineering graduates are of non-U.S.-origin, and they are increasingly choose to return to their home countries after graduation. Exporting more lawyers and legal services is at best a mixed blessing, and it is hard to judge in any case where comparative advantage lies in the legal field. These caveats aside, while we have and can maintain a huge trade surplus in services, most exportable services are not readily scalable and capable of the high returns of the goods sector. Nonetheless, Rampell’s point that we need better rules to open global markets in services trade is well taken, and we can almost certainly increase our exports of many IT software and hardware products and services if markets are fully contestable.

Turning to the manufacturing sector itself, the most competitive part of the sector in the US is in high technology goods and in sophisticated products that require complicated systems integration expertise, such as commercial aircraft and chemical refineries. Even though a number of “jobs that rely on cheap labor,” such as in the large food processing sector, remain, the future drivers of growth are mostly in advanced products with substantial embedded technology. President Obama’s Director of the National Economic Council Gene Sperling, whose speech on manufacturing occasioned the Yglesias posting, reminds us that 70 percent of private sector R&D and 90 percent of patents originate in manufacturing. It is noteworthy as well that vibrant software sector depends on continuous advances in hardware—processing speed, new materials, better communications infrastructure—that is the province of the manufacturing sector. Much of the productivity improvements in services like retail and logistics owe a great deal to the IT developed by manufacturers. Due to a variety of favorable changes in the terms of trade in recent years—a weaker dollar, rising labor costs abroad, substantial productivity gains, and cheaper and more abundant domestic energy—we are well on our way to meeting the goal of doubling our exports in five years.

Both Yglesias and Rampbell also underestimate the technical sophistication, jobs creation power, and global competitiveness of non-IT businesses like aerospace, medical devices and pharmaceuticals, heavy construction equipment, factory machinery, and even automobiles. German and Asian automakers come to the United States to take advantage of a host of comparative advantages, and are starting to export from their U.S. platforms. Productivity gains come from both process improvement and introduction of labor sharing equipment, but research shows that these factors do not inhibit job creation. What Yglesias and Rampell don’t sufficiently appreciate is that domestic manufacturers have outsourced millions of jobs in recent decades—to other American firms. The modern “smart factory” spawns a need for IT technicians and analysts required to service equipment and reap the tsunami of data generated about production processes by modern IT systems. Logistics is often outsourced to a UPS, an IBM, or a FedEx. The entire business consulting sector feeds off of modern manufacturing to a large extent. For every factory job, there are probably three to four local jobs to support the factory, according to numerous studies. And linking the words “low paying” to “factory jobs” has been misleading for decades in the U.S. context.

Manufacturing is one key element in the growth of the economy and of standards of living, not to speak of our national defense posture. The mix of public policies needed to promote this sector is the story of another day, but to write it off is a grave mistake.

Previously the Manufacturing and Society Program discussed whether or not the US needs a national manufacturing strategy. Watch the full discussion below: