July 23, 2010
Romer Misses the Mark on Manufacturing
A healthy manufacturing sector is essential to America's economic prosperity in the 21st century. But you wouldn't know that reading last Sunday's New York Times, where former Obama Administration Council of Economic Advisors chair Christina Romer writes that there are no compelling reasons for US manufacturing policy.
According to Romer, the recent hubbub about manufacturing is due to the fact that people have a "feeling" that "making things" is important. In reality, she writes, consumers "value haircuts as much as hair dryers." To be sure, all of us need haircuts, some of us more than others. But Romer's argument that we should value all industries of the economy the same is just not true. It's reminiscent of economist Michael Boskin, another former CEA chair, who said it doesn't matter whether a country makes computer chips or potato chips.
The fact is that some industries are characterized by high productivity and economies of scale that reduce costs and drive economic growth throughout the economy. As Clyde Prestowitz writes of Romer's own example:
Production of hair dryers can be done in large factories that produce economies of scale. Such scale economies lead to lower prices, lower inflation, higher productivity and thus higher wealth creation for the whole economy. In addition, producers of hair dryers invest in research and development to foster innovation of new, more efficient, less energy using, and easier to produce dryers.
Investment in new product and process innovations is what drives economic growth over the long-term. And as we discuss in "Manufacturing Growth: Advanced Manufacturing and the Future of the American Economy," manufacturing is absolutely central to innovation, something that many economists like Romer and economic commentators like Matt Yglesias don't seem to understand. The manufacturing sector comprises two-thirds of the nation's industry investment in research and development (R&D) and employs nearly 64% of the country's scientists and engineers.
But Romer doesn't mention manufacturing's importance to innovation in her article. Instead, she prefers to argue with what she sees as the common rationales for manufacturing policy -- market failures, jobs, and inequality -- none of which she finds "completely convincing."
On the first issue, she writes that market failures in manufacturing -- where positive spillovers mean that some benefits of a new manufacturing plant go to other companies in the area, thus providing a rationale for government investment -- are small, citing two academic studies on the subject. But many other studies have found that manufacturing is a central component of regional industrial ecosystems, and that being near manufacturing can accelerate innovation and strengthen regional competitiveness. As President Bush's Council of Advisors on Science and Technology wrote in 2004, "design, product development, and process evolution all benefit from proximity to manufacturing, so that new ideas can be tested and discussed with those 'working on the ground.'"
Indeed, recent research suggests that losing high-tech manufacturing can imperil a nation's capacity for future innovation. Harvard's Gary Pisano and Willy Shih write that America's "industrial commons" -- the collective engineering, R&D and manufacturing capabilities that sustain innovation -- are being hollowed out and the United States can no longer produce many high-tech products. Moreover, research and design are starting to follow high-tech manufacturing abroad, imperiling America's historic advantages in innovation.
Next, Romer writes that the impact of manufacturing on jobs relative to the employment needs of the economy is small and that we should focus on boosting aggregate demand instead:
Unemployment today is high, but not because of a decline in manufacturing. That decline has been going on for 30 years -- and for most of the 1990s and 2000s, the unemployment rate was less than 6 percent.
Put aside that this obscures the fact that manufacturing employment generally followed the business cycle with only modest declines until 2000 when it fell off a cliff -- declining by 5.5 million jobs from 2000 to 2008, or 32 percent. Romer understates the impact of manufacturing on jobs for two key reasons.
First, she ignores the fact that manufacturing facilities have extensive backward linkages, generating output and employment throughout the economy. Indeed, manufacturing's "multiplier effect" in terms of both output and employment is larger than any other sector of the economy. Specifically, studies demonstrate that every dollar in final sales of manufactured products supports $1.40 in output from other sectors of the economy. And the average job in manufacturing produces two to three spinoff jobs elsewhere in the economy. Even if employment on the factory floor never reaches levels of previous decades, when these effects are taken into account, manufacturing's employment footprint is quite substantial.
Second, Romer completely misses the connection between America's persistent, massive trade deficits and our employment situation. In 2010 the trade deficit stood at nearly $500 billion, down from a record of $760 billion in 2006. With such large deficits, it's difficult to see how more fiscal stimulus to boost aggregate demand, which Romer favors, will fill the jobs hole in the economy. It would certainly create some jobs, but much of that demand would be filled by imports, which creates jobs in other countries. Rather, eliminating the trade deficit would create millions of jobs in the United States.
And the best way to close the trade deficit is by expanding manufactured exports. This is because the large majority of US trade -- nearly 70% of exports and 83% of imports -- is still in goods. Manufactured goods in particular comprise 57% of US exports. Can exporting services help reduce the trade deficit? Absolutely, and the United States enjoyed a $149 billion surplus in services in 2010. But it took 11 years for service exports to double to its 2010 level of $543 billion. The simple arithmetic shows that the current positive balance in services would need to quadruple to eliminate the deficit in goods. This is implausible, to say the least.
What about inequality? Romer writes correctly that while manufacturing pays higher-than-average wages, it is no longer a source of high-paying jobs for less educated workers. Manufacturing is a technologically sophisticated enterprise and today's manufacturing workers must have a wide array of abilities, including the production skills to set up and operate processes, design and development skills to continuously improve those processes, as well as proficiency in maintenance, repair and supply chain logistics. But then the policy response should not be to ignore manufacturing but ensure that workers have the skills for advanced manufacturing industries.
Romer ends by implying that manufacturing policy is driven by economic nostalgia for an earlier age, writing, "public policy needs to go beyond sentiment and history." To be sure, policy must account for the ways in which manufacturing has changed over previous decades. Some labor-intensive industries are likely gone for good, while the increasing use of information technology, robotics, and high-precision tools means that today's factory workers must have much greater skills than previous generations.
Fortunately, advanced manufacturing policy need not be about sentimentality or history, but about creating the next generation of advanced technologies that spur innovation, drive productivity, and power economic growth in the 21st century. It is about strengthening a sector that is a key catalyst of employment and economic growth. And it's about ensuring the international competitiveness of the US economy, closing the trade deficit and out-competing other nations whose governments rightly view high-tech manufacturing as a strategic industry.
The good news is that the Obama Administration has recently recognized that advanced manufacturing is critical for the future prosperity of the US economy, even if its former chief economist does not.
For more on the importance of advanced manufacturing to the US economy, see "Manufacturing Growth," a joint report by the Breakthrough Institute and Third Way.
Front page photo credit: Obama-Biden Transition Project (Creative Commons).