January 25, 2010
Global Supply Chains and American Economic Competitiveness
In his State of the Union address, President Obama laid out his election-year vision for restoring America's global competitiveness. U.S. manufacturing figured prominently:
Think about the America within our reach...an America that attracts a new generation of high-tech manufacturing and high-paying jobs...we have a huge opportunity, at this moment, to bring manufacturing back.
Last weekend, the New York Times ran a long and important piece on why one particular high-tech product, Apple's iPhone, is manufactured in Asia and not the United States. The article is part of a renewed debate about how the United States can reinvigorate its manufacturing sector, or whether it even should.
A key part of the article is that there is a dearth of middle-income jobs in U.S. manufacturing. A combination of labor-saving technological improvements and the off shoring of more labor-intensive manufacturing has led to a sharp reduction in factory jobs that were once a pathway to the middle class for many Americans. Manufacturing employment on the factory floor may simply never reach levels of previous decades.
Nevertheless, as we have written previously, advanced manufacturing remains critical to U.S. prosperity in the 21st century for three key reasons:
- Advanced manufacturing drives productivity and innovation. Two-thirds of R&D investment occurs in industry and manufacturing is a core component of the nation's innovation ecosystem that is key to creating new technological industries.
- Advanced manufacturing generates output and employment throughout the economy. It has the largest economic multipliers of any industry and large manufacturing facilities sustain entire communities. Even if manufacturing never supports as many direct jobs on the factory floor as it has in the past, restoring advanced manufacturing is thus essential to America's long-term employment challenges.
- Manufacturing is critical to improve the nation's trade balance and tackling our $500 billion cumulative trade deficit. Manufactured goods still comprise 57% of U.S. exports and closing the trade deficit will be difficult, if not impossible, without manufacturing playing a key role.
So there is a strong rationale for renewed government efforts to help strengthen this vital sector of the economy, but how?
The fact is that global manufacturing has fundamentally and irreversibly changed in recent decades in ways that has altered the structure of national economies. In essence, the production system has become globally fragmented. In a new paper on this subject, economist Richard Baldwin calls this globalization's "second unbundling."
The "first unbundling" occurred with the introduction of steam power, which led to a sharp reduction in shipping costs. Production was no longer tethered to local consumption; factories could produce for internal markets that could now be reached by rail or foreign markets by steamships. Yet production was still local. It tended to cluster within factories and in industrial districts, both to increase the scale of production and to coordinate closely with other actors within a particular industry.
The "second unbundling" occurred with the rapid advance and diffusion of information and communications technologies, beginning in the mid 1980's and accelerating in the late 90's, which led to an unprecedented reduction in coordination costs both within and across national economies. For the first time, it became economical not just to geographically separate consumption from production but separate different stages of the production process. Today, coordination is still necessary for production, but that coordination has become increasingly internationalized into global supply chains with key components being produced in regional networks.
Apple's production process epitomizes this transformation. As the New York Times story notes, the iPhone is designed in the United States, but includes semiconductors manufactured in Germany and Japan, memory from Korea and Japan, display panels and circuitry from Korea and Taiwan, chips from Europe, and rare metals from Africa and Asia. The final device is assembled in China. All told, just 10 percent of iPhone components are manufactured in the United States.
It's important to note that it's not simply lower labor costs that are behind the iPhone story:
It isn't just that workers are cheaper abroad. Rather, Apple's executives believe the vast scale of overseas factories as well as the flexibility, diligence and industrial skills of foreign workers have so outpaced their American counterparts that "Made in the U.S.A." is no longer a viable option for most Apple products.
Just as important is that China, Japan, Korea and Taiwan are part of a competitive regional electronics supply chain cluster that is self-reinforcing. As Ryan Avent writes, "After some level of Asian development and integration, it became more attractive for manufacturers to locate there as more manufacturers located there." Manufacturing firms are sustained by operating within a cluster of related firms and suppliers and drawing on pools of specialized labor and other resources. This phenomenon is known as "economies of agglomeration," and it is an increasingly important feature of the 21st century global economy.
Despite the era of globalization, geography still matters - just in new ways. Even as supply chains have globalized, proximity has retained an importance in manufacturing. This is particularly true for just-in-time manufacturing, where businesses seek to reduce inventory and waste and improve productivity by closely balancing the supply chain with product demand. If changes are made to the product design, proximity is important to reduce time lags in production. The rise of just-in-time production therefore means that the time it takes to ship supplies and components to assembly can be a much more important factor than the dollar costs of shipment itself.
This means that it would likely be difficult to bring manufacturing of key iPhone components back to the to the United States. Many of the key components of the supply chain - memory, consumer electronics batteries, flat screens, even semiconductors - have been progressively or completely off shored, and economies of agglomeration have taken over. So "bringing these jobs back," as President Obama says, would take more than simply closing the labor cost gap through either lower wages or higher productivity in U.S. manufacturing. It would also require a long effort to build our own regional manufacturing agglomerations around key components here in the United States, and that could prove costly.
Instead, a better strategy is to indentify the industries where we still have supply chain component ecosystems, particularly those at the higher end of the value chain, where policy and targeted investments can help retain and expand our competitive edge. We should also indentify emerging technology industries that have the potential to be a source of high growth, and ask what we can do to build new industry agglomerations and foster the commercialization and competitive production of those technologies in the United States.
We don't need to look far for recent examples of this strategy in action. The bailout of America's auto companies has been maligned as overreaching "industrial policy," but the logic of the move was clear. If GM and Chrysler had gone bankrupt, the entire industrial ecosystem and supply chain that supported the automakers in the United States would have collapsed, creating not just massive unemployment but also undermining America's future auto production capacity. Once lost, the network of parts suppliers could have been gone for good. From this perspective, the auto bailout efforts worked. As the President noted in his State of the Union, GM is again the world's top automaker, Chrysler is rebounding fast, and the auto industry added 160,000 jobs since the end of 2009.
The Obama Administration's investments in advanced battery technology for vehicles are an example of forward-looking policy to build an ecosystem in an industry that is in its early stages. It took $2.4 billion in stimulus grants to 48 different companies, but the Administration's efforts have helped to build a critical mass of advanced battery manufacturers, many of them clustered across Michigan and the American rust belt. Here, they may become a critical contributor to a globally competitive advanced vehicle production cluster, including the factories of the retooled "Big Three" automakers.
In this effort to identify key manufacturing opportunities, we also need to determine which industries are particularly important to sustaining a broader high-tech innovation ecosystem. Harvard Business School professors Willy Shih and Carl Pisano have made a persuasive case that a hollowing out of some high-tech supply chains in the Unites States have harmed the nation's ability to innovate and produce next-generation technologies. The consequences of losing these supply chains thus means more than losing the jobs of today; it could mean losing entire industries of tomorrow.
The new reality of global supply chains requires a new debate about manufacturing in the United States, one that recognizes that manufacturing has irreversibly changed, yet has become even more essential to sustaining American prosperity in the 21st century. The President is right to stake much of his vision for America's economic future on renewed American leadership in advanced manufacturing. But realizing that vision will require new strategies and new thinking.
For more reading, see "Manufacturing Growth: Advanced Manufacturing and the Future of American Prosperity," by Breakthrough Institute and Third Way