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U.S. Manufacturing Has a Key Role in the U. S. Economy of the Future

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In a Sunday column in the New York Times, Steve Rattner makes a case for building our future economic prosperity on the services sector. Apart from the somewhat perplexing irony of a former auto czar and captain of Wall Street throwing in the towel on manufacturing, his arguments could contribute to a self-fulfilling prophecy of an admittedly widespread view. There is a more positive economic and political case to be made that, instead of accepting a slow decline, we put our shoulder to the wheel and build on the apparently hidden but obvious strengths of U.S. manufacturing.

In the first place, growth in manufacturing production, when calculated on a value-added basis, has kept pace since at least the 1920s with the overall growth rate of the U.S. economy. The U.S. produces almost the same level of manufactured goods as China, and twice that of Germany and Japan.

Although production is below trend at this stage of the cycle, the sector is expanding at about twice the rate of gross domestic product (GDP). There has been tremendous improvement in productivity in this sector, at levels well above the rest of the economy. Due to relentless foreign competition, industrial firms have to do this if they want to survive, and also have little pricing power. The result of these two trends has been steady deflation in the domestic price of manufactured goods, which is down 3 percent between 1995 and 2008 compared to an overall price increase of 33 percent.

Productivity improvements and price moderation in this sector are one reason that living standards improve in the United States. Mr. Rattner would have us rely more on education and health care, two areas where inflation has increased at about twice the rate of the general price level. High productivity also helps keep wages and benefits in manufacturing higher than the averages.

It is hard to deny that U.S. producers have lost market shares both here and abroad to sophisticated competitors in China, Germany, and others, but we still enjoy trade surpluses in many industries. In 2010, the United States had a trade surplus in aerospace, construction machinery, semiconductors, mining equipment, industrial machinery, basic chemicals, paper, and engines, turbines and power transmission equipment. If high corporate taxes did not drive pharmaceutical production offshore, we would have a surplus in this industry as well. Exports of manufactured goods are growing at around 10 percent annually, and our trade in manufactured goods is in balance with all countries with which we have free trade arrangements.

As wage levels and other costs in developing countries rise faster than ours, some production capacity is returning to the United States. A recent BCG study found: "Within the next five years, the U.S. is expected to experience a manufacturing renaissance as the wage gap with China shrinks and certain U.S. states become some of the cheapest locations for manufacturing in the developed world." Foreign producers, such as Volkswagen, BMW, Honda, and Siemens, are validating this reality by moving production to the United States and exporting from this base; and Caterpillar, NCR, and others are moving production back to the United States.

There is also a strong political case for building on the strengths of the manufacturing sector. Two-thirds of all research and development is performed by manufacturing firms, which are the epicenter of patent and innovation activity, including in such areas as information technology which is so crucial to any productivity improvements in the services sector. Wages and benefits for production workers are higher among manufacturers, and the typical high levels of profits that a Henry Ford and a Steve Jobs captured from economies of scale help to enrich both investors and government coffers. Importantly, manufacturing is critical to national defense. As is becoming increasingly clear, we do not want to rely on foreign competitors for computers, communication infrastructure, rare earth materials, aerospace equipment, advanced sensors, let alone tanks and ships, if we want to maintain our traditional position of leadership and security. One searches the historical record in vain for a great power that did not maintain a solid base in manufacturing and the technology it spawns.

Given the likely continued weakness in the U.S. financial services sector and in housing, manufacturing will remain a source of strength in the current economic cycle, especially with the global terms of trade slowly shifting in its favor. Given the superior productivity performance it has sustained for decades, doing what we can to build the sector is a key to improving our standard of living, even if many of the lost jobs never return. Unless major services sectors such as health care and education can somehow begin to match the efficiency gains, breakthrough technology innovations, and price performance of manufacturing, it would be a mistake to base our economic future on them.

What can we do to ensure a "renaissance" in manufacturing? My list would include: improving science, mathematics, and technical training; upping our investment in basis scientific research and helping get our technological lead from the lab to the factory floor; working with allies to convince China that it's currency manipulation is harmful to the world economy and to its own; more aggressively seeking free trade arrangements with willing partners; improving deteriorating infrastructure in the United States; reducing corporate taxes to globally competitive levels; thinking hard about new regulations that fall mainly on the industrial sector; using U.S energy resources as an engine for growth; and adopting a more positive attitude toward the future of this sector lest we discourage the best and brightest from entering the field.