02/20/2012 01:18 pm ET Updated Apr 21, 2012

Manufacturing: Why We Should Help the Sector (But Not Too Much)

For many years, policy makers and public officials have argued about whether public policy should help promote American manufacturing or whether we should leave it alone and let the market do what it will.

As usual, such stark positions have little to do with reality. I start from the position that, like it or not, we have and will continue to have a significant industrial policy in America. It's just not a very smart one.

Each year we provide hundreds of billions in tax breaks for all sorts of industrial sectors, including manufacturing (tax credits for U.S. production and accelerated depreciation of equipment alone account for $450 billion in tax breaks, 2013-2017). But is this money well spent? Is this ad-hoc industrial policy working?

I'd say "not so much" at least relative to better, more coordinated ideas that grow out of a close look at the sector with respect to its potential role in economic growth and global competition. And yet, each year economists pull chins and wag fingers about how we must avoid an "industrial policy" that "picks winners." Meanwhile, other advanced and emerging economies, unburdened by this ideological parlor game, are crafting policy -- sometimes useful, sometimes not -- designed to boost their manufacturing sectors and claim global market share.

As strongly argued in a new Brookings document coming out next week (they're having a release event there Wed a.m.):

...manufacturing does indeed matter to the U.S. economy and that public policy can strengthen American manufacturing. The nation need not and should not passively accept the decline or stagnation of manufacturing jobs, wages, or production. American manufacturing matters because it makes crucial contributions to four important national goals.

-- Manufacturing provides high-wage jobs, especially for workers who would otherwise earn the lowest wages.

-- Manufacturing is the major source of commercial innovation and is essential for innovation in the service sector.

-- Manufacturing can make a major contribution to reducing the nation's trade deficit.

-- Manufacturing makes a disproportionately large contribution to environmental sustainability.

I've stressed these arguments in various posts, noting that 70 percent of private sector R&D comes from manufacturing, the trade surplus in services is small relative to the deficit in manufactured goods (see figure here), and, as I spoke to in Portland, OR just last week, clean energy manufacturing should be an important part of future production.

But, as my friend and wise economic thinker Christy Romer asked in a recent NYT critique of the pro-manufacturing policy position: where's the market failure? I was also reminded of this critical question in Zach Goldfarb's interesting piece in the WaPo yesterday on how subsidies to an American manufacturer (Boeing) created a comparative disadvantage for another firm (Delta).

Such critiques demand a response.

First, broadly speaking, you've got to know your history here (as Christy does, and her position is actually closer to the Brookings folks' view of targeted support). There exist market barriers, unique to manufacturing, that no individual private firm can overcome by themselves. There is no private firm that can coordinate a national smart grid, make or recoup the investment needed to move advanced battery technology from the university labs to the factory floor, penetrate export markets, and fight back against mercantilists trying to sew up market share here in clean energy manufacturing.

History also reveals -- as documented in must-read detail in this book on the history of government's role in innovation -- there is no transformative investment that reshaped our economy, from railroads to the Internet, wherein the federal government did not partner with the private sector to overcome these barriers. Not here, not in any other advanced economies, not even in emerging economies. To ignore this reality in the interest of "not picking winners" or "government doesn't create jobs" or whatever atavistic ideology you want to plug in, is to concede global competition to those unburdened by such dangerously wrongheaded thinking.

But what about Delta? Now, that's a tough one. Why does a private manufacturer like Boeing need the government (in this case, the Export-Import (XM) bank) to backstop its borrowing? If private credit markets won't do so, isn't that a market signal that something's wrong here and that if anything, the taxpayer should be spared?

Again, there are market failures and risks in play here that private investors cannot adequately offset. For one, Europe has its own consortium supporting aircraft manufacturing, Airbus, and those who oppose XM financing here have to explain why it's OK to unilaterally disarm. Second, and unique to this industry, there's just too much investment risk when you take a $20 billion order from Indonesia, e.g. (as in the WaPo piece); there's currency risk, stability risk, and for private lenders to take on such uncertainty would require very high rates of interest (h/t TM on these points).

Still, and this requires more research that I'll get to, I came away from the WaPo piece agreeing more with Christy et al in this case. Given the risks and competitive factors just noted, we should subsidize our exporters when they need it. But Delta has a case here. These subsidies have grown too large -- they are now more a function of the skill of your lobbyists than the need to offset the market failures.

So what should we be doing in this space? That comes right out of the market barriers noted above:

-- We should push back against the mercantilists who manage currency to tilt the playing field in uncompetitive ways -- and it's not just currency; non-tariff barriers abound.

-- We should support R&D, particularly in clean energy, with great attention the "death valley" between discovery in the labs and production in the factories.

-- We should ensure that workers have the technological skills that contemporary production demands.

-- We should pay a lot more attention to supply chains, as that's where most of the jobs are (Sue Helper, an author of the Brookings study, is a big promoter of this insight); that often means transitional support for, e.g., a machine shop that was making gear boxes for a Chevy to making gear boxes for a wind turbine.

-- We should carefully examine the union/management/government partnerships that Germany successfully implements in the interest of a stronger manufacturing presence, a point the Brookings folks also stress.

Again, I need to crunch more numbers on this, but my intuition is that we could do all this and more for less than we're spending now on credits, tax breaks, and subsidies that we're not adequately evaluating through the lens of market failure, innovation, and potential growth sectors.

We've already got a manufacturing policy. Now let's make it a smarter one.

This post originally appeared at Jared Bernstein's On The Economy blog.