US Battle to Revive Manufacturing – Part II

WASHINGTON: Unmentionable in America for the past half century, industrial policy is suddenly out of the closet and marching down Pennsylvania Avenue from the White House to the Congress and may even be about to storm the long hostile bastions of Anglo-American economic orthodoxy.

In his State of the Union address, President Barack Obama called for revitalization of manufacturing as the basis of an American economy “built to last.” He proposed a number of measures such as special tax credits for investment that creates high valued-added manufacturing jobs in America and greater government support of R&D in manufacturing. Even more telling was another speech given on March 27 at the Washington Manufacturing Conference by National Economic Council Director Gene Sperling, the president’s top economic adviser since Larry Summers returned to Harvard.

For those accustomed to Summers’ tight embrace of market fundamentalism and rejection of anything that might smack of government intervention in the market, the speech represented a surprising 180-degree shift. Long Summers’ trusty acolyte, Sperling turned his back on virtually everything the master had preached. Wasn’t it wrong to single out one sector of the economy for special attention? Not necessarily, because if that sector is manufacturing, it accounts for over two thirds of all private R&D spending and a higher than average proportion of productivity gains and innovation. So, if manufacturing contributes disproportionately to economic welfare, perhaps it deserves disproportionate attention.

But wouldn’t such attention distort markets and cause inefficiencies and misallocation of resources? Well, no, not necessarily, because economic studies have shown that there are positive spillovers, gains for the overall economy that cannot always be captured by one firm and won’t be developed without some public support.

These arguments are not at all new. As a member of the Reagan administration, I had this same discussion 30 years ago with a member of the Council of Economic Advisers. The arguments are as valid now as they were then. But they were buried by successive waves of hate-government-intervention-of-any-kind Republican economists and love-rational-expectations-econometric-models-of any-kind Democratic economists. 

So the arguments are now being exhumed.

The reasons are twofold. At one level, it’s simple. The president is asking some fundamental questions. At a White House meeting which I attended more than a year ago, he asked: “Why can’t we build high-speed trains in America? Why can’t we make batteries in America?” So Obama’s instincts are not so different from those of most ordinary Americans who wonder why everything they buy is made in China, Japan or Germany. His questions trigger a search for answers. At a more fundamental level, the president is asking these questions because he knows that America is not paying its way in the world and that its productive base is no longer generating sufficient wealth to maintain America’s far-flung geopolitical commitments while also delivering the American dream to future generations. The president knows that if he can’t revitalize the productive base, he and the country will both fail. And in the search for answers, his advisers have inevitably been driven to industrial policy.

So far, they’ve only addressed one dimension of the industrial-policy argument and that is, perhaps, the less important dimension of so-called positive spillovers or externalities. There’s nothing wrong with that argument, but the most compelling reason why America must have a pro-active industrial policy is because most of the other leading economic players – Korea, Germany, China, Brazil, Japan and others – do.

In such a world, the choice is not between having a policy or not. It’s between determining your own future or having it determined for you by another country’s policy. Take solar panels as an example. Three years ago at a White House meeting there was a debate about whether or not to provide favorable government-backed financing to US producers of solar panels. At the time, I noted that Germany, Denmark, Japan, Korea and China were all providing massive subsidies to their solar industries and argued that unless the United States was prepared to match those subsidies it would be madness to consider an American entrance into the industry. I was told that market forces would prevail, and I asked, “What market forces?” Obviously the market was determined by the countries providing massive subsidies.

Today, US solar producers are in desperate trouble, and China along with Korea and Japan appear to be dominating the global markets. If a major country adopts a policy of becoming a dominant player in an industry, that policy will preclude other countries from developing that industry unless those countries have similar and countervailing industrial policies.

So the decision not to have an industrial policy is also a decision to exit those industries in which other countries do have active industrial policies. In short, no policy is a de facto policy. In view of the large variety of comprehensive industrial policies of the likes of China, Brazil, Japan, Germany, Korea, Singapore, Taiwan, France, Sweden and Israel, it’s difficult to imagine that the United States can remain competitive in many industries without effective industrial policies. This inexorable conclusion has led to the resurrection of industrial policy in Washington.

Many believe the objective of industrial policy should be a manufacturing renaissance that will create millions of high-paying manufacturing jobs. Unfortunately, this is virtually a contradiction in terms. High-paying industries are not likely to be labor intensive. On the other hand, others seem to assume that whatever Americans can do in manufacturing, Asians and Germans can do better. That is also far from the case.

What America needs and can do is capital and technology-intensive manufacturing that may not create a lot of direct jobs, but will create the wealth that creates many innovations and industries that create lots of high-paying indirect jobs.

Think about it this way. There’s been much talk about Apple producing its iPhones and iPads in China and about how Steve Jobs told Obama that “Those jobs are never coming back.” But which jobs was Jobs talking about? The iPad is not really made in China. It’s assembled in China by workers being paid a 10th or less of what American assembly workers would need to be paid. Maybe those assembly jobs aren’t coming back. But they account for only about $7 worth of a $200 iPhone. The heart of the iPhone is its high-value components such as digital signal processors, electronic displays and memory chips. Those aren’t made in China. Rather they’re made in Japan, Taiwan, Korea, Germany and the United States. Production of these components is not labor intensive. There’s no reason why they can’t be produced competitively in the United States.

To achieve that, a new US industrial policy should focus on providing incentives such as free land, tax abatements and low-cost loans to lure global companies to put new production facilities in America. At the same time, the US government must aggressively coordinate with corporations to identify regulations and other measures that might be altered to enhance the attractiveness of investing in America. There should also be special training programs for workers and constant discussion between US officials and global companies about their needs and opportunities in the United States.

In short, Washington needs to start doing what many other countries do routinely. It’s not rocket science. It’s just good old industrial policy as first invented by Alexander Hamilton