CFO Studio Magazine, 1st Quarter 2012
By Gerald Najarian, Principal

INDEED— WHAT IS THE MATTER with manufacturing in our country? Well, the answer might be nothing. At least nothing out of the ordinary in the capitalist system.

But wait. Doesn’t everyone say that all our manufactured goods are made outside the United States? Aren’t manufacturing jobs being outsourced to China, India and other countries in Asia and the subcontinent? The answer to all these questions is, yes! But…

What really happened to U.S. manufacturing is fourfold: globalization, comparative advantage, automation and policy neglect at the national government level – all pretty natural in the American capitalist system. The first three of these are unavoidable, but the last, policy, can be addressed. More about policy neglect later in the essay. Let’s look at the unavoidable after a little statistical background.


Numbers and Trends

Since World War II, manufacturing has grown steadily. There have been some down years, but the slope of the line over the years has been upward. While ubiquitous — with factories emitting smoke into the atmosphere and employees queued up for the shift change — at its peak, manufacturing employment never exceeded 32% of the total non-farm labor U.S. labor force and was never more than 27% of GDP.

Between 1950 and 1970, manufacturing GDP grew at 3%; between 1970 and 1990, it grew at 4%. Since 1990, manufacturing GDP has grown at less than 2%. While growth between World War II and 1990 was good, and since then has been slow, there was always growth.

Employment is a different story. In the years since the war, manufacturing employment grew 18% until 1990 then declined by 33%! So as output grew, employment gradually declined, suggesting that productivity, abetted by automation, has grown.

We are, in fact, a much more productive manufacturing nation. Increased productivity is good news. All we need now is to put that productivity to use making things. And therein lies the problem – we need to make and sell more goods. With all the positive productivity gains, the use of our bounty languishes in its sight. Manufacturing capacity utilization stands at 75%, its lowest in more than 20 years. Most economists think that capacity utilization has to be in excess of 80% for the industry to be healthy and investing. Manufacturing output isn’t declining, it’s just anemic.

The Unavoidable and the Inevitable

Now let’s look at the unavoidable international phenomena and their effect on our ability to sell more. If India and China weren’t growing their manufacturing base, the United States would be producing more goods. We can’t stop globalization nor its close relative, comparative advantage, which is the labor cost differential enjoyed by developing countries. In a world that is experiencing rising expectations for the economic well-being of its citizens, industrialization is a rational policy for developing nations. We can see this industrialization/globalization as a threat or as an opportunity — and embrace it intelligently.

Comparative advantage will eventually take care of itself. Overtime, wages in industrializing countries grow (just as they did in Japan), and the advantage disappears, often going to another

less developed country until it, too, experiences wage growth. So it goes.

To try to compete with low-labor-cost countries amounts to a “race to the bottom.” The net effect of comparative advantage is that we are unlikely to see high labor content products, sneakers for example, manufactured in the United States any time soon. These two international factors won’t cease because we wish them to. We can, however, take advantage of them through policy.

Here in the United States, automation, which is inevitable, reduces aggregate demand among our citizens by requiring fewer workers and wage payments. The dramatic productivity growth since 1970, occasioned by automation and a better educated work force, has not been accompanied by comparable wage growth in manufacturing (or in other industries for that matter). Manufacturing wages grew in the post-war years up until 1980 and then began to level out. There were various reasons for this growth in wages and for the subsequent leveling, chief among them the influence of unions on the upside and their decline in the recent leveling period. Changing wage patterns is a complicated topic not in the scope of this essay. However, manufacturing employment and production (and the consequent purchasing power it can provide) can be influenced by promoting the quantity of output. In manufacturing operations terms, we need to manage demand to get factories operating three shifts.

What’s to be Done?

Manufacturing’s share of GDP is now at 12%, about $1.8 trillion in output. Its share of total non-farm employment is 9%, with about 12 million workers. Goals for growth, GDP share and quantity must be set — and policy directed toward meeting them. Employment goals are not necessary, as growth and output quantity will force the employment numbers up.

In 1990, the share of GDP represented by manufacturing was 17%. Perhaps this would be a good, though aggressive, goal to achieve over the next 10 years. Assuming very modest annual GDP growth, a 17% share of GDP in 10 years would yield 4 million to 5 million new manufacturing jobs. More importantly, increased manufacturing output radiates demand into the tangential industries that service the manufacturing industry and creates additional jobs at the rate of five to one.

Of course, having goals is not enough. Now is the time to make the policy, investment and focus changes that facilitate achieving the goals. Some of these changes can be traditional while some will be very untraditional. But they must be serious, and they must be substantial. First and foremost, some attitudes have to change. The animosity between manufacturers and national government has to give way to a mutually beneficial partnership. Naturally, both have to recognize their responsibilities to the public as well as their own constituencies. If the mutual suspicion can be overcome, some untraditional approaches can be tried.

The policy and investment initiatives needed to grow the U.S. manufacturing base will best be facilitated by focus; and focus comes from people and organization. To get that focus, the most dramatic change would be to establish a cabinet level Department of Manufacturing. We have departments of energy, transportation, agriculture, health, housing and education, all seeking to advance the state of the nation’s capability in their respective “industries.” If we believe that manufacturing is an important industry, why not a Department of Manufacturing? Such a department would certainly bring focus and coordination to manufacturing policy, but its real value would be to abandon the “hope as strategy” approach that now is the de-facto policy for manufacturing.

The needs for successful manufacturing growth are not unknown. Manufacturing needs quality logistics and location infrastructure. It needs trained and well-paid workers. And, the industry certainly needs sustained demand for its output from a weak dollar, aggressive export policy and serious economic stimulus. Most of all, manufacturing needs an industrial policy that promotes promising industries and protects them and others, where needed, to keep them strong and growing.

The last of these needs – industrial policy – is the most controversial because it goes against the grain of American capitalism. The manufacturing capitalism to which we are accustomed is a form of “incentivized laissez-faire,” in which 19th century norms of minimum government are combined with 20th century tax code encouragement. It is time to abandon this policy and recognize that national government can, with industry’s help, identify, invest in and protect the foundation industries of the future.

Such a policy doesn’t mean that government will be seeking to pick businesses in popular culture that are best left to marketplace selection. High-tech, environmental and basic industries would be candidates for an industrial policy. Structured along the financial models of venture capital/private equity, and with careful tariff protection, our industrial policy would be a uniquely American industrial model that can revitalize manufacturing. Finally, a policy like this one can’t be timid; substantial funding and strong political support are critical to success.

If we are serious about getting manufacturing growing at the rate it grew between 1970 and 1990, the American capital system will have to undergo some wrenching cultural changes. To maintain the current paradigm is to abandon the competitive edge to our manufacturing rivals.

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