A U.S. manufacturing renaissance is possible

For a long time, the conventional wisdom on manufacturing and trade has held that American manufacturing is doomed to die and that it doesn't matter because the U.S. economy will move to the "higher ground" of services and high technology.

Indeed, this was the thrust of the argument of an article by former Wall Street operator and Obama auto industry adviser Steven Rattner in Sunday's New York Times. Lamenting the recent rapid increase in U.S. income inequality , free trade apostle Rattner admitted that the globalization-linked decline of U.S. manufacturing is significantly to blame and further insisted that it would continue because American wages are too high for U.S. manufacturers to be globally competitive except in a few specialised industries like aerospace and defense where U.S. producers retain strong advantages.

Rather than trying vainly to hold on to manufacturing, argued Rattner, America should concentrate on service industries like education, entertainment, digital media, and financial services which are the sources of its greatest strengths and highest paying jobs. Facebook, Google, and Mastercard, he indicated, are the companies of America's future.

While it may be that these companies will have a bright future, the rest of this mantra is as superficially wrong as the conventional wisdom always is. That, after all, is why it is the conventional wisdom.

For one thing, the reason that services like entertainment, digital media, and financial services have grown and paid so well is that they don't face the same kind of import-driven global competition as manufacturing. As Nobel Prize winning economist Michael Spence recently noted in Foreign Affairs, employment growth in the United States over the past thirty years has occurred entirely in non-traded sectors of the economy which tend to be the service sectors.

But it's not even true that U.S. services trade produces mostly high wage jobs. If you look at the actual data on U.S. services trade, it quickly becomes clear that a very large part of it is in transport and travel services that are relatively low payers. The so-called sophisticated consulting, accounting, design, and other business services that are always mentioned as the future drivers of U.S. trade and welfare, actually make up less than half of U.S. services exports and a large portion of these are the result of global intra-company activities that are no indication at all of international competitiveness.

Fortunately, like all conventional wisdom, this analysis is also mostly wrong.

The truth is that the U.S. economy cannot experience a significant, stable, and lasting recovery with out some kind of a manufacturing renaissance.  It is generally agreed that the U.S. trade deficit is not sustainable over the long term and must be dramatically reduced as part of a major global rebalancing of trade surpluses and deficits. The U.S. deficit is overwhelmingly in goods with a roughly $800 billion goods deficit being reduced to an overall deficit of about $600 billion by a roughly $200 billion surplus in services. As the goods deficit continues to widen, the services trade base is simply too small to enable a growth in the services surplus rapid and large enough to overcome, even partially, the deficit in goods. So if a solid recovery is to come, it must come in goods, especially manufactured goods.

Fortunately , two recent and important studies indicate that it will. The conventional wisdom to the contrary notwithstanding, Booz & Company's report on the Future of American Manufacturing suggests that production from an American base can be quite competitive except in only a relatively small number of manufacturing industry sectors. It shows that in about half of such sectors, U.S. manufacturers are at present, fully competitive both in supplying the U.S. market and at supplying overseas markets. These are the areas such as aerospace, microprocessors, oil well drilling equipment, and medical instrumentation. In addition, however , it shows that in another 40 percent of industry sectors, U.S.-based producers are presently neck and neck with foreign producer for supplying the U.S. market and that with just a few tweaks, they could be dominant producers for their products in the U.S. market. That means that U.S. based manufacturing can compete in the U.S. market on a  head to head basis with foreign producers in about 90 percent of industry sectors. Thus, instead of its present 10 percent of GDP, U.S. manufacturing should, like Germany's, account for around 20 percent of GDP.

A second recent report by the Boston Consulting Group (BCG) argues that, in fact, that is just the direction in which U.S. manufacturers are heading.  It points out that more and more producers are realizing that the combination of rising wages in China and large hidden costs attached to producing in China is already leading a number of major U.S. companies to begin "re-shoring" some or all of their production back to the United States from Asia.

America needs an industrial renaissance and the good news from Booz and BCG is that it's going to get one.