Professor Romer Needs Manufacturing 101

Christina D. Romer, the former chairwoman of President Obama’s Council of Economic Advisers, took U.S. manufacturing to task recently in a New York Times op-ed.  Headlined “Do Manufacturers Need Special Treatment?” Romer suggests that support for manufacturing needs to “go beyond the feeling that it’s better to produce ‘real things’ than services.”

She’s asking the wrong question. Manufacturers don’t need special treatment. But what they do require is a level playing field. 

Romer is taking the academic view of manufacturing, and that’s a problem.  In the comfortable confines of a dusty textbook, her views may be fine.  But in a cutthroat real world filled with competition, cheating, and harsh mercantilism, the textbook view is very limiting.  Unfortunately, Romer sides with the safe, mathematical view, which means she’s added her name to the long list of economists who just don’t “get it.”

Case in point: Romer uses arcane jargon like “market failures…efficiency grounds…positive externalities” to justify her view that there is something wrong with manufacturing.  In her op-ed she explains that service work is just as important as manufacturing: “American consumers value health care and haircuts as much as washing machines and hair dryers. And our earnings from exporting architectural plans for a building in Shanghai are as real as those from exporting cars to Canada.”

Really, the bottom line is jobs.  Extolling the virtues of a hair salon misses a fundamental point.  Manufacturing supports more jobs, and pays better, than the service industry.  And those architectural plans being “exported”—how many jobs do they support, and what’s to prevent that architectural work from being outsourced as well?

Romer makes three arguments against manufacturing.  First, she says that “Government intervention can be justified on efficiency grounds if the free market won’t work well.”  But U.S. manufacturing advocates aren’t asking for a handout.  Instead, they’re saying that we don’t have a free market at work.  In reality, we have market failure.  There simply isn’t a free market when countries like China violate world trade laws and act in a protectionist manner.

I admire Romer’s intellect, but I am shocked that she doesn’t see this evidence of a market failure.  Our trade deficit in manufactured goods, which has quadrupled since 1998, isn’t a market failure? (Theory suggests that our trade balance should be trending toward equilibrium.) The fact that, on paper, U.S. steel and semiconductor production is far more efficient than Chinese production, but our market share is declining, isn’t a market failure? The fact that productivity of U.S. manufacturing workers has gone up while wages have not isn’t a market failure? And, the fact that dollars invested in the American economy by venture capital are producing diminishing employment returns, as Andy Grove has noted, isn’t some sort of a market failure? Only if you haven’t been looking.

Let’s consider why we need government policy in manufacturing in the first place. I borrow this from Jared Bernstein of the Center for Budget and Policy Priorities, and formerly the Vice President’s economic advisor. Bernstein says that manufacturers face barriers to entry, expansion, and innovation that no single, private firm can solve.  For example:

Research Barriers: R&D can be prohibitively expensive, and hard to capture profits (e.g., advanced batteries);

Coordination Barriers: No single firm could coordinate national projects like the internet or smart electrical grid;

Innovation Barriers: Firms need help morphing academic innovations into the production process;

Credit Barriers: Markets will underinvest when returns are particularly uncertain;

Exports: Firms need the federal government to push back against unfair trade practices.

I want to especially emphasize Bernstein’s last point. Enforcing the rules of trade that we already have on the books–a key piece of President Obama’s manufacturing agenda—does not mean asking for “special treatment.”  In reality, China is using market-distorting practices on a massive scale. Until China halts this mercantilism, we can’t have a free market.  And common sense tells us that enforcing these rules should be the status quo.  It should be standard practice.

Sadly, Romer argues against the importance of manufacturing. I’d like to point her to the Brookings Institution’s Howard Wial and Jonathan Rothwell, who recently did an outstanding job of emphasizing the importance of a strong manufacturing base to our national ecology of innovation, research, and development. Similarly, there’s also the award-winning work of Wally Shih and Gary Pisano, who made this same connection in a 2009 Harvard Business Review piece. If our nation values expertise in engineering, science, and technology, it must value manufacturing.

But most egregiously, Romer completely ignores perhaps the most important attribute of manufacturing: its jobs multiplier effect. Put simply, and to paraphrase the President’s former manufacturing adviser Ron Bloom, a community that attracts an auto assembly facility will also attract a Walmart. But, the opposite is never true. A typical manufacturing job supports four or five other jobs in the economy, directly and indirectly. Manufacturing plays an outsized role in our exports, and factories are often the largest local source of revenue for the public sector.

Finally, we must look at the argument that policy prescriptions are not effective. Much of what President Obama is proposing would actually undo current disincentives such as the higher taxes that manufacturers face in the U.S. (which can drive them abroad), the lack of skilled workers to fill jobs, insufficient public investment in infrastructure, and a lax overall enforcement of trade laws. The President is proposing smart policies–but they hardly rise to the level of industrial policy.

What Ms. Romer needs to do is explain the phenomenon of Germany’s thriving industrial sector. Despite strong industrial unions, high wages ($48/hour in manufacturing vs. $32/hour in the U.S.), and thick regulations, Germany is able to keep its global share of manufacturing and exports steady while China rises and the U.S. falls. 

How does Germany accomplish this? Its economic policies are shaped around supporting manufacturing. The United States, with better access to natural resources, immense human capital, and breathtaking entrepreneurship, should be outperforming Germany on a per capita basis, but we are not.

Fortunately, President Obama appears to have rejected Romer’s advice. If not for any of the above reasons, then for this one: from a strategic (though perhaps not economic) point of view, the U.S. does not want to depend on China to supply our military with parts, computer chips, rocket propellant, surveillance equipment, or anything else, really. If we lose the capacity to manufacture any of our key national security components, we really will have no choice. And China–which has ignored Romer’s advice–will have won this argument, which is far from academic.

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