"EVERYONE seems to
be talking about a crisis in manufacturing. Workers, business leaders
and politicians lament the decline of this traditionally central part of
the American economy. President Obama, in his State of the Union
address, singled out manufacturing for special tax breaks and support.
Many go further, by urging trade restrictions or direct government
investment in promising industries.
A
successful argument for a government manufacturing policy has to go
beyond the feeling that it’s better to produce “real things” than
services. 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.
The
economic rationales for a policy aimed specifically at shoring up
manufacturing largely fall into three categories. None are completely
convincing:
MARKET FAILURES Government
intervention can be justified on efficiency grounds if the free market
won’t work well. For example, when competition in a market is limited,
antitrust laws that prevent monopoly can be helpful.
In
manufacturing, the market can malfunction if there are positive
externalities across companies. That means that some benefits of a
manufacturing plant go to companies other than the one deciding whether
to build it. Clusters of manufacturing businesses can be more productive
than an individual one. As a result, when an entrepreneur sets up a
plant, some of the benefits accrue to other businesses in the area.
This argument could justify government subsidies or tax breaks. But large clustering effects have been hard to find. A study
by Professors Glenn Ellison of M.I.T. and Edward Glaeser of Harvard
showed that in many industries, businesses were only modestly more
clustered than if they were allocated randomly — suggesting that the
benefits, while real, may often be small.
Moreover,
the logic of clustering’s benefits is likely to apply outside
manufacturing. Software development, insurance and entertainment are
three service industries where we observe clustering and where positive
externalities may be large. Why single out manufacturing for special
treatment?
A related argument for subsidizing
manufacturing involves learning by doing. It takes time for a production
process to become efficient. But whether learning creates a role for
government depends on whether the eventual returns are captured by the
company taking the risk. If the company that jumps in first and
eventually succeeds reaps all the rewards, there’s not a market failure.
The company needs to count the learning period as part of the
investment cost. And with well-functioning capital markets, it should be
able to find investors without government help.
On
the other hand, if an early entrant paves the way, but other companies
come in later and snatch the rewards, government intervention could be
helpful. In this situation, private entrepreneurs may not do as much
early investment as would be good for the economy. Still, a study of the semiconductor industry
found that although learning by doing was substantial, most of the
rewards went to companies doing the early investing. And what spillovers
there were, crossed national borders.
The
possible externality of greatest concern may be national defense. The
argument that we need a strong manufacturing base in case of war must be
taken seriously. But it still doesn’t follow that all manufacturing
deserves special treatment. Which industries are truly essential in a
war effort? And might normal production in military industries, as well
as existing supply arrangements with allies, provide adequate
protection?
Without compelling evidence of special market failures in manufacturing,
it might be better to enact policies that will make all American
businesses and workers more productive and successful. President Obama mentioned some in his State of the Union address:
expansion and enforcement of free trade agreements; public investment
in basic science, infrastructure and education; and corporate tax
reform.
JOBS
A key argument for encouraging manufacturing is to create jobs and
reduce unemployment. Unfortunately, those effects are probably small.
Unemployment
today is high, but not because of a decline in manufacturing. That
decline has been going on for 30 years — and for most of the 1990s and
2000s, the unemployment rate was less than 6 percent.
Today,
we face a profound shortfall of demand. That truly is a terrible market
failure, and it warrants government intervention. But we need actions
that raise overall demand — like a tax cut for households so they have
more take-home pay to spend, more aid to troubled state and local
governments, and public investments in infrastructure. These are all
things that President Obama has advocated.
A narrow tax cut
for manufacturing is unlikely to raise aggregate demand significantly.
By making our industrial goods cheaper, it might stimulate foreign
demand, but probably not enough to make a dent in our unemployment rate.
On the other hand, more aggressive monetary policy that lowered the
price of the dollar would stimulate all our exports, and so have far
more impact.
At the same
time, plant shutdowns by large manufacturing companies leave huge holes
in local job markets, and moving is very costly for dislocated workers
with ties to their communities. There’s surely a role for government to
help these devastated areas.
One little-emphasized component of the president’s manufacturing plan
is $6 billion of tax credits for any type of company investing in
communities that have suffered the closing of a military base or another
major job loss. A spate of new research suggests that such “place-based” policies may be effective in raising local employment and wages.
INCOME DISTRIBUTION
A final argument for supporting manufacturing is distributional.
Manufacturing jobs are seen as one of the few sources of well-paying
jobs for less-educated workers. Indeed, in the four decades after World
War II, manufacturing jobs paid more than other jobs for given skills.
But
that is much less true today. Increased international competition has
forced American manufacturers to reduce costs. As a result, the pay
premium for low-skilled workers in manufacturing is smaller than it once
was.
Today,
manufacturing wages are high largely because production is
capital-intensive and technologically sophisticated. As a result,
educational requirements have risen. Now, more than half of
manufacturing workers have some college education, up from just over 20 percent in 1969.
There
are sectors where workers with good educations could earn good wages if
the economy were healthy. Why focus on manufacturing to create such
jobs? Instead, government could make it easier for workers to get the
education needed for high-skilled jobs in many fields — and encourage
business formation wherever entrepreneurs see a promising opportunity.
If
increasing income equality is the goal, it might be wiser to put money
into infrastructure than to subsidize manufacturing. Construction also
pays good wages, but with lower educational requirements. And America’s
infrastructure needs are enormous. Or, we could redistribute income
through the tax code — economists’ traditional tool.
AS
an economic historian, I appreciate what manufacturing has contributed
to the United States. It was the engine of growth that allowed us to win
two world wars and provided millions of families with a ticket to the
middle class. But public policy needs to go beyond sentiment and
history. It should be based on hard evidence of market failures, and
reliable data on the proposals’ impact on jobs and income inequality. So
far, a persuasive case for a manufacturing policy remains to be made,
while that for many other economic policies is well established."
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