Be patient with manufacturing

Posted: Sep 09, 2003 12:00 AM

 With Congress having returned from its August recess last week, the rhetoric on employment has heated up.  In particular, we are hearing more and more about the loss of manufacturing jobs.  A Federal Reserve Bank of New York study warns that many have disappeared permanently and will not come back even after rapid growth returns.  President Bush has responded by creating a “manufacturing czar” in the Commerce Department to focus on rebuilding that sector.  History, however, suggests that manufacturing can take care of itself.

 It’s important to remember that warnings about the death of manufacturing are not new.  I have been hearing them for more than 20 years.  For example, on April 24, 1983, the New York Times ran this headline: “Whither the Smoke in Old Smokestack Industries?”  A few days later on May 8, it hit on the point again with a story headlined: “The Twilight of Smokestack America.”

 Everywhere, it seemed, people were up in arms about the imminent disappearance of manufacturing from the U.S.  There were widespread calls for an “industrial policy” to help American companies compete with those in Japan.  Bookstores were filled with tomes such as The Deindustrialization of America by economists Barry Bluestone and Bennett Harrison.  Republicans and Democrats alike criticized President Reagan for his laissez-faire approach to this problem.  Many demanded that a full cabinet department be established to promote manufacturing with subsidies and trade protection, along the lines of Japan’s infamous Ministry of International Trade and Industry (MITI).

 The problem then—as now—is that there was no serious economic analysis supporting the doom-and-gloom.  When respected economists like Alfred Kahn of Cornell reviewed the Bluestone-Harrison book in the New York Times, he called it an “ideological tract masquerading as objective research.”  He went on to say that their analysis was “distorted,” their explanations “simplistic,” and their policy prescriptions “dubious.”

 Lest one think that Prof. Kahn was merely demonstrating partisan bias, it is worth remembering that he was a top economic adviser to Jimmy Carter.  If fact, the last Economic Report of the President during the Carter Administration carried one of the most devastating attacks on industrial policy ever published.  It said that government was incapable of picking winners and losers among industrial sectors and that any effort to do so would be counterproductive.  The result would be reduced efficiency and flexibility in the U.S. economy to the ultimate detriment of growth and living standards.

 Another prominent Democrat, Wisconsin Senator William Proxmire, also warned about politicization of the industrial policy process.  Industrial aid would not be allocated according to objective standards, but based on political power.  The squeaky wheels would get the grease, while genuinely promising new industries would receive nothing.  The whole industrial policy mechanism would eventually evolve into a tax on the successful to bail out losers.

 In time, the industrial policy fad faded away, not so much because its advocates had been defeated intellectually but because manufacturing came back on its own.  By 1987, Fortune Magazine was declaring: “The Smokestacks Steam Again.”

 What was really going on was not so much a structural change in the U.S. economy as a normal cyclical phenomenon.  Manufacturing tends to be more cyclical than services, the largest component of the gross domestic product.  That is, manufacturing rises further and faster during economic upswings and also falls further and faster during downswings.  The 1981-82 recession hit manufacturing especially hard because it was accompanied by an exceptionally sharp fall in inflation.  Many manufacturers, stuck with labor contracts negotiated when everyone thought inflation would continue rising, were mercilessly squeezed between rising costs and falling prices.

 Many companies did go under in the early ‘80s and many jobs were lost permanently.  But those businesses that survived were stronger than ever before.  Operations were streamlined, waste and fat were ruthlessly pruned, new technology was introduced and by the end of the decade American manufacturers were again world-class competitors.  And it was all done without the aid of an industrial policy.

 Japan, meanwhile, began the ‘90s by going into an economic funk that continues to the present day.  No one any longer talks about imitating MITI or about Japan overtaking the U.S. to becoming the world’s Number 1 economy.  On the contrary, many American policymakers worry that Japan still hasn’t made the reforms in its economy and political system that are necessary to restore it to health.  Most experts now agree that Japan’s vaunted industrial policy has been more of an impediment to adjustment than a facilitator.

 I firmly believe that the current angst over the loss of manufacturing jobs will reverse fairly soon as the economy makes a full recovery from the 2001 recession.  A year from now, I predict that manufacturing will be booming, businesses will be hiring, and all the demands for action by government will be forgotten.