Vaclav Smil on U.S. Manufacturing

by Reihan Salam

Vaclav Smil, a provocative thinker on energy and the environment based at the University of Manitoba, has written an intriguing article on what he characterizes as the decline of manufacturing in the U.S. While acknowledging that the U.S. manufacturing sector remains large and productive, Smil writes the following:

As befits a large, modern country, America’s manufacturing sector remains very large and has been growing in absolute terms. In 2009, US manufacturing accounted for more than 18 percent of global manufacturing and its value was higher (when compared in nominal, exchange-rated terms) than the total GDP of all but seven of the world’s economies (behind Brazil at $2 trillion and ahead of Canada at $1.6 trillion). The per capita value of manufacturing in 2009 was higher in the United States ($5,800) than in France ($3,900), Canada ($4,200), Italy ($5,100), and China ($1,500). When measured in constant monies, US manufacturing expanded by about 60 percent between 1990 and 2009, nearly matching the growth of overall GDP; it grew by 10 percent between 2000 and 2009, compared to a 15 percent increase in GDP.

But these numbers can be deceptive. America’s manufacturing sector has retreated faster and further in relative terms than that of any other large, affluent nation. US manufacturing as a percentage of GDP declined from 27 percent in 1950 to 23 percent in 1970 to 14 percent in 2000 to 11 percent in 2009. While manufacturing as a share of GDP has also declined in Germany and Japan, both countries have retained relatively larger manufacturing sectors at 17 and 21 percent, respectively. The contribution of manufacturing to per capita GDP is also higher in Germany ($6,900) and Japan ($8,300) than in the United States. The most shocking, but underemphasized, fact about global manufacturing is that Germany’s share of global merchandise exports is actually higher than America’s (9 percent vs. 8.5 percent in 2009), despite having an economy just one-quarter of the size.

As a consequence, the United States is lagging as a global economic competitor. In 2009, Germany and Japan had large manufacturing trade surpluses ($290 and $220 billion, respectively) while the United States had a massive manufacturing trade deficit ($322 billion). The other key measure — little known in popular discussions of manufacturing — is export intensity, the ratio of a nation’s exports to its total manufacturing sales. The global average export intensity is twice as high as that of the United States, which ranked 13th out of the 15 largest manufacturing countries in 2009, higher only than Russia and Brazil. Meanwhile, the leading EU countries had export intensities 2.5 times to 4 times higher than America’s. Comparisons of the value of manufactured exports on a per capita basis are even more dramatic: they are higher in Spain ($3,700), Japan ($4,000), Canada ($4,600), and Germany ($11,200) than in the United States ($2,400).

The US manufacturing sector is also badly trailing China’s, though in order to fully appreciate this, one must calculate the real value of China’s artificially undervalued currency (the yuan renminbi, or RMB). The 2009 data from the United Nations lists US manufacturing output at $1.79 trillion versus RMB 14 trillion or $2.1 trillion for China when converted at the official exchange rate for 2009 (about RMB 6.8/US dollar). But according to the purchasing power parity (PPP) conversion preferred by the International Monetary Fund, one RMB should be worth 29 cents, or RMB 3.4/US dollar. Even if the real RMB value were only 50 percent higher than the official rate, the total added by China’s manufacturing in 2009 would be in excess of $3 trillion, or about 67 percent above the US total.

Smil challenges the notion that our relative decline in manufacturing shouldn’t concern us because it is inevitable that affluent countries will shed manufacturing:

According to this logic, since it is burdened by high labor costs and strong environmental regulations, the United States cannot compete with China and other low-income countries. But as both Germany and Japan demonstrate, high wages and high environmental standards are entirely compatible with continued manufacturing­­ success, if not in low-tech apparel manufacturing, then certainly in high-tech and high-end electronics, automotive, and machine tool manufacturing. Moreover, thanks to rising productivity, labor costs constitute a diminishing portion of overall manufacturing costs, particularly in high-tech sectors. In these sectors, China increasingly attracts manufacturing because of its established networks of suppliers and infrastructure — both of which are comparative advantages created through government policies, not granted by nature.

This is a worthy point, yet the implications for employment levels aren’t very encouraging. That is, a manufacturing revival might improve the balance of trade, but it won’t necessarily lead to a marked increase in the number of manufacturing jobs. 

America’s extraordinary appetite for foreign oil accounted for just over half of its trade imbalance in 2010. In nominal terms, crude oil imports grew from $5 billion in 1973 to $342 billion in 2008. The don’t-worry-be-happy camp assures American policy makers that this dependence on energy imports is nothing to worry about; even the self-proclaimed enemies of America will continue to sell it more oil. But in 2010, half of America’s refined liquid fuels came from imports of crude oil or oil products. Such a high degree of dependence makes the country vulnerable not only to price spikes, which are rare but deeply felt, but also to actual physical shortages whose likelihood is, unfortunately­­, much easier to contemplate given the recent upheavals in the Middle East.

This is also important, and it offers valuable historical perspective. There is good reason to believe, however, that energy imports will decline over the next three decades, as we’ve discussed.

Why should Americans worry about the trade deficit if so many economists say it is a sign of wealth and is nothing to worry about? This rationalization of trade deficits is to be expected from a country that valorizes consumption above all else. But the only reason America has been able to sustain such a high trade deficit for so long is because the United States holds the world’s reserve currency: foreigners buy US bonds, allowing Americans to buy foreign products. A smaller trade deficit would allow the United States to properly maintain and expand its substandard infrastructure, creating many new jobs and increasing US exports.

I am more sympathetic to Smil’s concerns on this front than I had anticipated, in part because he addresses concerns regarding the advent of a hyperactive industrial policy:

Underlying all the false optimism regarding America’s trade deficit and declining manufacturing sector is a misplaced fear that acknowledging the dire straits of manufacturing will result in a new industrial policy complete with government bureaucrats determining prices, setting quotes, or subsidizing production targets. And, to be sure, government must be involved. The continuing success of German, Japanese, and South Korean manufacturing for export has been made possible by conditions created by government policies. As detractors of such involvement point out, this has often meant preferential targeting of some sectors and promotion of their advancement. This strategy has not always paid off: it worked well for Japanese car manufacturers during the 1970s and 1980s, but it did not work for Japanese microchip makers. In 2010, semiconductor sales by Intel and Texas Instruments were more than twice as large as the total for Toshiba and Renesas.

But these governments have also rejuvenated their manufacturing sectors in ways that are less intrusive and ultimately far less costly than ignoring the reality of combined public-private competition from abroad. Compulsory high school attendance, combined with the entrenched belief that there is no comfortable future without a university degree, has also undermined America’s ability to train the skilled labor force needed in modern manufacturing. The German model offers the greatest contrast, with most pupils (about 70 percent) never attending Gymnasium (up to grade 13) but, after Hauptschule or Realschule (ninth or tenth grade), entering a Berufsschule for a wide variety of vocational training in apprentice programs.

We might disagree about the virtues of Germany’s educational model while agreeing that industrial policy is usually unwise. On education, a diversification of industrial providers seems like a better, more adaptive bet than “fighting the last war” by embracing rigid vocational training. In fairness, Smil is not so much advocating that course as using the German model to illustrate it. His basic prescription is an attractive one:

Health care reform, tort reform, and tax reform could help America attract and keep manufacturing domestically. US manufacturers are burdened by more expensive employee benefits (all of its EU competitors and Japan have considerably less expensive national health insurance; the United States spends 16 percent of GDP on health care compared to 9 percent in the United Kingdom and 11 percent in Germany), and by a high incidence of lawsuits. American manufacturers are particularly disadvantaged by a marginal tax rate higher than that of most of its competitors. Supporters of America’s high corporate tax rate argue that the tax rate doesn’t actually disadvantage manufacturing firms. They point to companies like General Electric, which has avoided paying US taxes for two years in a row. But GE — unlike Daimler or Liebherr or Fujitsu — is as much a finance company as it is a manufacturing company; it uses write-offs from its overseas lending divisions to offset the taxes on its American manufacturing. The example of GE proves that GE has been extraordinarily adept at tax avoidance, not that the high corporate tax rate is working.

Per The American Phoenix, I tend to think that we’re going to see a revival of import substituting manufacturing in the U.S. and its immediate neighbors in the near future even without active policy steps. But again, I don’t think it’s going to be enough to alleviate our longer-term employment woes in itself.

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.