A New "American System"

Over the past couple decades, "globalization" in the United States has meant the rise of the Finance, Insurance, and Real Estate (FIRE) sector.  Meanwhile, many other parts of the American economy have been hollowed out.  Manufacturing jobs have been slashed in part due to automation but also due to a global trade system in which various international players are afforded many opportunities to subsidize their industries while the US undermines its own domestic manufacturing sector.  The technology sector has witnessed its own share of outsourcing and offshoring, and job opportunities for US-born workers are also undercut by many companies' use of temporary worker visas (such as the H1B visa).  Further undercutting domestic labor, a flood of illegal workers has placed more pressure on the wages and employment opportunities of low- and semi-skilled workers.  Under these conditions, the US growth rate has substantially declined since 2000; even the high point of the business cycle during the Bush years was well below that of any cycle since World War II, and the economic policies of the Obama administration have proven disappointing by the administration's own standards.  So where to go from here?

In 1791, facing a debt-burdened new nation with relatively little domestic industry, Alexander Hamilton prepared his "Report on Manufactures," which proposed a system of tariffs, subsidies, and domestic investments as a way of ensuring future economic vitality and industrial independence for the United States.  The first Secretary of the Treasury's report provided in many respects the originating germ for the economic policies of the Whig and later Republican parties of the nineteenth century.  Politicians like Henry Clay and Abraham Lincoln and economists like Henry Carey advocated for an "American System" that encouraged the development of a skilled population with economic opportunity and industrial development.  Some variant of the "American System" drove US economic policy throughout much of the nineteenth century until the middle of the twentieth.  During this period, the United States accumulated massive wealth.  This wealth in turn provided the financing for many of the social programs of the twentieth century.

The "American System" has the following insight: the American economy cannot flourish over the long term with merely the financial and resource extraction sectors.  Resource extraction can fuel economic growth, and a sophisticated financial system also seems necessary for a modern economy to work at peak levels.  But the best gasoline and top-notch engine oil will not make a rusty jalopy into a vehicle fit for the Indy 500.  Hamilton and many of his allies were favorable to banking interests but also realized that an economy based solely upon banking would eventually harm those very financial interests.

We might restate this insight and instead note that the greatest form of capital is not simple currency or resources but human capital.  This human capital includes both various social institutions (such as a system of laws, cultural values, etc.) and the accumulated knowledge and talents of individuals.  It depends upon the belief that one's efforts will likely lead to some fruition.

American prosperity was built upon the nurturing of human capital within the "American System."  The evolving system of US laws encouraged prosperity by allowing innovators and producers to reap the rewards of success.  The social safety net of private charity and government institutions helped ensure that a person born into unlucky circumstances could still enrich his or her talents.  Universal education and literacy presented the young with the tools to train their minds and discover the world of learning.  Investment in infrastructure---from roads to canals to railways to highways---allowed for a more efficient transfer of capital, commodities, products, and knowledge.  Tariffs gave an incentive for American residents to try new manufacturing experiments.  The close proximity of manufacturing helped spur on new innovations: working with day-to-day production, Americans were more likely to realize how to do things better, smarter, and faster.  Moreover, the growing cost of labor encouraged further innovation in technology.

It is precisely now that we need a return to the investment in human capital.  As Andy Grove, former head of Intel, has argued in recent years, top innovation often goes hand in hand with direct involvement in production.  Whether the United States can over the long term remain a world leader in innovation after having exported industrial production remains to be seen.  We need to defend forthrightly American interests abroad.  It may no longer be enough to let foreign countries discriminate against American products and violate intellectual property laws even as the US opens itself completely to their products.  (And encomiums about the virtues of "free trade" miss the point that the current trade order is nothing like free trade or the free market.)  Trade policy must move beyond cheap imports uber alles.

We need an education system centered on skills and real learning---not on meaningless test scores.  We need to inspire hope in our youth, creating opportunity for both those with and without college degrees.  Throughout the 1980s and 1990s, many opportunities for workers with only a high school degree declined.  The 2000s have witnessed the closing off of opportunities for many with college degrees.  If young Americans will see no profit from developing certain skills, these skills are less likely to be cultivated.  As a recent Council on Foreign Relations study has shown, almost all the increase in the number of jobs from 1990 to 2008 occurred in non-tradable jobs, which often pay lower wages than tradable jobs.  So one could argue that, in some ways, the current flavor of globalization has made the US economy less competitive, as it encourages the growth of lower-paying, and often lower-skilled, jobs.

We need a sensible policy for infrastructure investment.  Energy policy is a key aspect of this investment.  The easy transfer of goods and people has proven especially valuable in a nation as vast as the United States, and the new ease of transporting information has unleashed the potential for considerable innovation.

I do not here intend to lay out a complete menu of policies that are necessary for the restoration of American economic growth.  Yet it is important to think about the overall contours of a public policy aim.  The precise policy mechanisms of the Hamiltonian "American System" might be outdated, but its basic notion is one with some merit.  We must shift from privileging extraction to rewarding talent, effort, and innovation.  The combination of market rewards and public investment created an economic order of profound vitality, opportunity, and prosperity.  As the American economic engine continues to sputter, it is time to engage in a thoroughgoing renewal---in part, by examining the wisdom of the past.

How About Effective Treatment?

Christina Romer, former top Obama White House official and key figure for the planning and defense of Obama's stimulus package, pens an op-ed today arguing that manufacturing should not receive "special treatment."  I'm not sure what "special treatment" means here: US economic policy is full of provisions that target various economic sectors, so I don't know what "special" targeting would be.  Beyond that semantic ambiguity, let's look at the three categories Romer says defenses of manufacturing fall into: market failure, jobs, and income distribution.  I think there are more than a few problems with each of Romer's criticisms on each point.

On 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. 

Romer seems to deny that "market failure" is taking place, but nowhere does she acknowledge that one of the biggest reasons for the decline of manufacturing is that the "free market" has been subverted by many of the US's trading partners, which support native industries to the detriment of American ones.  It would be hard to call the relationship between the People's Republic of China and the USA one that lives up to the principles of the "free market": instead, the PRC funds its industries and throws up barriers to foreign products even as intellectual property rights are not respected.  One defense of a manufacturing policy would be that such a policy would correct the anti-market distortions of global neomercantilism.

On 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. 

This analysis is partial at best.  It's true that manufacturing jobs alone will not turn around the nation's economic course.  But these jobs have traditionally been higher paying, and the "profound shortfall of demand" that Romer laments has been fed by the decline of jobs for the middle class.  By growing economic opportunities for the working and middle classes (which effective trade and manufacturing policies could do), we can inspire more demand and sustainable economic growth.  Romer's solutions of tax cuts and federal aid to state governments would seem to act more as band-aids than long-term investments for the renewal of the American economy.  Investments in infrastructure are a good longer-term measure, but they alone won't restore the economy.

On 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?

Romer's points about income distribution have a little more merit, but they still do not fully rebut the claim that manufacturing has traditionally offered more economic opportunity than many of the jobs in the "service" sector of the economy (many of which are now held by people with college degrees).  And, again, factory worker incomes have fallen in part due to foreign competition that is heavily subsidized and supported by foreign governments.

And why focus on such jobs in the first place?  One of the key reasons is that a productive manufacturing sector, rather than being a distraction from high-concept economic activity, actually plays a key role in the discovery of new innovations and new modes of economic growth.

Andy Grove, former CEO of Intel, has been hammering this point for a while: a vibrant manufacturing ecosystem benefits those attempting to create new things and solve old and new problems.  Grove suggests that, if you want to catch the next wave of development, you need to have an in-depth knowledge of manufacturing:

A new industry needs an effective ecosystem in which technology knowhow accumulates, experience builds on experience, and close relationships develop between supplier and customer. The U.S. lost its lead in batteries 30 years ago when it stopped making consumer electronics devices. Whoever made batteries then gained the exposure and relationships needed to learn to supply batteries for the more demanding laptop PC market, and after that, for the even more demanding automobile market. U.S. companies did not participate in the first phase and consequently were not in the running for all that followed. I doubt they will ever catch up. 

These manufacturing jobs play a crucial role in fostering new innovation and paths of economic growth.

There are plenty of reasons to be concerned about the decline of manufacturing.  This decline is not fated: it has been spurred on by decisions made by many in the US policy elite.  I'm not sure that manufacturing does need "special" treatment, but perhaps manufacturing could settle for effective treatment---which is much more than Romer's former boss has thus far provided.