The High Road for U.S. Manufacturing
Manufacturing employment could be stabilized with more widespread use of advanced production methods. Government policy can play a key role.
The United States has been losing manufacturing jobs at a stunning rate: 16% of the jobs disappeared in just the three years between 2000 and 2003, with a further decline of almost 4% since 2003. In all, the nation has lost 4 million manufacturing jobs in just more than 8 years. This was some of the best-paying work in the country: The average manufacturing worker earns a weekly wage of $725, about 20% higher than the national average. Although manufacturing still pays more than average, wages have fallen relative to the rest of the economy, especially for non-college workers. Manufacturing also employs significant numbers of white-collar workers: One in five manufacturing employees is an engineer or manager.
Continued hemorrhaging is not inevitable. The United States could build a high-productivity, high-wage manufacturing sector that also contributes to meeting national goals such as combating climate change and rebuilding sagging infrastructure. The country can do this by adopting a “high-road” production system that harnesses everyone’s knowledge—from production workers to top executives—to produce high-quality innovative products.
Promoting high-road strategies will strengthen manufacturing and the U.S. economy as a whole. Through coordination with highly skilled workers and suppliers, firms achieve high rates of innovation, quality, and fast response to unexpected situations. The resulting high productivity allows firms to pay fair wages to workers and fair prices to suppliers while still making fair profits.
How can this be done? Start with more investment in education, training, and R&D. But education alone will not allow firms to overcome the market failures that block the adoption of efficient high-road practices. Nor will it reinvigorate income growth, which even for college-educated men has risen only 0.5% annually since 1973 at the median. Similarly, increased R&D spending by itself won’t get innovative products to market.
More is needed. Competing with low-wage nations is not as daunting as one might think. Research by the Michigan Manufacturing Technology Center suggests that most manufacturers have costs within 20% of their Chinese competitors. Reducing costs by this magnitude is well within the range achievable by high-road programs, and a key institution that can help bridge this gap is already in operation. The federal Manufacturing Extension Partnership (MEP) program teaches companies to develop new products, find new markets, and operate more efficiently—and it pays for itself in increased tax revenue from the firms it helps. This program will not save all the manufacturing at risk, but it will increase the viability of much of it, while increasing the productivity and wages of those who perform this important work.
The low-wage fallacy
Two main forces have caused U.S. manufacturing employment to fall: the growth of productivity during a period of stagnant demand and the offshoring of work to other nations, especially China. Economists differ as to the relative contribution of the two forces, but as Nobel Laureate Paul Krugman argued in the Brookings Papers on Economic Activity, there is growing consensus that both are important.
Two groups of policy analysts argue that nothing should be done about the stunning fall in manufacturing employment, but for opposite reasons. One group, exemplified by a 2007 study by Daniel Ikenson of the Cato Institute, argues that the employment decline is a sign of soaring productivity, and that manufacturing is actually “thriving.” Another view, exemplified by New York Times columnist Thomas Friedman, says it is simply impossible to compete with countries whose wages are so much lower than ours. It is inevitable, he argues, that manufacturing will go the way of agriculture, employing a tiny fraction of the workforce.
Neither of these views is correct. Although U.S. manufacturing is not thriving, with appropriate policies it could be. First, there are problems with the Cato study’s statistical analysis. Second, a significant number of firms are holding their own, and more could do so with appropriate policies.
The Cato study says that U.S. manufacturing output reached an all-time high in 2006, but it fails to subtract the value of imported inputs. When one looks at manufacturing value added, even Cato’s data show that output has fallen since 2000. And even these data, drawn from U.S. government sources, paint far too rosy a picture because U.S. statistical agencies do not track what happens to goods outside U.S. borders. The result of this limitation (and of some complex statistical interactions) means that official statistics could be substantially overestimating growth in manufacturing output.
U.S. firms can and do compete with China and other low-wage countries, in part because direct labor costs are only 5 to 15% of total costs in most manufacturing. Many U.S. firms have costs not so different from those of Chinese firms. Therefore, it is not naïve to think that manufacturing can and should play an important role in the U.S. economy during the next several decades.
A 2006 study by the Performance Benchmarking Service (PBS) suggests that most small U.S. manufacturers are competitive with Chinese firms or could become so. Similarly, a 2004 McKinsey study found that in many segments of the automotive parts industry, the “China price” is only 20 to 30% lower than the U.S. price for a similar component. Note that neither this study nor the PBS study takes into account most of the hidden costs discussed below. Thus, low-wage countries are not necessarily low-cost countries. U.S. companies can continue to pay higher wages for direct labor and offset the added cost with greater capabilities—capabilities that lead to outcomes such as higher productivity, fewer quality problems, and fewer logistical problems.
Unfortunately, firms are handicapped in deciding where they should locate production because they often do not take into account the hidden costs of offshoring. A number of studies have found that most firms, even large multinationals, use standard accounting spreadsheets to make sourcing decisions. These techniques focus on accounting for direct labor costs, even though these are a small percentage of total cost, and ignore many other important costs.
Consider some of the hidden costs of having suppliers far away. First, top management is distracted. Setting up a supply chain in China and learning to communicate with suppliers requires many long trips and much time, time that could have been spent on introducing new products or processes at home. Second, there is increased risk from a long supply chain, especially with just-in-time inventory policies. Third, there are increased coordination and “handoff costs” between U.S. and foreign operations. More difficult communication among product design, engineering, and production hinders serendipitous discovery of new products and processes. Quality problems may be harder to solve because of geographic and cultural distance. Time to market may increase.
These costs can be substantial: One study by Fanuc, a robotics manufacturer, found that they added 24% to the estimated costs of offshoring. The challenges of dealing with a far-flung supply base make it difficult for firms to innovate in ways that require linked design and production processes. For example, one Ohio firm had based its competitive advantage on its ability to quickly add features to its products (cup holders in riding mowers, to take a nonautomotive example). But when they sourced to China, these last-minute changes wreaked havoc with suppliers, and the firm was forced to freeze its designs much earlier in the product development process.
Why would firms systematically ignore these costs? One reason is to convince outside investors that the company is serious about reducing costs by taking actions that are publicly observable, such as shutting factories in the United States and moving to countries with demonstrably lower wages. However, as the U.S.-China price differential shrinks because of exchange rate revaluations, higher Chinese wages, and increased transportation costs, firms (such as Caterpillar) are turning more to suppliers closer to home.
Many U.S. firms can close the remaining cost gap with low-wage competitors. Some firms are already doing so, and there is evidence that a few widely applicable and teachable policies account for much of their success.
For example, in the metal stamping industry, a firm at the 90th percentile has a value added per worker of $125,000—a large enough pie to pay workers well, invest in modern equipment and training, and earn a fair profit. In contrast, the median firm has a value-added per worker of about $74,000 per year. This is barely enough to pay the typical compensation for a worker in this industry (about $40,000) and still have money left for equipment and profit. This differential in performance is typical: The PBS consistently finds that the top 10% of firms have one and a half times the productivity of the median firms, even within narrowly defined industries. Moreover, the same practices (designing new products, having low defect rates, and limiting employee turnover) explain much of the differential in productivity across a variety of industries.
Building high-productivity firms
U.S. firms cannot compete by imitating China by cutting wages and benefits. Instead, they should build on their strengths by drawing on the knowledge and skills of all workers. Many of this country’s high-productivity firms prospered by adopting a high-road production recipe in which firms, their employees, and suppliers work together to generate high productivity. Successful adoption of these policies requires that everyone in the value chain be willing and able to share knowledge. Involving workers and suppliers and using information technology (IT) are key ways of doing this.
Workers, particularly low-level workers, have much to contribute because they are close to the process: They interact with a machine all day, or they observe directly what frustrates consumers. For example, a study of steel-finishing lines by Casey Ichniowski, Kathryn Shaw, and Giovanna Prennushi found that firms with high-road practices had 6.7% more uptime (generating $2 million annually in net profits for a small plant) than did lines without them. The increase in uptime is due to communication and knowledge overlap. In a firm that does not use high-road practices, all communication may go through one person. In contrast, in high-road facilities, such as the one run by members of the United Steelworkers at Mittal Steel in Cleveland, workers solve problems more quickly because they communicate with each other directly in a structured way.
Involving suppliers is also important. Take, for example, the small supplier to Honda that had problems with some plastic parts. On an irregular basis, parts would emerge from molding machines with white spots along the edge of the product or molds not completely filled in. These problems, which had long plagued the company, were not solved until Honda organized problem-solving groups that pooled the diverse capacities and experiences of people in the supplier’s plant. They quickly solved the problem. Molding machine operators noticed condensation dripping into the resin container from an exhaust fan in the ceiling, quality control technicians then saw that the condensation was creating cold particles in the resin, and skilled trade people designed a solution.
The continuing use of IT will be critical in improving manufacturing practice, but it will not necessarily boost productivity unless it is accompanied by a decentralization of production, a key element of high-road production. For example, a study by Ann Bartel, Casey Ichniowski, and Kathryn Shaw of valve producers found that more-efficient firms adopted advanced IT-enhanced equipment while also changing their product strategy (to produce more customized valves), their operations strategy (using their new IT capability to reduce setup times, run times, and inspection times), and human resource policies (employing workers with more problem-solving skills and using more teamwork). The success of the changes in one area depended on success in other areas. For example, customizing products would not have been profitable without the reduced time required to change over to making a new product, a reduction made possible both by the improved information from the IT and the improved use of the information by the empowered workers. Conversely, the investments in IT and training were less likely to pay off in firms that did not adopt the more complex product.
A key reason why the high road’s linked information flow is so powerful is that real production rarely takes place exactly according to plan. A manufacturing worker may be stereotyped as someone who pushes the same button every 20 seconds, day after day, year after year, but even in mature industries, this situation rarely occurs. For example, temperatures change, sending machines out of adjustment; customers change their orders; a supplier delivers defective parts; a new product is introduced. All of these contingencies mean that the perfect separation of brain work and hand work envisioned by efficiency guru Frederick Taylor does not occur.
In mass production, managers have often tried to minimize these contingencies as well as worker discretion to deal with them. In contrast, the Toyota production system, which accepts that the very local information that workers have is crucial to running and improving the process, sets up methods for the sustained and organized exploration of that information. Although these methods require substantial overlap of knowledge and expertise that may seem redundant, they produce substantial benefits.
For example, at Denso, a Japanese-owned supplier in Battle Creek, Michigan, someone approved a suggestion that a supplier be able to deliver parts in standard-size boxes, thus reducing packaging costs. Although these boxes were only two inches deeper than the previous boxes, the difference created a significant problem. Denso’s practice (following the just-in-time philosophy) was that a worker would deliver the boxes from the delivery truck directly to a rack above the line. The worker who assembled these parts had to reach up and over and down into the box an extra two inches 2,000 times per shift, which proved quite painful. The situation was corrected quickly, because of an overlap of knowledge. Denso had a policy that managers worked on the line once per quarter, and the purchasing manager had done that job in the past. Thus, the worker knew whom to contact about the problem (since she had worked next to him for a day), and the purchasing manager understood immediately why the extra two inches was a problem. He directed the supplier to go back to the previous containers. In a world of perfect information, Denso’s rotation policy would be a waste of managerial talent; but in a world in which much knowledge is tacit and things change quickly, the knowledge overlap allowed quick problem identification and resolution.
This high-road model of production provides an alternative to the current winner-take-all model, with corporate executive “stars” at the top supported by workers considered to be disposable at the bottom. In this view, there are no jobs that are inherently low-skill or dead-end.
Diffusing high-road practices
The practices discussed above are not new. In response to the Japanese competitive onslaught in the 1980s and 1990s, some U.S. manufacturers had begun to use them. But they have not been as widely adopted as they could be.
Markets alone fail to provide the proper incentives for firms to adopt high-road policies for two main reasons. First, the high road works only if a company adopts several practices at the same time. It must improve communication skills at all levels, create mechanisms for communicating new ideas across a supply chain’s levels and functions, and provide incentives to use them. Merely getting the prices right (adding taxes or subsidies to correct for market failures) is not sufficient to build these capabilities. Instead, it makes sense to provide technical assistance services to firms directly.
Second, many of the benefits of the high-road strategy accrue to workers, suppliers, and communities in the form of higher wages and more stable employment. Profit-maximizing firms do not take these benefits into account when deciding, for example, how much to invest in training. Many firms will provide less than the socially optimal amount of general training because they fear trained employees will be hired away by other firms.
For these reasons, there is a theoretical case that government services could outperform competitive markets in promoting high-road production. There is also practical evidence that this potential has in many cases been realized.
MEP has had significant success in helping manufacturers overcome many of these problems. Established in 1989 as part of the National Institute of Standards and Technology, the program was loosely modeled on the agricultural extension program. There are manufacturing extension centers in every state, providing technical and business assistance to small and medium-sized manufacturers. The centers help plants adopt advanced manufacturing technologies and quality-control programs, as well as develop new products. For example, the Wisconsin Manufacturing Extension Program has provided classes and consultants to help firms dramatically reduce their lead times (the time from order to delivery). A study by Joshua Whitford and Jonathan Zeitlin found that participants have cut their lead times by 50% and their inventory by 70%, improving their profit margins substantially while also improving performance for their customers.
Several in-depth studies have found that MEP pays for itself in increased tax revenue generated by the firms it serves. However, MEP remains a tiny program; its budget for fiscal year 2008 is only $90 million, less than $7 per manufacturing worker. This low level of funding makes it difficult for MEP to subsidize its services enough to capture their true social benefit. Currently, only marketing and facility costs are subsidized; this (very approximately) works out to be about a 33% rate of subsidy for first-time clients. Firms pay market rates for services actually delivered, meaning that they often buy services piecemeal when they have some extra cash. An increased rate of subsidy would allow the MEP to reach out with an integrated program to small firms that lack the capability to plan a coherent change effort. Such a program would enable MEP to teach skills such as brainstorming and problem-solving to a wider audience.
A market for private consultancy services to teach lean production has developed, but a 2004 study by Janet Kiehl and myself found that these consultants do not obviate the need for MEP. First, consultants tend to focus on areas that provide a quick cash return (such as one-time inventory reductions) rather than longer-term capability development (whose payoff would be harder for consultants to capture). Second, consultants are in practice a complement to MEPs, not substitutes. The reason is that MEPs expand the market for the outside provision of expertise by providing evaluations of firms, exposing firms to new ideas, and providing referrals to vetted consultants.
MEP could be even more effective if its scope were expanded so that it could link together the disparate skills that firms must learn to master high-road production. Some of these programs are already under way, but only on a pilot basis. Below are some key priorities:
Organize training by value chain in addition to focusing on individual firms. In the Wisconsin example above, the training was developed and candidate firms identified in conjunction with six large customer firms, including John Deere and Harley Davidson. This supply chain modernization consortium trains supplier firms in general (rather than firm-specific) competencies and promotes mutual learning by harmonizing supplier certification and encouraging cross-supplier communication. This framework meets diverse supplier needs through multiple institutional supports. For example, having customers agree on training priorities and encouraging suppliers to apply what they learn in class helps suppliers retain a focus on long-term improvement rather than short-term firefighting.
Include training on manufacturing services, because a key part of what high-productivity manufacturing firms offer is not just production itself but also preproduction work (learning what customers want and designing the products) and postproduction work (delivering goods just in time and handling warranty issues efficiently). These additional activities are often more tied to the location of consumers, who (at least for now) are usually in the United States. These activities also benefit from close linkages within and between plants. For example, skilled production workers and trade people can ramp up the production of high-quality products more quickly, produce more variety on the same lines, reduce lead times for customized products, reduce defects, and so forth.
Develop new products and find new markets. This is an especially important type of manufacturing service. These skills help high-road firms avoid competing with low-wage commodity producers. They also enable firms to make use of the additional capacity freed up by “lean” initiatives. MAGNET (the MEP center in Northern Ohio) has had significant success in this area. It employs a staff of 15 (plus four subcontractors) that can take a small company through all steps of the product development process. The MAGNET staff draws on ideas from several industries and technologies to help develop a diverse array of products, such as a light fixture that can be easily removed from the ceiling to enable bulb-changing without a ladder and a HUMVEE engine that can be replace in one hour, rather than the previous standard of two days.
Other possibilities include creating a national standard for evaluating the total cost of acquisition for components and teaching firms how to use energy more efficiently.
Creating discussion forums
High-road production techniques have been codified and shown to work. But this process of codification takes a long time. How will the next generation of programs be developed? In addition, the exact ingredients of the high-road recipe vary by industry and over time. Thus, it is useful to have forums for discussion so that industry participants can make coordinated investments, both subsidized and on their own. The forums could elicit the detailed information necessary to design good policies, thus avoiding government failure. However, organizing the forums is subject to market failures, because the benefits of coordinated investment are diffuse and thus hard for a profit-making entity to capture.
Federal and state governments could establish competitive grant programs in which industries compete for funding to establish such forums. Also, MEP should encourage cities and regions to apply to create such forums. A large literature, including case studies and statistical work, has found that firms concentrated in the same geographical area (including customers, suppliers, rivals, and even firms in unrelated industries) are more productive. The advantages of geographical proximity include the ability to pool trained workers and the ease of sharing new ideas. These advantages can be magnified if institutions are created that organize these exchanges, facilitating the communication and development of trust.
Several prototypes of these discussion forums already exist in a number of stages of the value chain, including innovation (Sematech), upstream supply [the Program for Automotive Renaissance in Tooling (PART) in Michigan], component supply (Accelerate in Wisconsin), and integrated skills training (the Wisconsin Regional Training Partnership and the Manufacturing Skills Standards Council).
PART includes communities, large automakers, first-tier suppliers, and small tool and die shops. Its membership reflects how much of manufacturing is organized today, with large firms outsourcing work to smaller suppliers, who remain geographically concentrated. The program, funded by the Mott Foundation, coordinates joint research among members and provides benchmarking and leadership development for small firms. It helps organize “coalitions” of small tooling firms that do joint marketing and develop standardized processes. The state of Michigan offers significant tax breaks for firms located in a Tooling Recovery Zone.
A bill to encourage the formation of discussion forums was introduced by U.S. Senators Sherrod Brown (D-OH) and Olympia Snowe (R-ME) in the summer of 2008. Called the Strengthening Employment Clusters to Organize Regional Success (SECTORS) Act, the legislation would provide grants of up to $2.5 million each for “partnerships that lead to collaborative planning, resource alignment, and training efforts across multiple firms” within an industry cluster.
Expanding MEP and creating discussion forums would cost about $300 million. I have calculated that if just half the firms increase their productivity by 20% as a result (the low estimate from Ronald Jarmin’s study of MEP’s effectiveness) and can therefore compete with China, the United States would save 50,000 jobs at a cost of only $6,000 per job, a cost that would be offset by increased tax revenue. This $300 million is a tiny amount of money. State and local governments currently spend $20 to $30 billion on tax abatements to lure firms to their jurisdictions. That spending generally does not improve productivity. Moreover, it is much cheaper to act now to preserve the manufacturing capacity we have than to try to reconstruct it once it is gone.
This $300 million expenditure can also be compared with that for agricultural extension: $430 million in 2006 for an industry that employs 1.9% of the workforce and produces 0.7% of gross domestic product (GDP). In contrast, manufacturing is 10% of the workforce and 14% of GDP.
Paving the high road
A number of observers have noted the fragility of high-road production in the United States. Cooperation, especially between labor and management, may flourish for a while but then collapse, or cooperation may be limited because management wants to keep its options open regarding the future of the facility. Low-road options (either in the United States or in low-wage nations overseas) remain attractive to firms, even if they impose costs on society. After a few failures, unions often become reluctant to trust again. Similar problems plague customer/supplier relations.
Therefore, we must look at broader economic policies that affect the stability of the high road in manufacturing and in other sectors. These policies can be divided into those that “pave the high road” (reduce costs for firms that choose this path) and those that “block the low road” (increase costs for firms that choose the low road, thus reducing their ability to undercut more socially responsible competitors).
Some examples of policies that pave the high road are universal health care, increased funding of innovation, and investments in training. Some policies that block the low road would be including in trade agreements protections for workers and the environment and strengthened safety regulations for workplaces and consumer products. Implementing these policies would require large investments but would benefit the entire economy, not just manufacturing.
Coordinated public effort to develop productive capabilities in the United States is an effective way of confronting the twin problems of shrinking manufacturing and stagnant income for most U.S. workers. With the right policies, the United States can have a revitalized manufacturing sector that brings with it good jobs, rapid innovation, and the capacity to pursue national goals.
Rather than abandon manufacturing, the nation can transform it into an example for the rest of the economy. The rationale for high-road policies is applicable to most industries in the United States. The policies outlined here could ensure that all parts of the economy remain strong and that all Americans participate in a productive way and reap the rewards of their efforts.
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Susan Helper (firstname.lastname@example.org) is the AT&T Professor of Economics at the Weatherhead School of Management, Case Western Reserve University.