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'Made in America' Is Not the Way Out

Author: Jagdish N. Bhagwati, Senior Fellow for International Economics
August 9, 2010
Financial Times

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President Barack Obama, addressing car workers recently at a GM plant in Michigan, defended his administration's motor industry bail-out, saying that it had rescued "the heart and soul" of American manufacturing, that "has been a symbol of our economic power". Mr Obama's words are only the latest in a new movement embraced by manufacturing chiefs and politicians alike--the new fetish for manufacturing.

Thus Jeffrey Immelt, the otherwise thoughtful chief executive of General Electric (a predominantly manufacturing company), proposed in July that the US have a new national goal to ensure "manufacturing jobs be no less than 20 per cent of total employment, about twice what it is today". Congressional Democrats recently launched their "make it in America" agenda, passed a manufacturing enhancement act and set up a commission to promote manufacturing.

This new fascination with manufacturing is a direct consequence of the financial crisis. The crisis began on Wall Street, so many conclude that the financial services sector is socially harmful or over-expanded and needs to be restricted. By contrast, it seems logical that manufacturing is both socially useful and ought to be larger.

But even if it were true that the financial sector must be curbed, it would not follow that manufacturing must be expanded. There are justifiable controversies regarding how to measure the value of the financial services sector. Paul Volcker, the former Federal Reserve chairman, famously remarked that the only socially productive financial innovation has been the ATM. But this is a witticism, not the truth. Certainly, some financial innovations, such as credit default swaps, can cause huge downside. This does not tend to happen with non-financial innovation. But non-financial services that are also non-industrial--Fedex, for example--should be equally prominent claimants for expansion.

In framing policy, we need to take into account that, in the US, all states compete to attract manufacturing industries by offering lucrative tax holidays, free land and other subsidies. Hardly any states--except New York, which is a financial centre and wants to keep it that way vis-à-vis a potential competitor such as New Jersey--compete to attract financial groups. Yet these huge subsidies to manufacturers are rarely added to the social cost of industrial bail-outs, such as those that Mr Obama praised for GM and Chrysler even though Chrysler had been bailed out twice already in its recent history. If you do add them, and compare their sum to the total social cost of the financial crisis, the picture is no longer one of unabashed mollycoddling of the financial sector and neglect of the manufacturing sector.

The flawed case for manufacturing is embellished by several subsidiary fallacies. Richard McCormack, editor of Manufacturing & Technology News, wrote at the beginning of the crisis: "Without an industrial base, an increase in consumer spending ... will not put Americans back to work." Yet why should the composition of output in favour of manufacturing industries matter so critically for employment creation? Increasing demand for those non-tradeable services that need suppliers and users to be close together--as, for example, with nursing and retirement homes--should have just the same effect on employment.

Underlying the current prejudice is the unwarranted presumption that manufacturing industries are technically more innovative than both services and agriculture. Yet agriculture had hybrid corn, the seeds that (at the time of the green revolution) helped growth in developing countries, while genetically modified seeds hold the same promise today. Equally, in services, innovation has transformed the retail and communications sectors--whether at DHL or Tesco.

In policy, sometimes Gresham's Law operates--with bad policies driving away good ones. With no good argument in its favour, a preoccupation with manufacturing industries threatens yet one more example of such a perverse outcome. By promoting manufacturing of all kinds (as can be expected as the sector's lobbies get down to work) at the expense of more innovative and dynamic service sectors, precisely when America is faltering in its recovery from the crisis, this unhelpful fascination promises to inflict gratuitous damage on an economy that can ill afford new wounds.

This article appears in full on CFR.org by permission of its original publisher. It was originally available here.

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