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A Wake-Up Call for Manufacturing

5/7/2012 --

Study co-authored by Michigan Ross professors says it's a critical time for the future of U.S. manufacturing.

View Study (pdf)

ANN ARBOR, Mich. — A recent uptick in U.S. manufacturing has optimists hoping a lost decade that saw steep employment drops in the sector is coming to an end.

Productivity is up, a relatively cheap dollar is boosting exports, and the wage gap between the U.S. and China is shrinking. Some companies are repatriating operations from overseas.

But a huge portion of U.S. manufacturing, as much as 40 percent, hangs on a knife's edge and could either stay in this country or go elsewhere in the coming years based on policy decisions, according a study by the Tauber Institute for Global Operations and consulting firm Booz & Co.

How the U.S. shapes education policy, worker training, the tax code, the regulatory environment, and its relationship with Mexico will determine whether manufacturing continues to rebound or spirals into permanent decline, say Michigan Ross professors Wally Hopp and Roman Kapuscinski, co-authors of the Booz study Manufacturing's Wake-Up Call.

The potential gains are huge, and manufacturing still is ripe for a rebound. U.S. factories produce about 75 percent of what the country consumes, according to the study. The right decisions by both business and political leaders could push that to 95 percent. The wrong decisions could drive it below 40 percent. Manufacturing directly accounts for 11 percent, or $1.47 trillion, of U.S. GDP. That rises to 15 percent of GDP when including economic activity directly linked to manufacturing.

"This study says there's an opportunity," says Hopp, associate dean of faculty and research and Alessi Professor of Operations and Management Science. "U.S. manufacturing has declined, but we are not structurally out of the game. Manufacturing is still here, it's big, and it's helping us out right now. Manufacturing matters; that's why this is an inflection point. We have almost 40 percent of the sector sitting on the bubble. It could stay here, it could go somewhere else. Are we going to line up enough factors to keep it here, or will we let it trickle away like we did during the lost decade of 2000-10?"

More than Wages

Contrary to popular myth, U.S. manufacturing held its own until about 2000. Then employment levels dropped as the trade deficit increased. Low-skill jobs were lost due to productivity gains and offshoring, and investment in new facilities lagged.

But high wages don't fully explain the U.S. phenomenon. Germany also has high wages, but enjoys a higher export rate and hasn't seen similar manufacturing declines. It turns out wages are just one factor of many when companies decide where to build factories. Just as important are worker skill level, the presence of industry clusters, nearby emerging consumer markets, and competitive regulatory and tax rules.

"Germany was aware of all of this and was much more active in manufacturing policy than was the U.S.," says Kapuscinski, professor of operations and management science and Goff Smith Co-director of the Tauber Institute for Global Operations, a partnership between Michigan Ross and the U-M College of Engineering. "Germany had more than 10 years of serious discussion that translated into policy changes. With 40 percent of the sector in the U.S. in the balance, relatively small changes in these policy areas could push the needle in one direction or another."

An issue that looms particularly large in the U.S. is finding technically trained production workers such as machine operators and maintenance specialists. Low-skill jobs may be disappearing, but high-skill ones are not. Since 1980 the number of high-skill manufacturing jobs in the U.S. has increased by about 40 percent despite a drop in total manufacturing employment.

The U.S. risks becoming a country with wide divergence between rich skilled workers and poor unskilled workers, Hopp says. Industry leaders surveyed by the study's authors confirmed that technically savvy production workers are hard to find in the U.S. but are more abundant in other countries.

The issue of worker skill increasingly will become a critical policy issue as factories become more automated and driven by new and rapidly evolving technology.

All Roads Lead to Education

Education was the ace in the hole for the U.S. for nearly a century. The country enacted compulsory education far earlier than most others and used that advantage to become a manufacturing powerhouse.

But other countries have caught up and passed the U.S. in education. American preoccupation with college preparation has marginalized vocation education and industrial arts programs, according to the study. To meet future employment needs, schools must recover their vocational training roles and also become more adept at vocational guidance to ensure that young people realize the diverse career paths in manufacturing.

"If you talk about manufacturing long enough, all roads eventually lead to education," Hopp says. "A huge determinant of how many manufacturing jobs remain in the U.S. will be our ability to create a skilled workforce."

One success story is South Carolina, where the ReadySC program invites industrial leaders into community colleges to help shape the curriculum. Executives actively engage with community colleges in shaping coursework and letting students know exactly what skills and classes they'll need for jobs in the state.

In addition to supporting and engaging in the education process, companies need to make the manufacturing industry attractive to young people. The study notes that manufacturing's reputation lags behind other industries among students and graduates, despite the buzz surrounding exciting products like the iPad.

"Modern plants are exciting, technical places to work, but the perception has not caught up with reality," says Kapuscinski.

Policy Matters

While heavy government intervention in business isn't encouraged by executives, lawmakers can help create a stronger environment for manufacturing.

The U.S. has the second-highest statutory corporate tax rate – 39 percent – among countries in the Organization for Economic Cooperation and Development. The actual rate paid by companies varies thanks to deductions and other tax rules. But most businesses use the 39-percent statutory rate when evaluating options. The current complicated code also adds compliance and tax strategy costs.

Hopp says the current structure is "the worst of both worlds" because the U.S. loses operations to other countries and doesn't collect the full tax rate. A simpler code with a tax rate in line with other industrialized nations would help manufacturing grow and boost revenue.

Regulatory compliance also is a sore spot with manufacturers in the U.S., mostly because of the time it takes to get through the process. South Carolina, again, demonstrates that government can streamline the process, keep the same rules and penalties in effect, and get companies permits in half the time – or less – than some other states.

"The knee-jerk reaction is that we're going to sacrifice worker safety or the environment when we streamline regulations," says Hopp. "That doesn't necessarily follow. You can still measure and hold companies accountable. The main complaint from firms isn't that the regulations are too strict. It's that they're too slow, too complicated, and the agencies are not responsive to the competitive needs of industry."

The U.S. also needs to build a stronger relationship with Mexico. While some low-skill operations will be sent offshore every year, keeping them closer will allow R&D and engineering jobs to stay stateside. “More of those types of jobs have followed low-skill manufacturing to Asia than initially estimated,” says Kapuscinski.

But Mexico isn’t an easy fix. Drug cartel violence along the border has made moving goods, people, and services more difficult. The country also has subpar infrastructure and needs better access to commodities, some of which could come from the southern U.S. Government and business leaders need to address these problems in a collaborative way because the payoff could be huge, the study says.

"If you could push a button and solve some of the problems with Mexico, that would really benefit both countries," says Hopp. "Ross Perot had the famous quote during the NAFTA debate about that giant sucking sound of jobs going to Mexico. That's the wrong way to look at this. Jobs are not a zero-sum game. That argument also assumes low-skill jobs would stay in the U.S., if not for Mexico. But that's not true. They would just go someplace else. Look at Germany. The rise of Poland has not caused German manufacturing to decline."

Another good government policy would be to encourage industry clusters, the study notes. Silicon Valley, Detroit, Hollywood, and Seattle are examples of industry clusters that have created thousands of jobs and tremendous revenue. Government can concentrate on infrastructure development in areas where organic centers of industry have begun to sprout.

These policies may seem like a lot to line up, but they constitute a series of small steps that can determine if the U.S. enjoys more global manufacturing power or sees a continued decline.

"BMW's plant in South Carolina ships its product all over the world, so the company could have put the plant anywhere it wanted," Hopp says. "Where is it? In the United States. That tells you it's possible. But all those variables have to line up to make that work. In the presidential campaign, manufacturing has emerged as an important issue. The candidates are all talking about it. This is a big chance."

—Terry Kosdrosky



For more information, contact:
Terry Kosdrosky, (734) 936-2502, terrykos@umich.edu