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  • Writer's pictureDan Herman

Why Manufacturing is Special. Really.

Those who know my thinking know that I’m not one to forgive our current (CDN) government’s policy on much of anything. However the recent announcement to invest $250 million in automotive innovation is one that I’m not necessarily against, nor is the general focus on the benefits of the manufacturing sector in an economy and thus the call to support it financially. Others, however, are quite fervently against it. Pundit Andrew Coyne calls it “a cultish preference for making things” while professor/economist Livio Di Matteo , who just happens to be a fellow of the right-wing Fraser Institute, calls it a “1930s Soviet-style view of economic development with heavy industry and manufacturing being the high ground of the economics.”

Yet somehow in these articles by two intelligent, well-studied individuals, the two most important factors related to the issue of manufacturing’s role in the economy are not mentioned. Public policy gets made, and unmade, by the coalescence of political will and public opinion so it drives me nuts vexes me that people with influential voices wilfully oversimplify what are ultimately extremely complex issues.

So why is manufacturing important?

1. The multiplier effect – every job or process in an economy, no matter where it’s done by a robot or a cat, has follow-on impacts across the economy, be it to transport final goods, provide inputs, repair or a litany of other services. One can calculate the effect of any industry through what’s called the multiplier, and the analysis of sectoral input-output tables. So what’s special about manufacturing? An overview of the research seems to highlight that manufacturing has a significantly higher multiplier than do other industries. Canadian and American data on this tend to be broadly similar.

Specifically, the US Bureau of Economic Analysis find that “for every dollar in final sales of manufactured products supports $1.40 in output from other sectors of the economy. Manufacturing has the largest multiplier of all sectors.”  And as the chart below shows, the differential between manufacturing impacts and those of other industries is quite significant.[1]

As for the CDN government, it defends its auto investment policy with a multiplier of 3.6! Statscan is far more modest, and more in line with the US BEA, finding a manufacturing sector multiplier of 1.74, just shy of construction and a ways back from agriculture.

Regardless of the specific number, what matters is that  it is significantly positive, and quite a bit more positive than other sectors of the economy. So yes, we could allow market forces to choose whether manufacturing exists in Canada, but in so doing we’d most likely be saying goodbye to those jobs, and to the associated jobs with them. And that leads to the second, more important factor.

2. Innovation – A few years ago Andy Grove said something that then was near-heretical about the way we manage knowledge and production. The former CEO of Intel stated that when companies outsource, and his former company was one that did-so aggressively, they cut not only direct jobs, but also what he called the “chain of experience” that allows ideas, knowledge and skill to connect and allow for technological innovation. Dow Chemical CEO Andy Liveris agreed, noting “where manufacturing goes, innovation inevitably follows.”  But didn’t we think that knowledge would seamlessly integrate itself from anywhere? Apparently it doesn’t.

And these comment aren’t just pity and dramatic anecdotes. Rather, as Harvard Business School professors David Pisano and Willy Shih find in their research, “Once manufacturing is outsourced, process-engineering expertise cannot be maintained, since it depends on daily interactions with manufacturing. Without process-engineering capabilities, companies find it increasingly difficult to conduct advanced research on next-generation process technologies. Without the ability to develop such new processes, they find they can no longer develop new products. In the long-term then, an economy that lacks an infrastructure for advanced process engineering and manufacturing will lose its ability to innovate.” These authors highlight that the view that a jurisdiction can specialize only in high-value research and development and forget about manufacturing “ignores the complex nature of innovation.”

In the late 1970s and early 1980s several American economists started to see these linkages. Two industries, in particular, got attention. Alan Altshuler looked at Japanese vehicle production and highlighted that as production increased in Japan, so too did Japanese patenting activity, and eventually the country emerged as the leading producer of automobiles. John Zysman from Berkeley found that the outsourcing of television production to Japan was followed by Japanese-led innovation on VCRs and hi-def televisions. One can continue past Zysman’s research to show how DVD and CD technology followed. Fast-forward to more contemporary products such as solar technologies and Pisano and Shih see the same process of production-mastery being followed by innovation and design mastery at play.

In short, the connections between thought and process are complex and the belief that manufacturing can be severed without any serious effects on the growth capacity of an economy is quite naïve. Now I suppose someone will comment that I’m against allowing any industry or company to die. This certainly isn’t the case. Rather I’m not opposed to admitting that certain industries are more important as a result of their cross-sectoral impacts and that so long as we ensure healthy competition therein, our public investments may yield positive long-term results.

Now, all this said, let’s be honest, manufacturing isn’t going to solve all of our economic problems. The so-called renaissance of manufacturing in the US is going to be a low-wage, low-employment one. A similar one in Canada would yield about the same. But as the above notes, it might yield important offshoots related to innovation, and even broader ones related to the effect of manufacturing on other domestic industries.

So should we protest government funding of certain industries to ensure their existence in Canada? I certainly think we doth protest too much.  For while it’s great to say we shouldn’t subsidize things and that the market should work itself out, we need to think carefully about the counterfactual (what would happen) and about its short- and long-term effects on employment, innovation and ultimately our long-term ability to compete. Doing so yields a far different vision of what the public interest is related to government support of industry.

[1] This BEA data is actually much more modest than other research sources. The Milken Institute, a non-ideological thintank, found for every job created in manufacturing, 2.5 jobs are created in other sectors. Older research by the left-leaning Economic Policy Institute finds a multiplier of 2.9.

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