Market Watch

This is a now or never moment to make US manufacturing more competitive

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As U.S. factories struggle to keep up with reopening-fueled demand—a task made harder by shortages of key components like computer chips—it’s a now-or-never moment to make domestic manufacturing more competitive.

There’s a brief window to reduce American dependence on fragile, overseas supply chains for critical products in areas like healthcare, tech and defense—and create new jobs to power the American economy.

Changing cost structures make this a propitious time to act. Global labor costs have equalized over time. In major industries like autos and machinery, U.S. productivity-adjusted labor costs are comparable to those of other manufacturing leaders in the OECD, such as Germany, Japan, and South Korea.

The McKinsey Global Institute identifies 16 of 30 U.S. manufacturing industries where timely investment could boost U.S. GDP by $275 billion to $465 billion annually, while adding up to 1.5 million direct and indirect jobs and making the nation more productive, competitive and resilient.

The 16 industries range from precision tools to auto parts, from pharmaceuticals and medical devices to semiconductors and communications equipment. What they have in common is their importance in supporting four crucial goals: economic growth, jobs, innovation, and national security. These industries made up $1.46 trillion in GDP in 2019, which is 61.2 % of total U.S. manufacturing GDP ($2.38 trillion) and about 6.8% of total U.S. GDP.

Together, they also represent a chance to reverse two decades of decline: in 1997, U.S. factories accounted for 25% of global manufacturing. Now the U.S. share is just 17%. And that’s despite years of attempts to counter the downward trend. The United States meets just 71% of its final demand with domestic goods, a smaller share than in Germany, Japan, or China. Achieving parity on this front alone could add $400 billion to U.S. GDP, even before considering market opportunities in next-generation products such as electric drivetrains or cell and gene biologics.

The fragmented nature of the U.S. approach—a subsidy or tariff here, some “buy-American” requirements there—has not moved the needle for the sector, nor have market forces alone. Investors simply aren’t providing the capital needed and their time horizons are usually too short.

What is needed is a cohesive strategy, based on the following three principles.

Develop today’s talent for tomorrow’s jobs. Much of what has passed for U.S. industrial policy has focused on saving specific jobs. This is the wrong approach. Sustained productivity growth comes from competitiveness, and that starts with skilled people. As manufacturing is becoming more digitized and automated, higher-level skills are more in demand than ever.

While companies bear the prime responsibility for workforce training, their ability to meet all skill needs is limited.

One area of possible government action has to do with skill certifications, which can differ widely, depending on the state; standardization or greater portability of certifications would could help smooth operations.

Invest where it matters most. To boost financial returns, many manufacturers have turned to cost-cutting, sometimes at the expense of their own long-term needs. Containing costs is necessary, but the result is that companies have skimped on capital investment. The McKinsey Global Institute estimates that the United States needs to invest $15 billion to $25 billion a year for the next decade to upgrade aging plants and equipment. Modernizing existing plants and building new ones could draw much-needed investment into communities that haven’t attracted investment by the tech or finance industries.

The United States has typically refrained from direct support to industry, and when governments seek to pick winners, they sometimes back losers. Still, it is worth studying what other countries do, and considering whether specific programs can be adapted.

For example, many overseas manufacturers can access long-term capital through national institutions like Germany’s KfW and the Japan Finance Corp.; the United States has nothing comparable. Other countries also subsidize upfront costs in strategic industries so that private capital can earn a return. Designing new types of “American-made” public bond offerings, guaranteeing demand through government procurement and encouraging investment from international sources willing to accept lower returns than U.S. investors are other possibilities.

Bolster the domestic supplier base. Large plants rely heavily on imported content and components, which makes it even more difficult for America’s supplier base of small- and medium-size enterprises (SMEs) to keep going or to attract capital. Since 1997, SME operating margins have fallen 20%, and about 15% have shut down, creating gaps in critical supply chains.

Policies to consider include capital access programs, business accelerators, tax incentives,and scaling up regional technology institutes. Other countries provide inspiration here as well, including Canada’s support of technology access centers at colleges and universities, and Singapore’s Productivity and Innovation Credit Scheme. The latter provides a 400% tax allowances for investments in automation, workforce development or intellectual property. Germany spends eight times as much on technical and business support to manufacturing SMEs as the U.S. Manufacturing Extension Partnership.

Larger manufacturers can also step up. It is often in their interest, particularly in an age of customization, to have access to domestic suppliers. They can work to build stronger relationships, for example by investing in SMEs’ talent and capabilities, partnering with them to find new opportunities and connecting with them to share real-time data. Research has found that companies that collaborate effectively with their suppliers have above-average profit margins.

The case to strengthen U.S. manufacturing is simple: making things matters—to fortify resilience, heighten competitiveness, and improve standards of living. A competitive and diversified manufacturing sector not only fuels the economy in good times but helps to keep it functioning during a crisis.

The United States does not, of course, have to make everything, but it has a strong interest in fostering the strong, diversified and inclusive economy that can serve the nation’s needs.

This article first appeared in Market Watch.