In December 2012, the Information Technology and Innovation Foundation (ITIF) issued a report titled Why America Needs A National Network for Manufacturing Innovation. The report asserts, among many other things, that “[t]he federal government must play a catalytic role in bringing NNMI into existence.”
My own view of government precludes me from sharing the ultimate goal of a government should initiate a National Network for Manufacturing Innovation (NNMI). I tend toward the Jeffersonian view of government — that government which governs least governs best. I am also a big believer in the power of incentives. In all walks of life what is obtained is what is incentivized. If employees know how they will be evaluated, for example, even a mediocre employee can achieve high marks by performing tot the evaluation. Tax policy is another excellent example, as is the patent system.
For better or for worse, the United States has not incentivized manufacturing. In fact, the incentives associated with manufacturing are to off-shore manufacturing rather than do it in the United States. There are too many bureaucratic hurdles to opening a business in the U.S., particularly a manufacturing facility. Anyone who doubts this needs to read Great Again: Revitalizing America’s Entrepreneurial Leadership.
Despite the lower labor costs in China, for example, the overall advantage associated with Chinese manufacturing is remarkably small. The cost of labor is approximately 7% of the overall cost, so even if China has a 50% advantage that is not nearly as large a benefit when you factor in shipping products and the potential for unrest given a Communist government historically prone to crackdowns and a growing middle class that will demand more and more to be happy. But China also offers tax incentives to businesses, which adds to the Chinese advantage. See Tax Policy Makes U.S. Uncompetitive, Not China’s Low Wages.
Thus, I don’t believe the federal government needs to coordinate a program or embark upon studies by some blue-ribbon panel. What the federal government needs is to institute a meaningful and coherent National Manufacturing Policy that offers tax incentives to manufacturers in the U.S. The federal government also needs to substantially lessen regulatory burdens. Through simple legislative reforms America could be made to be extremely competitive. Factor in that U.S. workers are dedicated and produce high-quality products, that the products don’t need to be shipped across the world to distribute and that civil unrest is extraordinarily unlikely in the U.S., and it is easy to envision a future where manufacturing returns to America to some appreciable degree.
Despite the fact that I differ philosophically on how the government should be involved, the report of the ITIF hit the nail squarely on the head in a number of critical areas. Anyone who is seriously interested in revitalizing American manufacturing should absolutely read the report, and you should read Great Again.
What follows are some of the highlights of the ITIF report, together with some observations of mine.
U.S. Manufacturing by the Numbers
While it is wonderful to see more manufacturing jobs returning to the U.S., it is critical to not be mislead about the significance of the numbers. The report explains:
Over the past three years, the U.S. economy created about 500,000 net new manufacturing jobs. Considering that the last time manufacturing employment expanded for even a single year was in the 1990s, that ought to be cause for celebration. But while this is good news, American manufacturing is hardly out of the woods. The decline in this sector in the intervening decade—the closure of 17 manufacturing establishments per day; the loss of 5.8 million manufacturing jobs; and an 11 percent decline in manufacturing output (when properly measured)—was so severe that the recent recovery barely begins to undo the damage.
In fact, the United States needs to take a new approach to manufacturing, one that comes to grips with the rapidly evolving economic landscape of the 21st century. American factories and American workers face stiff international competition across the full spectrum of manufacturing industries, from old to new, low-tech to high-tech. To overcome its challenges, American institutions will have to collaborate in ways that they generally have not in the past: across levels of government, within industries, up and down supply chains, and spanning the boundaries that separate production, research, and training.
Later the report directly says: “Policymakers must accept that U.S. manufacturing is in bad shape and that something should be done about it.”
Invent Here, Produce There Syndrome
The report recognizes that by outsourcing manufacturing has eroded America’s ability to sustain innovation. The report explains:
The United States excels at generating radical new technologies and spawning companies that bring them to market. But the nation’s ability to sustain innovation after these breakthroughs and to foster incremental improvements in manufacturing processes and systems of production has eroded. The story in this area is similar to the one in the skills area. U.S. manufacturers that once willingly took the risks of introducing and debugging new processes are less willing to do so now. The expected returns to individual manufacturers from taking such risks have declined as competition has intensified. Many have outsourced production in response. Yet upgrading domestic production facilities through process innovation has spillovers that benefit other firms in the industry and associated regional clusters. And once production migrates, it’s very hard to re-establish. Computer hardware, composite materials, and automobile components are just a few of the complex products that have been subject to the “invent here, produce there” syndrome. Collaboration among the beneficiaries of manufacturing innovation would help to stem the tide.
This theme was also specifically discussed in Great Again, in far greater detail. In January 2011, prior to Great Again being published, author Hank Nothhaft spoke at the Innovation Alliance conference. Prior to retiring recently, Nothhaft was former President and CEO of Tessera. This Marine Captain was a serial start-up CEO who experienced great success in Silicon Valley throughout his career. He told the assembled conference:
For 30 years now we have all been fed the carefully cultivated myth, that so long as America did the creative work, the inventing, then we can let other nations like China do the so called grunt work, the manufacturing. Simply, we would think; they would sweat. So we let manufacturing go and in so doing we lost the greatest economic force mulitplier in history. For manufacturing not only supplies middle class incomes to the three-quarters of all Americans without a college degree, it also creates up to 15 additional jobs outside of manufacturing for every position on the factory floor.
We also know that there is much innovation that occurs after the initial scientific breakthroughs or discovers. We know that early stage discoveries, breakthroughs and innovations rarely, if ever, scale up neatly. Thus, there are numerous innovations that occur after discovery and initial innovation on the manufacturing floor. So when we innovate here in the U.S. and outsource manufacturing those follow-on discoveries and innovations are owned by those outside the U.S. That means over time we will be a second class inventor nation, capable of only early stage breakthroughs and subordinate to the innovations of those who manufacture. Thus, we will lose our intellectual property advantage and we will have fewer jobs to show for it. This is why we need a coherent and comprehensive national manufacturing policy. The role of government is to set the rules and then get out of the way. It is time the government get about doing both if you ask me.
Innovation Means Doing Something New and Different
The ITIF report explains:
Many people associate innovation with basic research and the transfer of technology invented as a result of basic research from the lab to industry, whether to a start-up or to an established firm. These activities are important, but they are only part of a much larger and more complicated process of innovation. Innovation means doing something new and different in practice. Having new knowledge available is just one potential starting point for changing real-world operations. Innovation also encompasses skills, methods, and equipment that must be integrated with novel production processes and new products. Moreover, the innovation process may encompass the implementation of new and different business models, methods of supply chain integration, managerial techniques, workforce skills, and more. Indeed, “significant” innovation that is timely enough to provide a competitive advantage in manufacturing will generally require activities across many of these categories.
This should seem entirely obvious, but unfortunately it is anything but obvious. Innovation comes in many shapes and sizes, but at its core, as the report says, “[i]nnovation means doing something new and different…”
For reasons that are beyond my understanding, there are numerous academics and others who want to dismantle the patent system. These folks say that the patent system inhibits innovation, but they have no evidence and ignore history, which clearly demonstrates they are incorrect. If patents inhibit innovation then those places without a patent system, or at least with weak patent rights, should have economies that are growing by leaps and bounds. What you see is exactly the opposite.
These same academics and patent-haters choose to define innovation in a way that ignores that it is about something new and different. They want to absolve those companies that engage in patent infringement by pretending that those who are copying the inventions of others are the true innovators. That is one of the most intellectually disingenuous positions I have ever encountered, and while I try and understand how they can think that I am unable to see even the hint of logic or reason within their viewpoint.
This demonstrates an incredibly important disconnect. If those who are the “intellectual elite” do not even know what innovation truly is how can we hope to address the problem? It is not innovative to copy the work of someone else, and the fact that such an obvious statement needs to be made in a serious way is truly alarming.
There is no reason whatsoever to encourage or incentivize copycats who take innovation of others. In international circles we vilify those countries that have weak intellectual property protection regimes as stealing from innovators and creators, but there is a growing movement in the U.S. to vilify the innovators and creators and exalt as “innovators” those who copy. What bizarro world is this? Talk about market failure!
This brings us to the final point from the ITIF report I want to share; market failures and inadequate incentives. The report explains:
Markets fail to adequately incentivize manufacturing innovation, particularly process innovation. It is widely acknowledged among economists that successful innovations yield benefits for competitors, suppliers, and consumers as well as the innovating firm. These “spillovers” are a disincentive for investment. Many studies show that this disincentive leads private investment in both R&D and capital equipment to fall short of the level that would be optimal for the economy. This market failure particularly affects the approximately 250,000 SME manufacturers which comprise the backbone of U.S. manufacturing and which are shouldering an even heavier load as the supply chains of large firms become more complex.
This market failure particularly plagues the development of new manufacturing processes. New and improved processes are harder to protect using intellectual property rights than innovative products. In addition, at least one study finds that firms invest more in product R&D when they invest more in process R&D. So reducing process R&D also reduces product R&D. As a result, manufacturers under-invest in solving process challenges, particularly those that would help not only multiple firms in an industry, but also multiple industries.
The report is right, it is harder to protect processes than products in the U.S. Processes have been patentable since 1790 and have always been among the most valuable innovations, such as a new and improved method for plowing a field or planting, which would have been regarded as enormously important at the birth of our nation. But irrational fear of patents and the fact that processes can be so important have lead to these enormously important innovations being under protected. As stupid as it sounds, many of those same aforementioned academics and patent-haters believe that if an innovation is to important no patent should be granted.
Let that one sink in for a moment. We are told that trivial innovations shouldn’t be patented, and now we are being told that inventions of great importance are to important to be protected. That can’t make sense to anyone who cares to think about the issue with any depth and intellectual honesty.
We get what we incentivize, and unfortunately that is why manufacturing is hurting so much in America. What is truly sickening is that it doesn’t need to be this way.