Today's date:
Fall 1987

Manufacturing Matters

John Zysman, Stephen Cohen & Harley Shaiken - Zysman and Cohen are professors at the University of California, Berkeley, and co-directors of the Berkeley Roundtable on the International Economy Harley Shaiken teaches at the University of California, San Diego, is an advisor to the United Auto Workers and a national authority on industrial organization.

John Zysman - When Daniel Bell wrote the Post-Industrial Society in 1973, he captured an extraordinary shift in employment statistics - the number of service and white-collar occupations was exploding.

Extrapolating from this data, Bell offered a new vision of our society where information and services would replace manufacturing as the key economic mainstay. But Bell's vision was fundamentally flawed because he failed to realize that society remains driven by its industrial base. Saying manufacturing is unimportant is like saying the foundation of a new skyscraper is unimportant.

The reality is that we are experiencing a transition not from an industrial economy to a service economy, but from one kind of industrial economy to another.

The post-industrial vision also blinded America to the profound changes in the economy, the new international division of labor, and the new technical division of labor that has extended the production process outside the confines of the traditional manufacturing firm.

In the early 1980s, largely under the influence of the postindustrial vision, the trend in economic policy was to encourage knowledge-intensive, high-tech, high-wage service industries as a substitute for the old steel, auto and machine tool factories.

These old industries were experiencing falling wages, layoffs and plant closures in the Midwestern and Eastern "rust belt," and were emigrating offshore to places like Korea, Taiwan and Singapore. Many observers considered this just as well - that we should let the rest of the world do the dirty, low-wage manufacturing, while Americans earned high wages in the crisp, clean service and information economy.

But this way of seeing the American economy overlooked the direct linkages that tightly tie a substantial core of service employment and high-tech to manufacturing. Most high-tech products are producer, not consumer, goods. They are bought to be used either in the products of other industries - like microprocessors in autos - or in the production process involving robots, computers and lasers. Truck production is a good example of this.

A healthy truck manufacturing component in an economy will drive and be driven by a range of high-tech activities such as computer aided design, digital telecommunications, robots and flexible computer controls.

Truck manufacturing also drives some of the most sophisticated, high-value added sectors of the service economy. Such is the case with General Motors' Electronic Data Systems. The software systems and telecommunications GM uses in its production process make it one of the ten top communications companies in the United States today. General Motors illustrates the general case that, because manufacturing needs are so great, the manufacturing process ties the whole economy together.

Manufacturing placed in this new light shows how information processing and services that are utilized for mastery and control of production actually complement, not substitute or succeed manufacturing. Lose manufacturing and we will lose, not develop, high-wage services.

Manufacturing is where the lion's share of the value-added is realized. It is, in other words, where the profits are. Given the dependence of American high-tech firms on the private capital market, manufacturing generates the returns needed to finance the next round of R&D. Unless R&D is tightly tied to manufacturing and to the permanent innovation in production now necessary to keep an edge over competitors, R&D will fall behind.

For example, by abandoning the production of televisions, the US electronics industry quickly lost the know-how to design, develop, refine and competitively produce what is, in effect, the next generation of that product, the VCR. As a result, no one makes VCRs in America.

If America wants to stay wealthy and powerful, we can't shift out of manufacturing and into services. Were America to lose mastery and control of manufacturing, after a few short rounds of product and process innovation vast numbers of service jobs would be relocated outside the United States. Then, real wages in all service activities that dominate employment would fall, impoverishing the nation.

Nor can we establish a long-term preserve around traditional blue-collar jobs and outmoded plants. The challenge we face is to reorganize production, not abandon it.

Offshoring may well work for an individual firm in the short run, but in the long run, it means the internally generated erosion of the American economy that we are already beginning to see. American companies will not be as effective competing if the resources critical to their competitiveness are rooted outside the US. If we are to maintain a level of prosperity that is the condition of the open society we take for granted, American manufacturing must automate, not emigrate.

Stephen Cohen - Much of the problem is the management mindset. One example suffices. Goodyear's executive vice-president of production recently said, "Until we get real wage levels down much closer to those of Brazil's and Korea's, we cannot pass along productivity gains and still be competitive." This mindset ignores the reality of production. Aside from the obvious - that cuts might start with management salaries - why don't managers think of other alternatives?

Wages have never been the sole determinant of competitiveness. Unit cost, as the Japanese have clearly understood, has always been the central manufacturing issue.

Historically, US manufacturers have paid very high wages. Productivity in America has traditionally been higher than in other countries. Therefore, unit costs were low. Henry Ford's Model-T and the assembly line exploded the myth of the relationship between low wages and unit costs. He increased profitability while simultaneously doubling wages and lowering the cost of the product.

The alternative to wage cuts is radically increasing productivity. By finding new ways to manufacture and produce, innovation enables unit costs to be lower and wages to increase. And innovation, in addition to lowering unit costs, often raises quality, speeds the rate at which new products can be introduced and permits rapid response to market trends.

But if we've gone off to Singapore in search of low wages, as the Goodyear executive's mindset proposes, we're in real trouble when we try to maintain our market share. Today, market share depends upon a quick response to shifting consumer preferences.

Zysman - The Japanese steel industry is a prime example of a different mindset. Rather than move offshore to compete with the Koreans, they sunk hundreds of millions into sophisticated process controls in production. This not only lowered costs, but transformed the whole production process.

Now, they don't just mass produce a steel plate for a ship. Each plate can be chemically treated in a different way depending on where it fits on a given ship.

Harley Shaiken - If American firms continue to move offshore, they will lose more than control of the marketplace. Increasingly, they will lose the associated ability to make the production equipment and electronics that go along with basic manufacturing. Significantly, when they lose the capacity to innovate the tools that make the product, they ultimately lose their capacity to even imagine what the new products should be like.

Zysman - We can clearly see this problem in the American semiconductor industry today. How can an independent semiconductor firm compete with Hitachi if it has to use Hitachi machinery to make the semiconductors? Holding on to equipment-making capability is an absolute necessity for holding on to the semiconductor industry.

Shaiken - In the 1960s and 1970s, managers who were looking for production locations had two chokes: They could pursue the low-wage, labor-intensive route of assembling in Taiwan or they could automate and assemble in the US.

Now, in addition to the traditional attractions such as wage rates, the most sophisticated manufacturing processes can be located in Taiwan. And wages are still an issue because, even with highly automated manufacturing, there is still a significant workforce. So, in the 1980s, the issue is where to locate advanced manufacturing. It's no longer just a question of "Let's automate and bring production back to the US," but "Let's automate and locate in Korea."

Clearly, the whole US manufacturing base is not going to slide offshore. But when does the crisis come? When 10% or 15% of US manufacturing is offshore? These percentages are within the realm of possibility,

One example: The engine is the second most sophisticated part of an automobile. By next year, Mexico alone will have the export capacity of over two million engines. That will fill the order for one in every four cars assembled in the US. And if we consider Brazil's production as well, all of a sudden we see one of the most sophisticated auto systems being made offshore. If such sophisticated production can now take place in Mexico and Brazil, we are clearly talking about a new international division of labor in advanced production.

Another recent technological development really underscores the power of the shift in production. General Motors recently introduced a car, the Pontiac Le Mans, that invokes the image of that popular Pontiac muscle car of the 1960s.

But the Le Mans is designed by Opel engineers in West Germany and is coordinated by telecommunications with GM's technical design center in Warren, Michigan. The machine tools that build the car and the car's principal components are Japanese. The $425 million state-of-the-art production plant is located in South Korea. Only the point of sale is in the US.

To the extent that this new division of labor becomes a significant model, at some point the US won't even be able to be the point of sale because all our jobs will be elsewhere!

Cohen - To the frightening scenario of offshoring I add an even scarier eventuality. Let's talk about high-quality skills.

If our competitors' engineering skills become better than ours - not only in Japan or Germany, but in places like Korea - then we're really in the soup. How do we stay rich and powerful in a world where capital moves instantaneously, technology leaks out in no time, and we're less skilled? At the moment America still has a greater capacity for advanced work than Korea or Mexico. But only for the moment.

And if the skill base goes, following capital and technology, then what reason is there to produce here? And if there is no reason to produce here and wages fall by half, the relative distribution and size of America as a consumer market in the world will stagnate and shrink.

If America doesn't remanufacture, we will barely recognize this country 20 years from now. First, there will be a steady decline in the relative wealth and power of the US. Incomes will decline, but not equally. Society will become polarized. A small minority of high-wage job holders will be fine; the majority will be dramatically less well off. Overall, America will surely evolve into something akin to a South American society, with a couple of rich kids running around the good neighborhood and the rest very quickly becoming natives.

Second, before we get that far down the road, a radical lunge toward protectionism may well wreck the world economy.

Third, the costs of maintaining an old-fashioned military power based on the premise of technological superiority will become even more onerous. In a very ironic way, we may become like the Soviet Union, with a weakened economic base overburdened by the military. Or, we may become a reverse Japan - the inverse of their economic might and military weakness.

Shaiken - That's not much of a projection into the future. It sounds more like a description of the period we're rapidly moving into. Sure, young lawyers and stockbrokers can still eat their brie and drink white wine, but only under increased police protection.

The key characteristic of an America where manufacturing doesn't matter is polarization because we are losing high wage jobs and destroying opportunities.

Cohen - The other route, which leads back to the American Dream and away from a cyclical Third Worldism in which America gets dumber, then poorer, then dumber, is a route where manufacturing matters.

On that route we will understand that the key generator of wealth in a competitive world remains mastery and control of production.

Concretely, we'll have to develop policies to promote investment in technological development, in a skilled workforce, and in the offices and factories that house the technology and workers. And American management will have to grasp that competitive strength that arises from the kind of innovation in the production process that can only occur when manufacturing stays home close to R&D, its skill base and the consumer market.

One good sign is that some American firms, such as IBM at its Lexington, Kentucky keyboard assembly plant, are embracing the concept of "flexible manufacturing." They are responding to rapidly changing markets by paying greater attention to inventory control, quality of production and worker input.

Shaiken - In addition to process improvements, America must keep manufacturing at home. Until the late 1970s, the United States had technological advantages that protected the manufacturing base of this economy. Our most sophisticated techniques could not be exported because the infrastructure was not there in lower wage countries. Not protectionist law, but technological advantage protected America.

Now that great technological barrier no longer exists. If we are to control the new reality, we will have to reexamine our trade policy. The question is no longer how to keep the products of the Japanese and others out, but how to keep the US firms in.

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