Manufacturing's Economic Power Is Grossly Underestimated

Adapted from Marc Fasteau’s and Ian Fletcher’s new book, "Industrial Policy for the United States: Winning the Competition for Good Jobs and High-Value Industries."

There is a widespread belief among lawmakers and the public that manufacturing is not an especially valuable part of the U.S. economy. This misapprehension has undermined federal support for American manufacturing and contributed to its current crisis. 

Where does this costly mistake come from? It starts with the idea that manufacturing isn’t even that big a sector. For example, people  misinterpret the statistic that manufacturing is “only” 11% of GDP and 8% of employment. Or that from 1953 to 2015, manufacturing’s share of American employment dropped from 32 to 9%, and its share of GDP from 28 to 12%. Manufacturing, like railroads, seems to be something associated with America’s past—not its future. 

But the economic importance of a sector is not simply a function of its share of GDP. Restaurants (6% of GDP and 9% of jobs) could disappear tomorrow and we would only be inconvenienced. If the entire internet disappeared, we would experience huge disruption, but ultimately collapse back to the economy of 1994, which was not exactly primitive. 

But manufacturing produces goods that every modern society needs, such as steel, automobiles and telephones. America can’t defend itself with websites and financial speculations: We can only defend ourselves with physical machines, generally made of steel or aluminum and stuffed with physical electronic components, not just software.

Value Added vs. Total Output

Furthermore, the GDP numbers above refer to value added, not total output. Statistics avoid counting output both when industry X produces it and then again when industry Y takes it in, does something with it and spits it out the other end. The concept of value added subtracts from each industry’s output the value of the inputs that went into it, thus measuring only the value that the industry creates, rather than merely passes on. 

But measured by total output, that is without subtracting inputs, manufacturing in 2015 was not 12%, but 35% of GDP, and the source of not 9%, but 21%, of all jobs. This is a much better estimate of the “footprint” of manufactured goods, and of the importance of manufacturing in our economy.

Imprecise Growth Measurements

Since the early 1950s, services like healthcare, education and business services have exploded in dollar value, and thus in their share of GDP. But this growth relative to manufacturing largely just reflects higher inflation in services, which generally depend on direct human labor, than in manufacturing, which continually grows more automated and efficient. When adjusted for the inflation difference, the implied share of total value of manufactured goods in the economy (as opposed to their price) has not dropped significantly.

By creating demand for services and nonmanufactured goods, manufacturing contributes an exceptionally large amount to the other sectors of the economy. These range from iron ore to accounting services. As of one calculation a few years ago, their fractions of manufacturing’s output were: 

Together, these activities accounted for 15.4 million domestic jobs. Every manufacturing job thus supports 1.4 jobs outside manufacturing, the highest multiplier of any major sector. Almost a quarter of the jobs in the computer systems design and related services industry, for example, are attributable to manufacturing. And even this almost certainly understates manufacturing’s contribution, as official economic statistics do not capture large numbers of workers in sectors classified as services who are actually supporting manufacturing activities. 

Strong Synergies

Manufacturing also has exceptionally strong synergies with the rest of the economy; i.e., the ability to induce growth in other sectors. For example, cheap mass-produced steel, whose first major market was railroad rails, made skyscrapers possible. Vacuum tubes, originally produced to build radios, enabled televisions. Computer chips were invented when computers were room-sized, but eventually became sufficiently small, powerful and cheap to enable smartphones. Smartphones, in turn, enabled ride-hailing services. Jet engines developed for military aircraft enabled passenger jets, mass tourism and ultimately ... Disney World. 

Manufacturing is also a key driver of innovation, accounting for 60% of America’s research and development. Its R&D benefits not only manufacturing itself, but also technology-intensive service sectors whose ongoing growth depends upon advances in hardware.

For example, smartphone-based delivery apps only became possible once smartphones became physically manufacturable, about a decade after the software had become possible. There is a strong link between the location of production and the location of innovation. When production leaves America, research and development, product design and testing often follow. Innovation and production are embedded in an “industrial commons” of specialized suppliers, key service companies, shared engineering skills and manufacturing competencies. Keeping manufacturing in the U.S. is thus vital to maintaining America’s ability to innovate

Large Productivity Gains

There are only a few sectors where large, ongoing productivity gains are possible: manufacturing and several others, such as IT. Productivity growth in these sectors is the ultimate source of economy-wide income growth. Between 1950 and 2020, labor productivity in U.S. manufacturing increased by a factor of nine, while productivity in the economy as a whole merely tripled.

But as productivity in manufacturing and other dynamic sectors rises, it pulls up the economy’s average despite stagnant productivity in many sectors. This is why so many nations, quintessentially in East Asia, have used a push into manufacturing to develop their economies. Nations that used to be poor and agricultural, such as South Korea in 1960, didn’t become rich by finding ways to grow rice and catch fish with 20 times the productivity. They used proactive industrial policies to break into industries like steel and cars, where 20 times the per-worker productivity of a small fisherman or peasant farmer is the norm.

Some, Not All Are Valuable

This should not be misunderstood as implying that America should try to retain all manufacturing industries. The U.S. has shed many that are no longer viable in any developed nation because their production cost is mainly low-skilled labor—and has benefitted from doing so. But the U.S. has also lost manufacturing jobs in valuable industries it should have held onto.

We run a trade deficit in Advanced Technology Products of more than $200 billion, the very products we supposedly excel at making. Some developed nations that have done a better job of hanging onto these industries, such as Japan and Germany, have manufacturing wages comparable to ours. Direct labor cost in manufacturing averages only about 20% of output value—ranging from 11% for motor vehicles to 44% for apparel and leather goods—so high-wage countries can be competitive in many products.

There was nothing inevitable about our losses. They are the result of bad federal policy ranging from support for an overvalued dollar to free trade to failure to support civilian technology development. These mistakes and the decline of American manufacturing can be reversed. It is not a moment too soon.