Ian Fletcher

I wrote in a previous article about why America's manufacturing sector, despite record output, is actually in very deep trouble: record output doesn't prove the sector healthy when we are running a huge trade deficit in manufactured goods, i.e. consuming more goods than we produce and plugging the gap with asset sales and debt.

But this analysis of the problem only touches the quantitative surface of our ongoing industrial decline. Real industries are not abstract aggregates; they are complex ecosystems of suppliers and supply chains, skills and customer relationships, long-term investments and returns. Deindustrialization is thus a more complex process than is usually realized. It is not just layoffs and crumbling buildings; industries sicken and die in complicated ways.

To take just one example, when American producers are pushed out of foreign markets by protectionism abroad and out of domestic markets by the export subsidies of foreign nations, it is not just immediate profits that are lost. Declining sales undermine their scale economies, driving up their costs and making them even less competitive. Less profit means less money to plow into future technology development. Less access to sophisticated foreign markets means less exposure to sophisticated foreign technology and diverse foreign buyer needs.

When an industry shrinks, it ceases to support the complex web of skills, many of them outside the industry itself, upon which it depends. These skills often take years to master, so they only survive if the industry (and its supporting industries, several tiers deep into the supply chain) remain in continuous operation. The same goes for specialized suppliers. Thus, for example, in the words of the Financial Times's James Kynge:

The more Boeing outsourced, the quicker the machine-tool companies that supplied it went bust, providing opportunities for Chinese competitors to buy the technology they needed, better to supply companies like Boeing.

Similarly, America starts being invisibly shut out of future industries which struggling or dying industries would have spawned. For example, in the words of tech CEO Richard Elkus:

Just as the loss of the VCR wiped out America's ability to participate in the design and manufacture of broadcast video-recording equipment, the loss of the design and manufacturing of consumer electronic cameras in the United States virtually guaranteed the demise of its professional camera market... Thus, as the United States lost its position in consumer electronics, it began to lose its competitive base in commercial electronics as well. The losses in these related infrastructures would begin to negatively affect other down-stream industries, not the least of which was the automobile... Like an ecosystem, a competitive economy is a holistic entity, far greater than the sum of its parts. (Emphasis added.)

One important example of this is the decline of the once-supreme American semiconductor industry, visible in declining plant investment relative to the rest of the world. In 2009, the whole of North America received only 21% of the world's investment in semiconductor capital equipment, compared to 64% going to China, Japan, South Korea, and Taiwan. The U.S. now has virtually no position in photolithographic steppers, the ultra-expensive machines, among the most sophisticated technological devices in existence, that "print" the microscopic circuits of computer chips on silicon wafers. America's lack of a position in steppers means that close collaboration between the makers of these machines and the companies that use them is no longer easy in the U.S. This collaboration traditionally drove both the chip and the stepper industries to new heights of performance. American companies had 90% of the world market in 1980, but have less than 10% today.

The decay of the related printed circuit board (PCB) industry tells a similar tale. An extended 2008 excerpt from Manufacturing & Technology News is worth reading on this score:

The state of this industry has gone further downhill from what seems to be eons ago in 2005. The bare printed circuit industry is extremely sick in North America. Many equipment manufacturers have disappeared or are a shallow shell of their former selves. Many have opted to follow their customers to Asia, building machines there. Many raw material vendors have also gone.

What is basically left in the United States are very fragile manufacturers, weak in capital, struggling to supply [Original Equipment Manufacturers] at prices that do not contribute to profit. The majority of the remaining manufacturers should be called 'shops.' They are owner operated and employ themselves. They are small. They barely survive. They cannot invest. Most offer only small lot, quick-turn delivery. There is very little R&D, if any at all. They can't afford equipment. They are stale. The larger companies simply get into deeper debt loads. The profits aren't there to reinvest. Talent is no longer attracted to a dying industry and the remaining manufacturers have cut all incentives.

PCB manufacturers need raw materials with which to produce their wares. There is hardly a copper clad lamination industry. Drill bits are coming from offshore. Imaging materials, specialty chemicals, metal finishing chemistry, film and capital equipment have disappeared from the United States. Saving a PCB shop isn't saving anything if its raw materials must come from offshore. As the mass exodus of PCB manufacturers heads east, so is their supply chain.

All over America, other industries are quietly falling apart in similar ways.

Losing positions in key technologies means that whatever brilliant innovations Americans may dream up in small start-up companies in the future, large-scale commercialization of those innovations will increasingly take place abroad. A similar fate befell Great Britain, which invented such staples of the postwar era as radar, the jet passenger plane, and the CAT scanner, only to see huge industries based on each end up in the U.S. For example, the U.S. invented photovoltaic cells, and was number one in their production as recently as 1998, but has now dropped to fifth behind Japan, China, Germany, and Taiwan. Of the world's 10 largest wind turbine makers, only one (General Electric) is American. Over time, the industries of the future inexorably become the industries of the present, so this is a formula for automatic economic decline. Case in point: nanotechnology is probably the first major new industry in a century in which the U.S. is not the undisputed world leader.

America's increasingly patchy technological base also renders it vulnerable to foreign suppliers of "key" or "chokepoint" technologies. These, though obscure and of small dollar value in themselves, are technologies without which major other technologies cannot function. For example, China recently restricted export of the rare-earth minerals required to make advanced magnets for everything from headphones to electric cars. Another form this problem takes is the refusal of oligopoly suppliers to sell their best technology to American companies as quickly as they make it available to their own corporate partners. It doesn't take much imagination to see how foreign industrial policy could turn this into a potent competitive weapon against American industry. For another example, Japan now supplies over 70 percent of the world's nickel-metal hydride batteries and 60-70 percent of the world's lithium-ion batteries. This will give Japan a key advantage in electric cars.

The Obama administration shows no awareness of any of this, despite scratching a hole in its head over why job creation has stalled. (Hint: it hasn't stalled in the nations, from China to Germany, running trade surpluses with us in manufactured goods.) It is not yet too late to reverse these dynamics, but we are definitely running out of time. So the sooner we start questioning the sacred myth of free trade, which is largely responsible for this mess, the better.

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Ian Fletcher is Senior Economist of the Coalition for a Prosperous America, a nationwide grass-roots organization dedicated to fixing America’s trade policies and comprising representatives from business, agriculture, and labor. He was previously Research Fellow at the U.S. Business and Industry Council, a Washington think tank founded in 1933 and before that, an economist in private practice serving mainly hedge funds and private equity firms. Educated at Columbia University and the University of Chicago, he lives in San Francisco. He is the author of Free Trade Doesn't Work, 2011 Edition: What Should Replace It and Why. | www.freetradedoesntwork.com