Knowledge-Intensive Manufacturing Could Bridge Trade Gap

July 31, 2013

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Economists and politicians continue to push U.S. manufacturing as a central part of a healthy economic future. Yet for years prior to the recession, experts had claimed that American manufacturing was no longer viable and that the country needs to focus on being an information-oriented, service economy.

A recent report from research firm McKinsey Global Institute finds promise for growth in an intersection of these two areas. Knowledge-intensive manufacturing industries, the report reveals, can be cultivated to boost GDP and close the trade gap.

Knowledge-intensive industries are defined in the report as including motor vehicles, trailers, and parts; other transportation equipment, including aerospace; chemicals and pharmaceuticals; medical, precision, and optical equipment; semiconductors and electronics; and machinery and appliances.” From a skills and education standpoint, the industries share much in common with knowledge-intensive services, which include R&D, financial intermediation, and architectural and engineering services.

Unfortunately, while net U.S. exports of knowledge-intensive services have risen to a strong surplus, net exports of knowledge-intensive manufacturing has declined, contributing significantly to the total trade deficit.

The McKinsey report notes that the growing trade deficit in knowledge-intensive goods is not the result of exchange rates or international wage differentials, as “the trade deficit has grown in sectors that match up well with traditional U.S. strengths in R&D and innovation.”

Overall, McKinsey finds such industries account for 50 percent of U.S. manufacturing value-add and 40 percent of the manufacturing employment. Moreover, the R&D intensity is five to 12 times higher than all other manufacturing industries.

Yet the trade gap in these sectors continues to widen, from a net export deficit of $6 billion in the 1990s to $270 billion today. Motor vehicles, computers and office machinery, and semiconductors and electronics drove most of the decline, the report notes.

If knowledge-intensive manufacturing could approximate the success of global service exports, which saw its trade surplus jump from $30 billion in 1990 to $200 billion in 2012 (in nominal terms), “it would have a game-changing impact on the economy,” the report states.

There are promising signs for reversing the deficit, McKinsey finds. For example, although exchange rates can be volatile, since 2002 the dollar has “gradually depreciated on a trade-weighted basis by 24 percent,” making American-manufactured items more competitive in international markets. New technologies, specifically Big Data analytics, are disrupting many industries. Looking at the microdata, McKinsey identifies seeds of a potential reversal in the deficit already.

Looking forward, McKinsey sees numerous opportunities:

  • Since 2009, U.S. net exports of aircraft have more than doubled in real terms. In particular, Boeing’s delivery of 601 airplanes in 2012 (including 416 to non-U.S. customers) was 30 percent higher than deliveries in 2010 and is expected to increase by nearly 40 percent in total by 2020.
  • New automotive assembly plants have been established in the U.S. every year since 2005. The report estimates, “A single assembly plant can produce 200,000 to 300,000 vehicles annually and generate gross revenue of $4 billion to $6 billion.”
  • The growing supply of affordable shale gas has the potential to boost petrochemical production, which could accelerate the existing surplus to an additional $60 billion to $80 billion by 2020.
Other sectors will require more effort. Erasing the deficit in semiconductors and electronics, the report says, will require “an inflow of highly specialized talent,” as well as increasing the number of homegrown STEM-qualified (science, technology, engineering, and math) employees.

But the report states that running such businesses in the U.S. is becoming increasingly difficult, thanks to government tax and regulation policies, as well as an infrastructure and workforce which have “not kept pace with the demands of a 21st-century economy.”

Another study conducted by the National Association of Manufacturers (NAM) finds that “Because of our tax, tort, energy, and regulatory policies, it is 20 percent more expensive to do business in the United States than it is in the countries that are our nine largest trading partners -- and that excludes the cost of labor.”

The NAM report recommends strengthening the R&D credit, calling it “a jobs credit.” NAM points out that 70 percent of credit dollars are used for salaries of high-skilled R&D workers, stating, “Some 162,000 new jobs would be created if the credit was strengthened -- and even more if it was made permanent.”

The McKinsey study concludes that government action to ease the tax and regulatory burden on U.S. manufacturing would ultimately boost employment and, by extension, overall economic health and prosperity.

 

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