In getting the story wrong, The Economist inadvertently hits upon why manufacturing matters.

The Economist recently ran a piece arguing that manufacturing doesn’t matter. But in the course of their argument, they end up proving the opposite.

After years of neglect, “industrial policy” and revitalizing the industrial (read “manufacturing”) base appears to have taken root in the US economic policy making—and in many other nations as well. But, does manufacturing matter? Or, more specifically, is the governmental attention being paid to manufacturing justified? The Economist recently weighed in on this question with a resounding no.

In their critique, a piece entitled “The world is in the grip of a manufacturing delusion”, they take aim at the reasons cited to justify government aid to manufacturing. They argue that manufacturing is not that important for job creation or for innovation and productivity. They also argue that aid to manufacturing to attempt to help the transition to a zero-emission economy will only lead to an economically wasteful zero-sum competition among nations and that there are better ways to achieve resilience in the supply chain while protecting national security.

I don’t have anything to say about the latter two but will concentrate on the questions of jobs, innovation and productivity.

The cornerstone of The Economist’s argument is the existing difference between manufacturing and service. On jobs, they argue that modern manufacturing requires fewer production workers and those jobs are unlikely to be similar to the “good jobs” of the past. As they explain, “the sort of high-tech factories that America and Europe are attempting to attract are highly automated, meaning they are no longer a significant source of employment for people with few qualifications.” In contrast, service jobs are growing as “[a]cross the rich world, employment that requires mid-level technical skills (think machine operators) has given way to a mix of high- and low-level jobs, mostly in service sectors (think coders and baristas).”

Likewise, they see greater productivity gains coming from services. “According to the IMF, the gap between manufacturing and services productivity growth has shrunk in many countries since the turn of the millennium. In China and India its direction has flipped, with services productivity rising faster.”

They also suggest that the higher levels of innovation in manufacturing compared to services may be due to measurement. Since it is harder to measure the level of R&D, for example, in services as opposed to manufacturing, “services may be more innovative than typical measures suggest.” While I agree that innovation in services may be understated, a higher level of innovation in services is no reason for dismissing innovation in manufacturing.

The problem is that this analysis, for all the discussion of the direction of jobs, productivity, and innovation, is static rather than dynamic. It is locked into a trajectory extrapolated from the past where services were services and manufacturing was manufacturing. It fails to understand the change occurring in the structure of the economy is toward a fusion of manufacturing and services.

Ironically, the article includes some evidence of the structural shift that undercuts their argument. The Economist notes that “[a]ccording to the IMF, manufacturing-associated services have grown as a share of global output in recent decades.” They use this to show that job growth is in services and therefore any attention to manufacturing is mistaken. This completely misses the point. In order to have “manufacturing-associated services”, you have to have manufacturing. And these jobs will be different from the assembly line production work of the past. But they will be jobs built upon a healthy manufacturing base.

Likewise for productivity and innovation. Services and manufacturing are complementary. The need for increased productivity in manufacturing can drive innovation in services and innovation and productivity improvements in manufacturing benefits up-stream and down-stream services. Complementary means both are needed. Public policy emphasizing the services part of that fusion while neglecting the manufacturing parts is simply wrong. It would end up with a weaker, less productive, and more brittle economy.

Curiously, in its zeal to downplay the importance of manufacturing, The Economist has revealed it is still stuck in the old industrial mindset. I’ve often said that the creating classifying the economy as agriculture, manufacturing and services is like classifying society as the peasant, clergy, and nobility. It is a categorization that is simply not useful anymore.

A starting point to better understand this fusion of manufacturing and services is to adopt a value-chain perspective. To think about making value rather than making things. In that regard, I would direct your attention to a report a few years back from the National Academy of Engineering on Making Value rather than making things (see earlier postings here and here – to download the report, click here).

As the NAE study notes:

Although it is not yet in widespread use, the concept of making value is a particularly effective way of examining the success and failure of individuals, businesses, communities, and nations. Making value is the process of using ingenuity to convert resources into a good, service, or process that contributes additional value for a person or society. While value creation is often used to refer to the ability to provide things of worth for the customer or user, making value is used here to emphasize the entire system of activities that is necessary to conceive, produce, and deliver these things–especially the design and production processes that often receive less attention in discussions of value creation. (emphasis in original)

Taking a value-chain approach can result in some important new insights. In their Brookings paper “Innovation and manufacturing labor:  a value-chain perspective” Kate Whitefoot, Walter Valdivia, and Gina Adam found a remarkable shift:

The manufacturing value chain shrunk by more than 4 million workers from 2002 to 2010 and those who worked in factories took the heaviest toll. What is striking however is that during this same period, which included the last recession, employment in upstream services expanded 26 percent for market analysis, 13 percent for research and development, and 23 percent for design and technical services.

An analysis that focused just on the manufacturing part of the value-chain would have missed this important point.

I realize that some time the supporters of a robust industrial policy fall into the same trap as The Economist did of focusing to much on the narrow image of the manufacturing factory. We all do so because it is a shared view that is easy to communicate. But if we are to craft effective policy, we need to update our perspective to better understand the changing structure of our economy. And the first thing we need to do is breakthrough the false dichotomy of manufacturing v. services.

Given how entrenched that view is, I know this will be hard. Just look at the standard language we use in reporting economic news. But we need to try.