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Home > Social Issues
A Systems Thinking Perspective on Manufacturing & Trade Policy
by Bob Powell, 9/13/03
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Loop B1 shows that individual companies make rational decisions to downsize to reduce company expenses; this reduces industry and excess capacity. But loop R2 shows the sum of all the downsizing decisions has an overall industry "side-effect" of reducing employment, income, and demand to create even more excess capacity. This economic vicious cycle can lead to overall economic collapse. From Sterman, "The Long Wave Decline and the Politics of Depression."
Many believe the loss of manufacturing and manufacturing jobs isn't a problem, believing that other countries can do the manufacturing and we'll do the high value-added innovation and design.

This belief itself may be the greatest threat to our economic health.

This paper explains why the U.S. is losing manufacturing and other jobs, why it's a major problem, why government can and should take action to address it, and what government can do to promote growth, create jobs in the U.S., and reduce the exodus of jobs from the U.S.

Perhaps more importantly, there are many things the U.S. can stop doing so as to not drive jobs out of the U.S. Current policies that fall in this category could be described as a form of "reverse protectionism." Stopping "reverse protectionism" is not protectionism.

I realize that some of the recommendations are unorthodox ... however, I have made a genuine effort to justify them.

Comments and corrections appreciated.

Download the paper:
A Systems Thinking Perspective on Manufacturing & Trade Policy, 44 pages (598K). Updated 12/24/03 with a brief explanation of the systems thinking perspective and minor additions. (598K) [Originally titled "Government Policies to Foster Manufacturing," 10/06/03]
One reader's comment:
         "I started reading your white paper, and all I can say is 
          that it is brilliant, on point, frightening, and more."

The origin of the "long wave" from a system dynamics perspective (see diagram at right) is described in the paper by John Sterman of MIT on the Long Wave Decline and the Politics of Depression (pdf, 21.1Mb).

Testimony To Colorado Senate on SB-04-170, Keep Jobs in Colorado, 2/09/04 (2 pages, 211K)

A Systems Thinking Perspective on Manufacturing & Trade Policy

Table of Contents:

I.    Preface

II.   The Systems Thinking Perspective

III.  The U.S. economy in trouble: A perfect storm. 

IV.  The Challenge of Dealing with the Mess

V.   The loss of manufacturing is a major problem. Here’s why.

1. No magic wall exists between "innovation & design" and "manufacturing." An "innovation and design" economy won’t replace the "old manufacturing economy."

The "innovation and design" and "old manufacturing" economies are each other’s customers.

The loss of manufacturing jobs leads to the loss of design jobs. There is no magic wall between "innovation and design" and "manufacturing."

2. National security is compromised as the U.S. manufacturing base degrades.

3. The U.S. trade deficit is increasing exponentially. What cannot go on forever will stop. The longer this trend persists, the greater the eventual repercussions and dislocations.

4. An economy in the trough of the long wave economic cycle is partially responsible for the loss of manufacturing and other jobs; without strong and appropriate government action the economic pain will be great and prolonged.

The origin of the long wave from a system dynamics perspective is explained by John Sterman of M.I.T.

Sterman’s "Possible Policy Errors"

5. The theory of comparative advantage is not a valid justification for "free trade" policies that promote the transfer of the factors of production, not simply trade in products. Therefore, policies should not be formed using it as a rationale.

"Comparative advantage" says that when everyone does what they do best and trades, then everyone benefits. However, trading products is "trade," but moving the "factors of production" that produce the products is not within the scope of simple trade; it is "economic migration."

That companies will migrate to locations with the greatest "absolute advantage" is explained by the systems thinking archetype, "The Attractiveness Principle."

A great many, perhaps even most, economic clusters have not formed because of comparative economic advantage; they were formed due to "accidents" or protected from competition or even government-subsidized.

The benefits of policies that promote trade are not spread evenly. There are winners and losers and the losers are not compensated. Even retraining is paid for by the public at large, not by the winners.

The requirements of the classical theory of comparative advantage are not met.

VI. Can government take action to slow or reverse the loss of manufacturing? Yes. Should it? Yes.

1. Change the mindset that "Government has done all it can do."

2. Not only can government do something, it’s an essential and appropriate role for government to take action, because it’s to the advantage of no one company or group of companies to bear the burden of doing so.

3. Government must be the entity that takes a long-term focus, because the focus in the private sector is primarily short term. Only government can create effective incentives to reinforce a long term focus and effectively represent the future to the present.

VII. Here’s what government can do.

1. Fund and actively promote economic clusters and societal networking.

Why promote clusters and societal networking?

Here’s how to promote economic clusters.

Here’s how to promote societal networking.

2. Inform companies of the hazards of moves offshore to countries such as China.

Outsourcing is not a reliable competitive advantage. Expected cost reductions are often not achieved; supply interruption and quality risks often outweigh rewards.

Companies selling to China often create their own competitors.

Many companies who expect to sell to Chinese markets are disappointed because worker income is insufficient to purchase the products.

3. Help companies improve operational excellence.

4. Tailor tax policies to tie corporate compensation to, and reward, long-term improvement.

5. Improve company awareness of potential shifts in the value chain.

It helps regions identify clusters on which to focus and helps companies be aware of shifts.

Profits can shift in the value chain in different directions for different products.

6. Stop allowing R&D investment tax credits to companies that do not retain their complementary assets (e.g., manufacturing) in the U.S., because when a nation that subsidizes an innovation does not retain the manufacturing, it does not fully profit from the innovation.

7. Do not let the dollar become overly strong relative to other currencies …

… due to excessively high real interest rates (in the recent past).

… due to currency manipulation and undervaluation by other countries.

… and don’t be too concerned that a weaker dollar will cause inflation; a 5% fall in the dollar raises consumer prices 0.2% … the impact is often overstated

8. Government can increase support for training and education.

Government support of training and education is needed due to their "positive externalities."

Support for engineering technical education has been lagging.

Financial support for education should come primarily from the Federal level to prevent "free riding" by states. Colorado is a prime example of a "free rider" state.

9. Do not engage in "tax competition," despite its allure.

Cutting taxes may be irresistible in the face of countries that engage in "tax wars," but beware of the downside: enormous and growing infrastructure backlogs."

States engaging in tax competition by cutting taxes on corporations to attract them must be prepared to explain to other taxpayers that their taxes must be raised to pay for infrastructure.

Tax competition within the U.S. does not "create jobs," it only redistributes them.

"Tax wars" with other countries does not help them in the long run; it only allows countries to lower taxes to the point that they mortgage their long-term future for short-term gain.

10. Do not allow corporations to engage in flawed transfer pricing schemes to avoid U.S. taxes that distort accounting of profits and losses.

11. Exclude corporations that move their headquarters to foreign countries from government contracting.

12. Domestic tax policy should be geared to increasing demand, not promoting investment, because of where the economy is in the long wave cycle.

13. Measure and publicize "national productivity" based on all available U.S. worker hours, in addition to the highly-publicized hourly productivity of employed workers.

14. Include environmental standards in trade pacts.

Trading with countries that do not abide by comparable environmental standards creates an uneven playing field and does not help them in the long run; it only allows them to mortgage their long-term future for short-term gain.

It is incorrect that, as incomes increase, citizens of other countries will value their environment more and increase protections so as to lower pollution in the future.

In countries without constitutional democracies (especially in dictatorships) and without the technical competence and financial means to perform sound science, citizens cannot properly value their environment; the market doesn’t set prices for the environment, governments do.

15. Include labor standards in trade pacts.

Trading with countries that do not abide by comparable labor standards creates an uneven playing field and does not help them in the long run; it only allows them to mortgage their long-term future for short-term gain.

Requiring labor and environmental standards for trading partners helps them develop a more productive and loyal workforce.

In countries without constitutional democracies (especially in dictatorships) and without the technical competence and financial means to perform sound science, citizens cannot properly evaluate the effects of detrimental labor practices.

16. Include intellectual property protection standards in trade pacts.

17. Recognize the parallels between protecting intellectual property and protecting
labor and the environment: intellectual property protections protect private capital; labor/environmental protections protect social capital.

18. There are so many factors affecting trade that achieving a "level playing field" is extremely difficult. Therefore, focus on outcomes by promoting "even trade," not "free trade."

19. Enforce intellectual property and labor/environmental protections by a certification process

20. Identify those to whom companies will listen and trust, those who have the needed credibility to convey these messages.

VIII. Appendix A: Fostering Economic Clusters

IX.  Appendix B: Shifts in the Value Chain Due to Disruptive Technologies

X.   References

URL: http://www.exponentialimprovement.com/cms/fostermfg.shtml

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