Daily Archives: March 6, 2012

During the past decade the US sat on the sidelines while many nations around the world competed aggressively to win larger shares of manufacturing output and employment. The next decade is likely to be different. In several recent speeches and policy proposals, President Barack Obama has laid out a compelling case for why manufacturing matters for the health of the American economy and has signalled that the US will be a more active player in the intense global competition for manufacturing.

The manufacturing sector has led the US economic recovery in the past two years, expanding by about 10 per cent and adding more than 330,000 jobs since December 2009. This is a small number compared with overall private-sector job gains of 3.7m during the same period, but US manufacturing employment is growing for the first time since the late 1990s. And there are promising signs that American companies are beginning to shift some of their foreign operations back home. Rising wages abroad, the decline in the dollar’s value, increasing supply-chain co-ordination and transportation costs, and strong productivity are combining to foster this “insourcing” trend.

A resurgence of manufacturing in the American economy is important for several reasons.

First, the US must rebalance growth away from consumption and imports financed by foreign borrowing and towards exports. Manufactured goods account for about 86 per cent of its merchandise exports and about 60 per cent of exports of goods and services. Even though service exports are becoming more important, the only way the US can rebalance growth and make a significant dent in its trade deficit is by increasing exports of manufactured goods.

Second, on average manufacturing jobs are high-productivity jobs with good pay and benefits. Even though the premium on manufacturing wages has been declining over time, it remains significant. Both workers with only a high-school degree and those with a college degree earn significantly more on average in manufacturing than their peers in the rest of the economy.

After staying roughly constant during the 1990s, manufacturing employment dropped by about 32 per cent between 2000 and 2011. This precipitous decline was a major factor behind the increase in wage inequality and the polarisation of job opportunities between the top and bottom of the wage and skill distribution. Contrary to conventional wisdom, the loss of manufacturing jobs was not the inevitable result of productivity gains. In the 1990s, with comparable productivity growth, manufacturing employment was roughly constant.

During the coming decade, with the right incentives, US manufacturers can again win larger shares of global value added as they did in the 1990s.

Third, manufacturing plays a substantial and disproportionate role in innovation. A strong manufacturing sector supports the key building blocks of the nation’s innovation ecosystem – its skilled scientific, engineering and technical work force, its research and development, its ability to identify technical challenges and provide creative solutions.

Manufacturing only accounts for about 9 nine per cent of the nation’s jobs and 11 per cent of the nation’s output. But it employs about 36 per cent of the nation’s engineers and accounts for 68 per cent of R&D spending by business which in turn accounts for about 70per cent of total R&D in the US. American leadership in science and technology depends on R&D investment by manufacturing companies, and the social returns to such investment are substantial, far exceeding the returns to the companies that fund it.

Despite the offshoring of parts of their supply chain, American multinational manufacturing companies continue to locate most of their R&D investment and research work force in the US.

But this share is gradually declining as they shift some of their R&D from both the US and Europe to Asia in response to rapidly growing markets, ample supplies of technical workers and engineers, and generous subsidies.

China and other emerging economies are actively building their research capabilities and aggressively competing for the R&D of American manufacturing companies. At the same time, the comparative attractiveness of the US as a location for such activities is slipping in part because of shortages in the scientific, engineering and technical labour force and restrictions on the number of immigrants with these skills.

President Obama’s 2012 budget proposal calls for $1tn in discretionary spending cuts over the next decade, reducing the share of discretionary spending to five per cent of gross domestic product by 2022. Despite its overall austerity, the proposal contains measures to boost manufacturing. Many of these – including policies to increase high-school graduation rates; workforce training programs at community colleges; more funding for basic research, infrastructure investment, and scientific, engineering and technical education; and immigration reform – would benefit other sectors as well.

President Obama’s plan for business tax reform would also benefit manufacturing. The plan would reduce the statutory corporate tax rate from 35 per cent, soon to be the highest in the OECD countries, to 28 per cent. The US rate would fall to 25 per cent for manufacturing and even lower for advanced manufacturing which is targeted for a 19 per cent increase in R&D funding in the budget.

Given its outsized share of R&D investment, manufacturing would also benefit disproportionately from the President’s proposal to expand and simplify the research and experimentation tax credit and to make it permanent. Although the US was the first nation to introduce a tax credit for R&D in the 1980s, many countries provide far more generous incentives now. Recent research confirms that the credit is a cost-effective way to encourage business research spending and that the society-wide returns to such spending exceed the private returns to the investors who fund it, often by a considerable margin.

President Obama recognises that manufacturing matters for the health of the American economy. And despite severe budgetary constraints, he has laid out an ambitious set of policies to achieve that goal.

The writer is a professor at the Haas School of Business at the University of California at Berkeley and former chair of the Council of Economic Advisers under President Bill Clinton.

Benjamin Netanyahu’s meeting with president Barack Obama on Monday went as well as could be hoped. The Israeli prime minister stressed his oft-repeated desire for the US to establish “red lines” for Iran, but avoided any appearance of a disconnect with Washington. Mr Obama promised that the US will watch Israel’s back and continue to deploy the newest tool in its diplomatic arsenal: targeted financial sanctions, in this case powerful disincentives for countries and institutions to import Iranian oil. As a result we are unlikely to see an Israeli military strike anytime soon, as ‘Bibi’ seems willing to give sanctions time to work.

That’s the good news for Mr Obama. The bad news? That Bibi seems willing to give sanctions time to work.

Mr Obama now faces an extremely difficult task: remaining tough on Iran without sabotaging the US economic recovery. While the strategy of squeezing Iran financially is logical, it comes with serious economic risks that are not often recognised. We’ve entered a new era in which the distinction between the financial and security spheres no longer holds: geopolitics drive markets even as markets drive geopolitics.

Enforcing oil sanctions against Iran could threaten the global economy. In the context of improving global growth, removing too much Iranian oil from the world’s energy supply could cause an oil price spike that that would halt the recovery even as it does some financial damage to Iran. For perhaps the first time sanctions have the potential to be “too successful”, hurting the sanctioners as much as the sanctioned.

Since the US began a concerted effort at the end of last year to dissuade and disrupt the purchase of Iran’s oil among its customary buyers in Europe and Asia, we have seen Japan, South Korea and the European Union all agree to reduce or stop entirely their imports of Iranian crude. To the surprise of oil traders, global markets, and perhaps even US policymakers, other buyers have not stepped up their purchase of Iranian oil in response. China has not yet indicated that it will increase volume as many expected and India seems poised to make at least modest cuts. It’s this last fact, not just geopolitical tensions, that accounts for much of the increase in world oil prices in the past week.

Countries’ willingness to toe the line on sanctions – driven by fear both of a nuclear Iran and of loss of access to the US financial system – puts paid to the notion that US power has markedly declined, but also presents a severe risk to the US and world economies. Successful sanctions threaten substantial macroeconomic damage worldwide.

Those involved in the oil market do not believe that oil-producing countries possess the spare capacity to replace more than a small amount of Iranian crude without causing a price spike. Despite what US government officials may say publicly, the alarmingly high price levels that we see today already take into account the existence of any marginal alternative supplies, as from Angola. Even if Saudi Arabia makes up most of the displaced volume in global markets, the resulting thin spare capacity worldwide would place the market right where it was in early 2008, when oil prices surged to record highs. Suffice to say that this helps no one involved: not Israel, not Mr Obama’s re-election bid and not anyone seeking to prevent Iranian acquisition of nuclear weapons.

This presents Mr Obama with a dilemma. The main economic risk to his re-election is that the US plunges back into a recession. The main foreign-policy risk is a mishandling of the Iranian situation. But sanctions, the best method for handling Iran, imperil the economy, while relieving financial pressure on Iran could reduce oil prices and aid the US recovery -but would also lead to undesirable outcomes in the Gulf, whether an Israel strike or, worst of all, Iranian development of weaponised nuclear capacity.

The Obama administration knows that whichever policy choice the president makes, his Republican rival, most likely Mitt Romney, will be sure to highlight its failings. If he loosens sanctions, Mr Romney will call the president weak on Iran and insufficiently supportive of Israel; if overly successful sanctions cause an oil-price spike, the GOP will say that Mr Obama’s energy policy is hurting Americans. The predicament threatens to make foreign policy, an issue on which Mr Obama seemed to have little vulnerability, a serious liability electorally.

All is not lost for the president, however, and there is a path forward. The US can pressure Iran without sabotaging the economic recovery. What he must do is maintain his tough public rhetoric on sanctions, no matter how harsh it appears, while privately signaling China and India – and only China and India – that it is fine for them to purchase Iranian crude, but at a significant discount from market price. Forcing Tehran to sell discounted barrels would provide the desired result: a substantial reduction in Iranian revenue with less impact on global energy prices and less harm to the US and world economies.

It’s a tricky diplomatic line to walk, to be sure. It will likely not assuage the administration’s critics either domestically or in Israel. But it may be the only way out of the dilemma. It would ensure that sanctions work as intended: hurting Iran and not the world – or the president’s re-election chances.

This article is co-authored with David Gordon, head of research, and Clifford Kupchan, Eurasia practice head at Eurasia Group. Ian Bremmer is the president of Eurasia Group and author of the forthcoming book, ‘Every Nation for Itself: Winners and Losers in a G-Zero World’

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