American Innovation, a Murder Mystery

Mene Ukueberuwa, "American Innovation, a Murder Mystery,"Wall Street Journal, December 13, 2019, https://www.wsj.com/articles/american-innovation-a-murder-mystery-11576277193American Innovation, a Murder Mystery Addressing 20,000 rallygoers at Dallas’s American Airlines Center recently, President Trump praised a “beautiful new Louis Vuitton plant” he’d toured that morning. The plant will bring about 1,000 jobs to a small town near Fort Worth, and Mr. Trump was displaying his good habit of celebrating work wherever Americans find it. But despite cheers of approval, one imagines he and his supporters would have preferred to christen an advanced “machine and manpower” plant—the kind that might assemble airplanes for the arena’s namesake. A craft workshop for a French luxury brand doesn’t quite capture the MAGA ideal. The president’s pledge to make America great again has always borne the implicit claim that America no longer makes anything great, whether Fords or farm equipment. There’s some truth to that, and both airplanes and handbags are examples of how U.S. manufacturing has fared since the mid-20th century. The key measure is productivity—how much value each worker produces—which bears heavily on job creation. Highly productive industries like chemicals, weapons systems and aerospace still draw strong domestic investment. But employment has shrunk because better machines and logistics have diminished the need for manpower. Productivity has risen more slowly for simpler types of manufacturing such as textiles and home goods, leading many companies to seek cheaper production overseas. There has also been a notable slowdown in improvements to the quality of goods produced. For about a century, beginning with the Second Industrial Revolution in the 1870s, American growth was driven by tinkerers, trusts and corporate labs, which eked out regular advances in products based on engines, electrical circuits and signals, and synthetic materials. Today, another half-century later, a coast-to-coast flight still takes you as long as it took your father in the 1970s. And with the major exception of computers, nothing in your luggage is likely to be much more useful or valuable than dad’s equivalent. Who killed American innovation? Answering that question could be a vital step toward re-energizing growth. Unfortunately, in their search for a culprit, Mr. Trump and many policy makers and commentators have implicated causes that aren’t responsible for the slowdown and tried solutions that hinder growth: • The free traders. Since the beginning of his 2016 campaign, Mr. Trump has often blamed the decline of heavy industry on his predecessors’ trade policies. “I did disagree with Ronald Reagan very strongly on trade,” he said in his final debate with Hillary Clinton. As president he has blasted the North American Free Trade Agreement—a signature achievement of Mrs. Clinton’s other half—as often as any federal policy. Describing the effect Mexico and other trade partners have had on domestic production, Mr. Trump said last year that “they’ve destroyed the steel industry, they’ve destroyed the aluminum industry and other industries, frankly.” In this view, politicians opened U.S. manufacturing to an assault from foreign competitors that produce and sell more cheaply. That reduces American manufacturers’ incentive to invest in better plant and products, benefiting rivals in protected economies. Yet open trade can’t explain the overall slowdown of U.S. innovation. To be sure, competition from Mexico reduces the incentive for U.S. Steel to invest in new fabrication techniques. But progress has also slowed since the mid-20th century for American companies that are heavily supported and protected, like Boeing. And there are countless industries in which U.S. companies retain a large lead in innovation despite trailing in global market share—most notably, cutting-edge electronics like smartphones and semiconductors. U.S. protectionism couldn’t have prevented other nations from eventually catching up. Georgia Tech economic historian Steven Usselman notes that American firms throughout most of the 20th century expected this “convergence” of international capability to occur decades earlier than it did. Yet even as manufacturing executives lobbied for support in their sectors, they backed general liberalization of trade as a net economic good. • The investors. It’s common to blame stagnant innovation on large companies that reduce productive investment in favor of shorter paths toward profit. A growing number of Republicans have adopted this critique, notably Florida Sen. Marco Rubio. In May Mr. Rubio issued a 40-page report lamenting a drop in research and innovation and blaming “shareholder primacy theory” that focuses on increasing returns to shareholders. Instead of investing in plant and products, he argues, executives focus on cutting costs and optimizing debt to boost quarterly earnings. Critics of shareholder capitalism point to charts showing that plant and equipment have shrunk as a share of corporate assets since the 1950s, and that R&D in manufacturing have declined. But it’s unlikely these trends were caused by a sudden aversion to long-term commitments among investors and managers. Consider that in place of hard goods, companies are investing more in intangible assets, like the patents gained by acquiring a startup, or enterprise software that simplifies communication and accounting. These expenses may not boost employment in the same way as, say, new delivery trucks. But they reflect as much willingness to spend in ways that don’t deliver returns immediately, and in some cases never do. More important, there are entire business models based on risky long-term strategies—and those companies don’t have trouble finding backers. American financiers overinvested in rare-earth mining and hydraulic oil and gas production a decade ago based on rosy projections of global growth. And no one could accuse WeWork’s owners of valuing quarterly earnings over long-term potential. The rise of venture capital means more investors than ever are seeking the riskiest bets, and not only in software. Lavish support is available in biotechnology, robotics and other types of engineering in which backers have faith in an eventual payoff. • The regulators. This is the favorite suspect of innovators themselves, who understandably bristle under the increasing burden of federal rules. A company that makes or moves physical things faces limits on land use, passenger safety, pollution, chemical content and more, nearly all of which have gotten stricter since the 1970s. Peter Thiel, the billionaire tech investor, condemns federal regulators as the greatest obstacle to American innovation. “I would say that we’ve lived in a world in which bits were unregulated and atoms were regulated,” he said in a 2015 interview. His point is that restrictive rules are responsible for the slowdown in the engineering of mechanics (atoms) relative to software (bits). Whatever the benefits, every mandatory trial, emissions cap and maintenance rule reduces manufacturers’ output, decreases profit and restrains the ability to experiment. Yet the international comparison again casts doubt on this explanation. Countries that have developed quickly since the innovation slowdown, such as China, Japan and South Korea, placed less emphasis on consumer and worker protections than the U.S. did. Their bureaucrats attempt to boost industrial output, rather than hinder it. Despite decades of infrastructure marvels and greater shares of the world manufacturing market, none of these countries have caught up to the U.S. in achieving breakthroughs. Unlike 20th-century America, most of their growth has come from technologies discovered elsewhere. If regulation were decisive in hampering technological progress, one would expect zealously permissive regimes to surpass the fussy West. With legislators, investors and regulators largely off the hook, what’s left? The best evidence suggests that the seemingly boundless American progress of last century died a natural death. After 100 years of success, engineers around the 1970s found themselves less able to develop ever more productive designs and applications for the core technologies of the Second Industrial Revolution: combustion, electricity, signals, synthetics. As with previous revolutionary technologies—the steam engine, steel, gunpowder—the returns from each discovery gradually diminished. Productivity growth has slowed as a result. No other explanation accounts for why the slowdown has affected nearly every field of manufacturing. The internationally competitive garment industry and the protected sneaker industry both use similar production methods to those of 50 years ago. Neither high-tech combine harvesters nor simple winter jackets fulfill their functions much better now than two generations ago. No other country, regardless of trade or industrial policy, has demonstrated any more ability to break through. This realization is vital because it reframes every development in the U.S. economy since engineering progress diminished. For manufacturers since the 1970s, with few opportunities to grow by investing in better plant and equipment, offshoring parts of the production process may have become their only way to compete, not merely a way to grow faster. When companies lost much of their ability to improve product quality, lower production costs let them cut prices instead, raising living standards by other means. Critics like Mr. Rubio argue that the “financialization” of the economy has been counterproductive. In truth, the financial sector’s keenness for viable bets has helped sustain the overall growth of U.S. manufacturing. The low rate of nonperforming loans suggests the U.S. isn’t overleveraged compared with peers that boast a higher manufacturing share of output. Most important, the rise of software and high-end electronics looks less like a distraction from productive growth and more like a savior that has kept America moving when no other industry could. From IBM to Snapchat, tech companies have produced countless exportable goods and services and brought massive sums of foreign dollars into the U.S. economy. The software revolution has also propped up manufacturing by improving design capability, supply-chain logistics and marketing. A 2016 Deloitte survey of industry executives world-wide predicts that the U.S. will overtake China as the most competitive destination for manufacturing, as an ever-increasing share of growth occurs at the high end. Recognizing that the 20th century’s innovation streak died naturally should encourage policy makers to resist the allure of a Frankenstein industrial policy: slapping tariffs, subsidies and incentives on industries like electrodes, trying to revive the circumstances of a bygone economy. Protectionism can help companies maintain or increase market share. But manufacturing is shrinking as a share of employment in developed and developing economies alike. There’s little evidence that state support fosters commercially viable breakthroughs better than the market, so it’s an inefficient strategy for an advanced economy. Incentives to redirect capital, like Mr. Rubio’s proposal to punish stock buybacks through the tax code, would cause waste by discouraging companies from saving for better investments later. There’s no telling how innovation in engineering may eventually spring back to life, whether a new style of software next year or a mind-bending new field of physics next decade. Meanwhile, policy makers should take care to preserve the economic freedom that helps businesses find ways to prosper absent revolutionary progress. And Mr. Trump should heed his better angels by continuing to support every type of great thing America makes.