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  • Writer's pictureMarco Annunziata

The surprising key to keeping the U.S. recovery going: Manufacturing innovation

The current U.S. economic expansion is already one of the longest on record—it turned 104 (months) in February. The manufacturing sector holds the key to making it the longest. Manufacturing is currently seen as unglamorous, unloved, needing protection just to survive. I believe this view is profoundly misguided, and that it is in manufacturing that we will see the most powerful growth-enhancing technological transformation ahead.

The U.S. economy has picked up speed, and the global economy with it. The IMF recently noted that we are enjoying the most broad-based synchronized upswing since 2010. The U.S. labor market keeps expanding at a robust pace and has created over 17 million jobs since the recovery started; the unemployment rate holds at a very low 4.1%, and strong economic activity keeps attracting more people into the labor force.

Wage growth remains muted, however, with average hourly wages increasing at a modest 2.6% pace in the last twelve months. This is a problem. Stronger wage growth would give better support to household consumption, and it would make it easier to reduce income inequalities.

Slow wage growth is disappointing, but it should not be too surprising. True, a tighter labor market should boost wages—I believe that it will, and that in the coming months we will see more robust wage pressures.

But sustainable strong wage growth depends on productivity. Only when productivity rises at a robust pace can workers enjoy faster wage increases without compromising their firms’ competitiveness and market position.

Productivity growth has been dismal of late. In the decade prior to the financial crisis, 1996-2005, U.S. labor productivity rose at an average pace of 3% per year. During the recovery, 2011-2017, it averaged a measly 0.7%--over four times slower. Most other advanced economies have suffered a similar fate.

What I find most worrying is that manufacturing sector productivity has suffered an even more severe slowdown: from 4.8% to 0.3% a year. From the early 1990s to the onset of the global financial crisis, productivity growth in manufacturing outpaced the rest of the economy by a significant margin; now it is lagging behind.

Economists disagree on why productivity growth has slowed. Some think we are not measuring it correctly, failing to capture much of the value created in the digital economy. Others argue that today’s innovations can’t power economic growth as much as the ones of the industrial revolution.

I find this pessimism on innovation grossly misplaced. A number of powerful new technologies are beginning to take hold in the manufacturing sector. Additive manufacturing, or “3D printing”, is perhaps the most exciting. It allows manufacturing companies to build lighter and stronger components; and it brings greater speed and flexibility to the cycle of design – prototype – test – revise and produce. A number of other ‘digital-industrial’ innovations are set to transform manufacturing, boosting the efficiency of industrial equipment, bringing data-driven improvements in operational efficiency, and providing workers with new up-skilling tools like augmented-reality wearable devices.

But to move the needle on productivity, these new technologies need to be deployed on a wider scale. The main culprit for slower productivity growth, in my view, has been lack of investment. During most of this economic recovery, business owners have been bombarded with dire predictions from economists and media outlets, warning that another crisis or recession lurked just around the corner, and that at best we faced a long period of extremely slow growth (“secular stagnation”). Companies took an understandably cautious stance, holding back investment.

When investment lags, the capital stock gets older and less efficient. New technologies take much longer to scale across the industrial system. It should be no surprise that productivity has stagnated.

The good news is that investment has now started to pick up. Non-residential fixed capital formation accelerated through 2017, rising at an average pace of 6% for the year, after a small contraction in 2016 and a modest 3% rise in 2015. The investment to GDP ratio is inching closer to 17%, not too far from the 18% pre-recession average.

Business confidence is high, indicating that the investment upswing is likely to continue—thanks also to tax reform and streamlined regulations. If it does, I believe we will see a marked acceleration in manufacturing productivity, as companies deploy the new technologies and learn to adapt their operations and managerial practices to exploit their full potential.

Manufacturing could be poised to re-establish its traditional role in leading overall productivity growth, supporting stronger wage growth and giving this economic recovery a second wind.

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