October 8, 2016

Which Comes First -- Skills Training or a Competitive Dollar?

Dire warnings abound that America will never be competitive with Germany -- or even stay ahead of China and its army of cheap labor and increasingly sophisticated robots -- unless it adopts the apprentice-based approach to career and technical education for which Germany has become famous.

In the United States, manufacturing has a serious image problem has lost its appeal to young workers. In addition to a general feeling that factory work is dirty, bright young people listen to their parents and others who have lost manufacturing jobs to low-wage workers in China and elsewhere and say, “Factory work is not for me. It has no future.”

Three problems lie at the heart of the manufacturing skills gap. First, potential trainees are looking elsewhere for work because manufacturing is not attractive. Second, manufacturing is not attractive because it is losing its international competitiveness and profitability. Third, manufacturing is losing its competitiveness because the dollar is overvalued, making it hard for US manufacturers to compete with imports and in export markets.

This note suggests that the exchange rate problem needs to be fixed before efforts to attract and train workers can be fully successful.

The manufacturing image problem

Manufacturing has become known as an industry in decline, one that is fleeing to countries such as China and Vietnam where workers are abundant, cheap, and enthusiastic about leaving the farm and working in a modern factory.

Unfortunately, the failure of factory work to appeal to young people in America who are looking for a good career does not stop with those planning to work on the factory floor. Work in manufacturing research labs, in managing CNC machinery, and in designing flow processes also lacks appeal among a growing number of graduate students.

A few years ago, I examined the share of graduate students in U.S. universities seeking a degree in science, technology, engineering and math (STEM) -- all fields highly and almost uniquely relevant to manufacturing. Then I compared these results over time with a similar analysis of graduate students seeking an advanced degree in finance and related MBA-type fields.

The results were shocking. As can be seen in Figure 1, the demand for graduate degrees in STEM fell like a rock, dropping by 2006 to only 75% of the share realized in 1990. This drop is highly correlated with the decline in the U.S. trade from near balance in 1990 to a deficit exceeding six percent of GDP in 2006.

Figure 1

This correlation is no coincidence. The U.S. trade deficit is driven almost entirely by deficits in manufactured goods trade. The growing deficit reflects the growing inability of U.S. manufacturers to compete in world markets. As the manufacturing sector’s competitiveness has fallen further behind, job layoffs have become increasingly frequent, and profitability has declined, leading to reduced productivity-enhancing investments in plant, equipment, R&D, and, yes, in worker skills training.

Faced with this sad picture of manufacturing’s decline, graduate students who might otherwise have gone into the high-tech end of manufacturing instead chose to seek training in more promising fields. And guess where many of them went – into finance and business management.

Figure 2

While America’s trade deficit was getting worse by the year, the stock markets were booming. The Dow, for example, went from about 3,000 in 1990 to roughly 13,000 in 2006-07. The graduate students, discouraged by the dismal track record of manufacturing, came to the understandable conclusion that finance would make a far more interesting and profitable career.

By the mid-1990s, the stock market was on a bull run, and grad students flocked into business schools across the nation. Despite some ups and downs, the share of graduate students getting MBAs had basically stagnated between 1990 and 1995, but it began to accelerate sharply thereafter. By 2007, the share of MBAs in total graduate degrees had risen by over 10 percent.

One of the best ways to make manufacturing attractive is to make it profitable. Profits create a sense of dynamism, change, and a brighter future.

Setting priorities for the next four years

But how can manufacturing be made more profitable so that young people demand training in relevant manufacturing skills starting in high school and continuing on through certificate degrees in community colleges, and perhaps to four-year and even graduate degrees? What should America do first -- train workers as Germany has been doing, or make US manufacturing more profitable by making the US dollar more internationally competitive?

But, you may say, this is a false dichotomy. Yes, in a perfect world, both initiatives could move forward simultaneously. However, in our imperfect world where politicians, administrators and institutions are constantly juggling priorities, feeling they are being asked to do too many things with too few resources, setting relative priorities remains important -- especially if one objective will fail unless the other is accomplished first.

Why focus on fixing the overvalued dollar first?

I would suggest that efforts to improve the supply of worker skill training in America will not bear full fruit unless demand for better skills training by workers and factory managers alike increases rather dramatically, and that the demand for better skills training will not materialize until the manufacturing sector as a whole is made more profitable by moving the overvalued US dollar to a trade balancing equilibrium exchange rate.

For example, it is worth noting that the real secret of Germany’s success with worker skill training programs is not some magic formula of “classroom + apprenticeship” training that America does not understand. In fact, America has had formal vocational education programs involving both classroom and apprenticeship training since the Smith-Hughes Act of 1917, and these programs were highly successful in supporting America’s industrial development before, during, and after World War II.

Instead, Germany’s real secret to manufacturing and skill-training success is a real exchange rate for the euro that, for Germany, is sharply undervalued. This allows Germany to sell its manufactured products world-wide at good profit margins. An undervalued exchange rate has also made it possible for German manufacturing to maintain a world-class image and to make solid investments in plant, equipment, R&D, and worker skills training.

The undervaluation of the euro for the German economy is highlighted by the fact that, during the past 20 years, the overall German current account surplus has equaled 3.4 percent of GDP on average -- a highly respectable figure, but one that disguises the dramatic improvement in Germany's current account balance from a deficit of 1.7 percent in 2000 to a surplus of over 8 percent in 2015. Over the same 20 years, manufactured exports have fluctuated within a few points of 85 percent as a share of total merchandise exports (Figures 3 and 4). The profitability that an undervalued currency has bestowed on manufacturing in Germany has made it easy for German industrialists to attract some of the best and brightest young workers and to provide them with the skills training they need.

Figure 3

Figure 4

During the same period, America has run a current account deficit averaging 3.4 percent of GDP -- with deficits of nearly 6 percent of GDP in 2005 and 2006. Manufactured exports declined from nearly 85% in 1999 to just over 60 percent in 2014 as a share of total merchandise exports (Figures 3 and 4).

The main reason smart businesses invest money is to make money. As long as the game rigged against them with the 25 percent overvaluation of the dollar, making money will continue to be very difficult for American manufacturers – especially for companies competing with imports or trying to export.

The fastest way to boost demand for skills training would therefore be to boost the profitability of manufacturing, and the fastest way to boost profitability is to make made-in-America products internationally competitive with an internationally competitive exchange rate for the dollar. Otherwise, efforts to increase investments in plant and equipment, R&D, and worker skills are likely to accomplish little.

Aside from various trade remedies such as countervailing and anti dumping duties (which clearly have an important though limited role to play), the most frequently heard recommendation for improving profitability is to improve productivity. 

But this recommendation has a real Catch 22. What business, which is currently losing money, would make costly investments that may take years to implement and recover costs, knowing that any investments made in plant, equipment, worker skills, etc. will almost certainly be matched if not exceeded by foreign companies that are already profitable?

Leaving aside obvious non-starter ideas such as massive government subsidies or high tariff barriers, the only way to provide the immediate boost in the overall profitability of the manufacturing sector that is needed to stimulate major productivity-enhancing investments, including investments in vocational training, is to move the dollar to a trade balancing equilibrium exchange rate.

Doing so would trigger an avalanche of investments in plant, equipment, and the like. It would also make it possible to pay more attractive wages. Suddenly, the image of manufacturing would begin to change. Young people looking for a good career would once again seriously consider manufacturing.

A competitive exchange rate would thus lead to demands from young workers for better, job-focused training.  A competitive exchange rate would  generate increased output and profits that would lead manufacturers to demand more well-trained workers – and to supply more financial assistance and more apprenticeship opportunities.

A competitive exchange rate would also generate economic growth, which would mean more tax revenues, even if tax rates were lowered as part of a badly-need comprehensive reform of America’s tax system and all of its special-interest loopholes. More tax revenues would mean more government resources to support training programs at all levels – from high school through doctoral programs and on into the R&D labs.

The key takeaway from this skills training example is that the average U.S. manufacturer first needs to be able to make a decent profit producing manufactured goods that can be traded internationally. However, this can be achieved within the next four years only if the exchange rate is moved much closer to its trade balancing equilibrium exchange rate. Other routes would take far longer and could fail entirely without the stimulus of rising profitability.

If the next President seriously wants to make it possible for all Americans to realize the American dream of a good middle class job or more, manufacturing deserves priority attention. If America is to enjoy the benefits of a true manufacturing renaissance, the first task on Day 1 of the new administration should be to assign a panel of experts to develop, in close and open cooperation with all relevant stakeholders, an action program designed to make America competitive today and for the rest of the 21st century. And the program should begin with implementing a policy that will make the American dollar once again truly competitive.

High on the list of policies designed to make the dollar competitive that a panel of experts should review are the following:

  1. Market Access Charge (MAC). This policy, which has been designed specifically to move the dollar to its trade balancing equilibrium exchange rate and keep it there with IMF-legal, market-friendly incentives, is needed to fix the general overvaluation of the US dollar.
  2. Countervailing Currency Intervention (CCI). This policy is needed to discourage further currency manipulation by countries such as China and to correct any currency-specific cases of misalignment that may arise.
With these two policies in place, the American manufacturing sector would once again be internationally competitive, profitable, and attractive as a career. Factories would demand workers with job-relevant skills training and, in cooperation with community colleges and other relevant education institutions, would be able and motivated to supply the necessary training. And students would be attracted by the prospect of working in a dynamic, modern industrial sector.

America Needs a Competitive Dollar - Now!

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