Production, not innovation, will win the future

In his State of the Union speech, President Barack Obama called on Americans to "win the future" and to do so by dint of innovation and doubling exports.

Because it played to Americans’ assumption of an innate entrepreneurial superiority that effortlessly produces game changing silver bullet solutions, this part of the speech was roundly applauded by virtually all of the president’s audience as well as the broader public. All were reassured by the Obama’s announcement of additional funding for development of high-speed trains, wind turbines, batteries, and solar panels. Surely, in the near future, American factories would be churning out vast quantities of these and other high-tech products to supply world demand and spur a U.S. economic renaissance that would produce good middle class jobs.

There was one dissenting group — most of America’s academic economists. Speaking for them, former Council of Economic Advisers chairman and current Harvard economics professor Greg Mankiw chastised the president in a New York Times op-ed reciting the orthodox catechism that because globalization is always a win-win proposition, there is no way the United States can be in economic competition with China or any other country.

Nevertheless in comments picked up last week by the Financial Times, Secretary of State Hillary Clinton was clearly feeling the competition. "Let’s just talk, you know, straight realpolitik," she said. "We are in a competition with China. Take Papua New Guinea: huge energy find. Exxon Mobil is producing it. China is in there every day in every way, trying to figure out how it’s going to come in behind us, come in under us."

She continued: "I might also mention China has about a $600 million development program for these Pacific Island nations, and what do we have? Zero." She followed that by saying: "We are in an information war and we are losing that war."

The FT also notes a recent diplomatic cable declassified by WikiLeaks from the U.S. embassy in Nairobi saying, "In pursuing its economic interest here, China is free to ignore human rights, democracy, and other issues which complicate the U.S. relationship."

The tone of all that suggests there is, in fact, a lot of economic competition between the United States, China, and other countries. And even where the competition is not directly economic, as in the case of the "information war," it is indirectly economic both in the sense that the U.S. can’t match what China is spending on it and in the sense that the ultimate objective of the "war" is often access to limited raw material sources and markets.

Not only is the United States losing the competition that Clinton finds so frustrating, but it is also losing on a much broader scale. Take exports and Obama’s goal of doubling them in the next five years. At first blush, things look good. U.S. exports are up about twenty percent so far in 2011, well on the way to the doubling target and an important part of an apparent economic recovery that has just brought under nine percent for the first time in three years. The only problem is that the exports are being drowned in a renewed flood of imports. As a result, the U.S. trade deficit is rising back toward the four percent of GDP level that is generally accepted to be unsustainable, and the present U.S. recovery is being bought at the cost of higher debt and lower economic growth potential for our children.

The truth is that the president’s export-doubling target is silly and meaningless. But no more so than the notion that America’s future will be rescued by innovation razzle dazzle that Americans are uniquely capable of achieving.

Just read this past weekend’s interview by Wall Street Journal editor Alan Murray with United Technologies CEO Louis Chenevert, Applied Materials Executive Vice President Mark Pinto, and Suntech Power CEO Zhengrong Shi. These business leaders are unanimous in the view that China is taking innovative leadership in the very green technologies the White House is targeting. In particular, Pinto, who has moved Applied Materials’ Chief Technology Office, its R&D center, and most of its solar oriented production to China, emphasizes that the critical factor in this trend is not R&D or innovation per se, but large scale production. Says he: "where you’ve got the manufacturing scale — that’s such a big factor in improving the technology –  scale plus technology is going to win. Where would you invest? The place where they’re investing in the scale."

Adds Dr. Shi, "Manufacturing also requires innovation. China is actually in the situation where they have to consider the future of manufacturing technology. So I think there’s a lot of innovation in manufacturing."

In other words, innovation isn’t the mana from heaven that economists have long assumed it to be. It doesn’t arise from some unique American gene. Rather than innovation leading to production, it is production that leads to innovation.

And it is precisely here that the United States seems to be suffering from gene deficiencies. In an important new study, Manufacturers Alliance adviser Ernest Preeg points out that U.S. manufactured exports as a share of global exports fell in the decade of 2000-2010 from 19 to 13 percent while China’s rose from 7 to 20 percent.

Top venture capital firm Kleiner Perkins’ chief John Doerr has said that the United States seems to be losing in the competition for green technology leadership.

The reason for this and for Clinton’s frustration at not being able to compete for influence and access to global commodity sources and markets is not that America lacks innovation. No country has been more innovative in the past thirty years than the United States. The reason America is increasingly losing out and lagging behind is that it lacks production. And that lack of production capability is now also leading to a decline in innovative capability.

From this, two conclusions follow. Greg Mankiw really needs to update his textbook, and if Obama wants to win the future for America he’ll need to reverse his priorities — focus less on innovation and exports and more on domestic production that can competitively substitute for imports.