An in-depth look at a small element of Congress’ competition bill that will have a big impact on small manufacturers.
by Connor O’Brien
The headline-grabbing supply chain crisis and surging prices for durable goods across the economy since the start of the pandemic have given new momentum to a long-building movement to rethink American manufacturing, trade, and competitiveness policy. This effort has culminated in the Senate’s U.S. Innovation and Competition Act (USICA) and the House’s COMPETES Act. Members of both chambers will begin negotiations during the Spring recess to reconcile these two bills and send a bipartisan competitiveness and manufacturing bill to President Biden’s desk after a year of work in Congress.
One justification of this effort is geopolitical—a desire to reshore certain supply chains on national security grounds—while another has been to move the technological frontier forward in key industries, including artificial intelligence, semiconductors, and biotechnology, for its own sake as well as to safeguard American economic competitiveness. This effort is important given the well-publicized slowdown in productivity growth in the U.S. since the 1970s. But while advancing frontier technologies, methods, and processes is necessary to boost American productivity growth over the long run, it is not alone sufficient—this advancement must be accompanied by a diffusion of knowledge and management practices from frontier firms to laggard firms and from booming regions to legacy cities. The next American manufacturing boom, in other words, must be broadly-shared. Tucked into both USICA and the COMPETES Act are large funding increases for the Hollings Manufacturing Extension Partnership (MEP). Expanding the reach of this program that gives small and medium-sized manufacturers access to more advanced technologies and methods has the potential to spark a new era of growth for upstart manufacturers.
USICA proposes $2.4 billion in new funding for MEPs through 2026 while COMPETES offers $1.4 billion over this window. Originating in the late 1980s in response to stiff competition from West German and Japanese manufacturers in new global markets, the MEP program evolved under the National Institute of Standards and Technology into a small but fruitful investment by the federal government, helping small manufacturers in all 50 states solve technical issues, connect with universities and consultants, and scale up production. MEP centers across the country have had huge positive impacts on job creation and client firms’ revenue, and by one estimate may recoup federal investments in the program at a 14-to-1 rate. Given the pressing need for policy to close the widening productivity gap between leading and stagnant manufacturing ecosystems and how far the U.S. lags behind in the technical support it provides for small manufacturers, negotiators should prioritize MEP funding and agree to the Senate’s higher $2.4 billion funding level. Enabling MEPs to serve more manufacturers and expanding their mission will both contribute to boosting aggregate productivity growth and also provide a much-needed lift to some of the country’s left-behind manufacturing communities.
Productivity Growth is Slowing and Unevenly Distributed
The manufacturing sector has been hit particularly hard as American productivity growth has turned sluggish. Economists typically measure productivity using either output per hour of labor or with a measure called Total Factor Productivity (TFP), the production of a firm divided by a weighted average of its capital and labor inputs. In the manufacturing sector, TFP has been stagnant since the mid-2000s and has fallen outright since the Great Recession.
Not only has manufacturing productivity flatlined, but lagging firms have fallen further behind the leaders. According to experimental Dispersion Statistics on Productivity (DiSP) jointly produced by the Bureau of Labor Statistics and U.S. Census Bureau, the productivity gap between frontier and laggard firms’ productivity in manufacturing industries has, on average, increased over the last three decades. Leading edge firms have pulled away fastest in high-tech manufacturing sectors like semiconductor, computer, and electrical equipment manufacturing. Meanwhile, there has generally been productivity convergence between firms in “low-tech” sectors such as textiles, footwear, and food manufacturing. Worryingly, this means that the problem of widening productivity gaps is most acute in the advanced sectors upon which U.S. competitiveness is most dependent.
Within the semiconductor manufacturing sector, 90th percentile firms were 9.5 times as productive as firms in the 10th percentile in 2000—today, they are a whopping 37 times as productive. In industrial machinery, leading firms (in the 90th percentile in productivity) were 1.8 times as productive as lagging firms (in the 10th percentile in productivity), but were three times as productive as of 2018, a 65 percent increase in the gap. In other industries, gaps between sector leaders and laggards have declined, such as in apparel knitting mills (35 percent decline), motor vehicle parts (14 percent), and sugar product manufacturing (45 percent). In these industries, frontier knowledge has spread to less-productive firms faster. This may happen for a few reasons. In some cases, frontier knowledge may have remained stagnant, giving lagging firms time to catch up, while in others, structural changes within an industry or changes in policy may have enabled faster movement in knowledge from leaders to laggards. However, this has not generally been the case across the manufacturing sector broadly, where the gap between the most and least-productive firms has grown.
Geographically, aggregate labor productivity (all non-farm sectors) has also grown unevenly. Between 2007 and 2020, labor productivity grew tremendously in a select number of states, including North Dakota (54 percent), Washington (42 percent), California (41 percent), and Oregon (39 percent), reflecting these states’ explosive growth in fracking and software, respectively. Much of the country, however, did not see this kind of growth. Louisiana’s labor productivity grew just 5 percent over this span, Connecticut’s 2 percent, while labor productivity outright declined in Wyoming. Rather than productivity converging across regions and firms, we have instead seen high-income regions tend to get more productive while poorer states lag behind. Alarmingly, after decades of convergence through most of the 20th century, the gradual catching up of laggard states to the leaders has stopped.
All of this suggests that knowledge—blueprints, processes and practices, or more subtle, tacit “know-how”—is spreading across the economy more slowly than in decades past. Innovations continue to push the technological frontier outwards (though this process may be slowing down, too), but new knowledge and cutting-edge practices are not spreading to less productive firms and regions like they once did. This is both a symptom and cause of the broader decline in dynamism that is ailing the American economy and it is severely hurting our manufacturers’ ability to compete globally. It is also a justification for policies like manufacturing extension services that accelerate knowledge diffusion and make connections between firms, suppliers, and consultants that can help firms adopt better methods faster.
Extension Services: A Productivity Growth Workhorse
The United States’ Hollings Manufacturing Extension Partnership—a network of joint federal-state funded centers in every state—was established in the late 1980s out of concern that advanced manufacturers in countries like Germany and Japan were pulling ahead. MEP centers provide two types of services. The first includes direct advice, consulting, and research. The second is brokerage between client firms and third-party consultants, suppliers, or experts, a role some experts have likened to hosts of a dinner party. In both cases, program staff help small firms with technology adoption, supply chain challenges, entry into new markets, and overall process improvements.
In Germany, manufacturing support services like the country’s Freunhofer institutes are viewed as important factors that contributed to the strength and persistence of manufacturing in an era of more open trade and competition. By no means should the U.S. seek to import the German manufacturing ecosystem wholesale, of course—its manufacturing sector is less dynamic, dominated by older firms, and rarely produces new “superstar” firms. But this element of its system is well suited to the needs of small manufacturers. Fraunhofer institutes throughout Germany offer tailored research services to small and medium-sized manufacturing firms within their area of expertise. In deep collaboration with local universities, Fraunhofer institutes provide both customized research services and access to highly-trained students, apprentices, and researchers who often later return to firms as full-time employees or part-time consultants. Translating basic research breakthroughs into industrial applications and building local ecosystems of specialists has enabled the famous German “Mittelstand”—the country’s economic backbone of SMMs—to continue innovating. Globally, research assistance for SMMs has proven particularly useful for firms well behind the technological frontier.
Empirical research on the MEP program suggests it provides substantial benefits to client firms. MEP centers regularly gather survey data on jobs saved or created, new sales, or cost savings attributable to their assistance. Research from the Upjohn Institute using this data estimates that in FY2020, MEPs directly or indirectly created or retained 252,000 jobs in client firms, boosted GDP by $20.9 billion, and returned $1.99 billion to the Department of Treasury in additional tax revenue, representing a nearly 14:1 return to the federal government on its investment. Some skepticism of these results is warranted given the firm-level effects are self-reported, but more traditional academic work confirms the program does indeed boost productivity, particularly for very small firms and manufacturers of durable goods. Assistance from MEP centers has also been found to lengthen the lives of participating firms.
New Legislation Will Make Small Manufacturers More Competitive
USICA and COMPETES propose substantial increases in funding for the MEP network, though they each differ in the size of their expansions. The Senate’s USICA bill contains $2.4 billion in new funding through 2026 while the House-passed COMPETES allocates $1.4 billion. The former expands the program’s mission to cover cybersecurity and supply chain resiliency, as well as an explicit focus on helping manufacturers reshore production. The latter additionally creates a pilot program to award funding to MEP centers for workforce development and supply chain resiliency, establishes a national supply chain database, requires further outreach to underserved communities, and allows centers to receive competitive funding from other agencies.
Both sets of reforms maintain core elements of the MEP network that make it flexible and effective, namely its decentralized structure. Being composed of separate centers allows for the program to adapt to specific regional challenges and avoid the pitfalls associated with constricting top-down management from Washington. Further, this structure allows enterprising program managers to innovate and share best practices with other centers. The renewed focus in both bills on resiliency in the face of global supply chain disruptions is also particularly timely and fits with broader goals of rebuilding durable manufacturing ecosystems rather than targeting the reshoring of individual firms. Additionally, greater and more certain federal funding will allow centers to build deeper long-term partnerships with universities, workforce development programs, and important firms within supply chains, a key feature of the German model. The combination of decentralization between states—allowing centers to learn from and compete with each other—and this move towards a more comprehensive, wrap-around support system for small manufacturers aligns well with the push to sustainably reshore manufacturing to the United States. Embracing and building on MEPs in this way is well-suited to this moment of global recalibration in manufacturing and trade.
In addition to a sharper focus on building supply chain ecosystems and durable research relationships, straightforward funding increases, will bring our manufacturing extension service budget closer to those of top competitor economies. Historically, Japan has spent 30 times as much and Germany 20 times as much as a share of GDP on manufacturing extension services as the United States. The Senate bill’s $2.4 billion over five years will not close this gap, but would more than double the federal government’s existing investment. MEPs have the resources to only serve a small fraction of SMMs in their regions. In many cases, firms don’t necessarily need expensive, frontier technologies to substantially increase their productivity. Simply applying lean manufacturing principles to their processes will substantially cut costs, boost sales, and extend the lives of small firms. Given how many firms remain unserved by MEPs and the strong return-on-investment seen from many MEP centers, the conference committee should adopt the larger funding increase in the Senate bill.
Fighting the slowdown in productivity growth that is at the heart of so many of America’s economic problems requires addressing its deeper causes from multiple angles. We do need a more coherent policy environment that accelerates technological innovation and growth at the frontier of human knowledge, but also policy which allows ideas, processes, and know-how to spread to communities and businesses across the country. Building up the country’s network of MEPs is thus a critical investment in the future of America’s manufacturing competitiveness. It embodies exactly the sort of low-cost, pro-dynamism policies that the country should be enacting right now.