September 25, 2013    Volume 20, No. 13

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MIT: With Loss Of Manufacturing The U.S. Innovation Engine Is No Longer Working

By Richard A. McCormack, Editor

The loss of so much manufacturing capacity from the United States over the past decade has had a negative impact on the country's ability to innovate, long considered to be the nation's greatest economic and sociological strength, according to a two-year study from the Massachusetts Institute of Technology.

The United States no longer has the industrial "ecosystem" necessary to bring new ideas to market. Finance, equipment, suppliers and manufacturers are not available in the United States to make prototypes and scale up commercial production of innovative ideas and products. This holds true for high-tech start-ups, the best small- and medium-sized manufacturing companies, and U.S.-based multinational corporations.

"Serious basic weaknesses in the industry ecosystem are prevalent," according to MIT's Production in the Innovation Economy (PIE) study in a book published on Sept. 20 titled Making in America: From Innovation to Market. "In some companies we interviewed, these weaknesses took the form of managers' worrying about having to bring parts of production back in-house because they feared for the survival of their suppliers. The cost of substituting for missing suppliers would divert resources from the development of new lines of business."

In looking at the country's fastest growing small- and medium-sized manufacturing companies, almost two dozen MIT professors and a total team of about 40 researchers found that "problems showed up in the length of development cycles, as the companies slowly dripped in resources out of their previous year's profits -- without access to much or any outside funding." There are "few" external resources available to companies wanting to start full-scale production of new products. "[C]ommonly available resources like training, local banking, and multiple supplier sources have disappeared, thus opening great holes in the industrial ecosystem."

As the MIT researchers interviewed hundreds of people in small and high-tech start-ups, in Main Street manufacturers, in the world's largest multinational companies, and in foreign competitors, they realized that "our own understanding of when and how innovation can come to life in the economy [had] been transformed," the study concludes in its final paragraph. "We have watched great inventions in search of machine shops and suppliers capable of making prototypes and pilot projects; great start-ups in search of funds first here, then abroad, to commercialize products on a large scale; and plain good ideas about improving products and processes remain unrealized. Our own initial lofty conceptions of innovation as the discovery of new general purpose technologies that burst into the world and create whole new industries have been brought down to American earth by recognizing the need to tie them to the challenges of sustaining the human talents and material capabilities required to build these new industries. As researchers, we still have our dreams; after the PIE project, we realize we need partners to bring them into the world."

Manufacturing & Technology News spoke with Martin Schmidt, MIT professor, Associate Provost and director of the Task Force on Production in the Innovation Economy, about the task force's findings shortly after they were presented at MIT. Here is what he had to say:

Question: Do you think the main finding of the MIT study -- that the loss of manufacturing has resulted in the degradation of the country's innovative capacity -- is well understood in the United States?
At a national level, the discussion seems to worry about manufacturing in three contexts: jobs; national security; and innovation. We felt we had an opportunity to weigh in on the last point in a significant way. We worked as hard as we could with rigorous, quantitative research to get to the bottom of understanding the importance of the linkage of a production ecosystem to innovation. Our conclusion is that they are terribly important.
We can talk about jobs and national security, but if this is a nation that views its ability to innovate as a core strength, then we need to pay attention to manufacturing.

Q: Over the years, I have heard many organizations like the Cato Institute and economists such as [Columbia University professor] Jagdish Bhagwati argue emphatically and successfully that the United States does not need manufacturing. Given what the PIE researchers have concluded, do you think we've heard the end of that argument?
Well, I hope so. I hope that our work and other people's work provide a real quantitative grounding for this discussion.
The surveys we have done, the interviews we undertook and the benchmarking of other nations relative to China and Germany provide some fairly compelling arguments as to why a domestic production ecosystem is really important. The PIE study provides some historical perspective on why we are where we are today, namely the erosion of the vertically integrated firms associated with the push of the capital markets to make firms more efficient in their use of capital. That has had consequences.
The PIE results provide a fairly comprehensive picture of not only what has happened, but what the consequences of that are. Then it provides a roadmap for what we ought to be doing: moving forward to strengthen this important ecosystem in terms of maintaining our innovative advantage.

Q: You said your quantitative research indicates the consequences of the hollowing out of the U.S. industrial ecosystem. What are they?
As we focused on the start-ups and the Main Street firms, we found that their ability to innovate in new products was constrained by the inability to access this rich ecosystem. Or, said in a different way, when we looked at the firms that were successful versus ones that were less so, one of the key differentiators was whether or not they lived in a rich ecosystem for the work that they did. The consequence of not having that ecosystem is constraining our ability to innovate and it slows things down.
We saw lots of examples where the development time for new products is lengthened by the lack of access to production capabilities in a [product] development sense. While industry has figured out how to network a complex global supply chain, we don't have an effective means to use that supply chain in [new product] development.

Q: Do you think there is a direct correlation between what has happened with the hollowing out of the American manufacturing sector and the country's current economic doldrums, the jobless recovery and the Great Recession, since, as PIE notes, once the industrial base was lost, so too was the capacity to innovate and create good jobs and new industries?
Well I'm not an economist.

Q: I prefer that you not be an economist to answer that question, since most economists don't care.
We had 6 million manufacturing jobs that have been lost in the last decade and some people argue that they are never coming back and others argue that shale gas and rising costs of labor in China are all going to lead to a reshoring of manufacturing capability. I don't feel there is any good quantitative analysis of that, but our historic growth has been based on leveraging our innovation. If our ability to innovate is under threat, then our growth as a nation is also under threat. That is the way I view it.
At times, we look to singular industries and declare that if they can outsource production and be successful, then we shouldn't worry about this. So a lot of attention gets paid to consumer electronics -- and Apple being the greatest icon of that -- where you have firms that can innovate in new products but don't manufacture any of the products under their own roof -- and in many instances manufacture those products in other parts of the world. But while that is true, it is an anomaly -- a function of the standardization of the manufacturing processes for the core technologies that feed into consumer electronics. We don't see that standardization in other areas. The semiconductor industry is the epitome of that ability to standardize on a manufacturing process and then share that manufacturing process [globally] through the foundry mechanics. We just haven't seen that model work in other industries.
If we focus on the consumer electronics industry as the example of why we don't need manufacturing to support innovation, then we are overlooking some enormously important areas and we are reaching the wrong conclusions.

Q: Most economists and policymakers are convinced that the United States remains the innovation engine of the world, but without manufacturing is that really the case? Is this a myth that has to be overcome?
Yes. Clearly we continue to innovate in software and services to some extent, but in the manufacture of real products it's a constraint. One of the things I would highlight in the PIE work is with the Main Street firms that doubled revenue and increased headcount between 2004 and 2008. When you look at those companies and ask what was the key to success, there were a few common denominators. Some had to do with having really innovative leaders who would look broadly at their core capabilities that they had and seek opportunities to deploy and pivot those capabilities in other markets. But a firm in Massachusetts that is really excellent at making and welding [storage] tanks isn't going to be realizing that opportunity to branch into new markets if they are not sitting next to innovators coming out of MIT who need that capability in a destructive new [technology] area. That startup from MIT might be able to find that tank manufacturer in some other place in the world, but that will slow them down, and they will be competitively disadvantaged. It's also a lost opportunity for, in this case, Massachusetts, to have had this enterprise really accelerated. If you have that capability nearby you are going to use it.
One of the things we overlook is that we have startups coming out of places like MIT and they garner the resources necessary to do what they want to do. But we argue that it takes them longer to do it when they can't access a local ecosystem. But what is completely overlooked is the idea that if they had that local ecosystem, they strengthen those firms through partnerships. There are spillover effects from innovations.

Q: The PIE research on the start-up companies from MIT that make physical products found that none of them could scale-up to commercial production in the United States. Was that a frightening finding?
We found that a large fraction of them were venture backed and when they got to the point of demonstrating a functional prototype and ramping production on their unique capability, the established sources of venture capital were challenged to support the last round of investment.
One of the common sources of capital in that last round was foreign investment, which might have been coming from Singapore, Russia or China. Quite frequently, those investments carry with them a commitment to do something in the region where that investment is coming from. The invention and the scale-up is occurring here but you don't capture that production capability, which then feeds innovation of the next generation of products.

Q: One of the phrases I see in the report is that the loss of the U.S. industrial ecosystem has "alarm bells ringing in the halls of MIT." Do you see things changing for your students?
The national dialogue is healthy. A lot of people are talking about it and a lot of people are concerned. We have the ear of Washington in a bipartisan sense. Everyone appreciates the importance of this.
But you need to focus on this at the regional level. MIT has a great partnership with the Commonwealth of Massachusetts as well as with local players. Each region needs to come together and make this a priority.
So with the federal focus and the regional energy level there are lots of reasons to be optimistic because of the discussion and the thoughtful processes that people are going through.

Q: Having covered Washington for 30 years, I know that to do anything requires legislation -- an authorization and appropriation. But the capacity for new legislation is not working at the moment. Congress is completely distracted. There are only a few on Capitol Hill who understand these issues, and fewer who propose legislation addressing them.
We've had some very good engagements with the Deputy Secretary of Commerce Patrick Gallagher, but I'm not in Washington, so I can't comment on the state of function or dysfunction there. But we can make a difference at the regional level and maybe that is what should drive the change.

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