In May 2013 shareholders voted to break up the Timken Company—a $5
billion Ohio manufacturer of tapered bearings, power transmissions,
gears, and specialty steel—into two separate businesses. Their goal
was to raise stock prices. The company, which makes complex and
difficult products that cannot be easily outsourced, employs 20,000
people in the United States, China, and Romania. Ward “Tim” Timken,
Jr., the Timken chairman whose family founded the business more than a
hundred years ago, and James Griffith, Timken’s CEO, opposed the move.
The shareholders who supported the breakup hardly looked like the
“barbarians at the gate” who forced the 1988 leveraged buyout of RJR
Nabisco. This time the attack came from the California State Teachers
Retirement System pension fund, the second-largest public pension fund
in the United States, together with Relational Investors LLC, an asset
management firm. And Tim Timken was not, like the RJR Nabisco CEO,
eagerly pursuing the breakup to raise his own take. But beneath these
differences are the same financial pressures that have shaped corporate
structure for thirty years.
Urging Timken shareholders to vote for the split, Relational
Investors argued that they should want “pure-play” companies,
focused on a single industrial activity. Investors would then be free to
balance their portfolios by selecting businesses in industrial sectors
with varying degrees of risk and sensitivity to different phases of
economic cycles. A firm such as Timken—about one-third a steel company
(a materials play) and about two-thirds a bearings and power
transmission business (an industrial components play)—would lock
investors into a mix that, Relational Investors claimed, leads to a
discount on share price.
Timken management argued that making both materials and products
enabled them to bring to market higher-quality goods that met
customers’ needs: for example, their ultra-large bearings for windmill
towers, which measure two meters in diameter, weigh four tons, and have
to stand up to extreme wind and temperature conditions. Controlling the
entire value chain, they said, allowed them to fine-tune the attributes
of the steel in order to make superior products. Nonetheless, the
financial calculation about how to maximize quarterly returns won out.
Timken’s story is not only about stock prices and product quality.
Since the 1980s financial market pressures have transformed U.S.
corporate structure itself. The system was once dominated by a few dozen
very large, vertically integrated firms in which most or all of the
functions needed to take a new idea about a product or a service to
market—from R&D, design, manufacturing, testing, and logistics
through sales and after-market services—were contained within the four
walls of a single corporation. Now even the big firms are smaller,
leaner, and centered on “core competencies,” with much of their
production outsourced and overseas. Those pressures have driven
companies such as Timken to hive off activities that involve heavy
capital outlays, require large workforces, or promise less profitability
in the short term.
The contribution of this decades-long trend to the rapid decline in
American manufacturing has not been fully acknowledged. But
understanding its role is essential to a revival of American
manufacturing that will create jobs and promote long-term economic
health. Both private and public sectors are taking constructive steps.
Will American finance get in the way?
Timken was one of hundreds of manufacturing companies in a sample of
firms interviewed by an MIT research team about their experiences in
bringing novel ideas, products, and processes to market. I was a
principal investigator in that project. The aim of the
project—Production in the Innovation Economy—was to discover whether
we really need manufacturing to gain the benefits of innovation:
economic growth, new companies, new profits, and good new jobs in this
country. After all, Apple and other companies like it—which do
R&D, design, and distribution but little or no production in the
United States—reap the lion’s share of their profits here. To
explore these issues, the MIT researchers collected data on the efforts
to scale innovation up to market by startup firms, Main Street small and
mid-sized manufacturers, and Fortune 500 companies. When we learned
about the Timken shareholders’ vote, we realized that we were seeing
up close and in real time the forces that over the past thirty years
have transformed and shrunken manufacturing in the United States.
In the radical downsizing of American manufacturing, changes in
corporate structures since the 1980s have been a powerful driver, though
not one that is generally recognized. Over the first decade of the
twenty-first century, about 5.8 million U.S. manufacturing jobs
disappeared. The most frequent explanations for this decline are
productivity gains and increased trade with low-wage economies. Both of
these factors have been important, but they explain far less of the
picture than is usually claimed.
Since the 1980s, financial market pressures have driven companies to
hive off activities that sustained manufacturing.
In the case of productivity gains, there have clearly been major
advances over the long term. The periods of advance, however, do not
correlate neatly with the years of greatest job losses. Some periods of
rapid productivity growth also saw employment growth, or at least of
stability in the manufacturing workforce. Research by economist Susan
Houseman and her colleagues on the past decade—when manufacturing
employment has fallen off the cliff in the United States—suggests
productivity growth in manufacturing was actually modest, but national
statistics fail to account for the rising volume and value of imported
components and thus systematically overstate productivity. The corrected
numbers indicate that productivity growth over the past decade took
place primarily within one manufacturing industry: computers and
electronics. So productivity gains alone can hardly explain the
shrinking of U.S. manufacturing employment.
Nor can trade and outsourcing to low-wage countries account for
manufacturing declines that began well before China became a factor.
Today there is overwhelming evidence for the powerful effects of
globalization and trade on manufacturing employment, particularly in
those regions home to labor-intensive industries such as apparel and
furniture, which were heavily exposed to import competition. But the big
impact of low-wage imports hit in the United States only after the entry
of China into the World Trade Organization in 2001. Before then the
proportion of imports coming from low-wage economies relative to imports
from high-wage economies was very low. Economists generally found it too
small to explain manufacturing job losses. Even taking into account the
outsourcing of existing jobs as well as import competition, it was
implausible a decade ago to attribute a significant share of job
destruction in manufacturing to these causes. Department of Labor
surveys found that outsourcing and offshoring jobs represented less than
one percent of all layoffs in 2003, and two percent in 2004. These
surveys did not catch the total volume of jobs being transferred
overseas, but in all estimations those jobs amounted to a small fraction
of total annual job turnover in the American labor market.
To better understand the decline of American manufacturing, we need
to go back well before the last decade to see how changes in corporate
structures made it more difficult to scale up innovation through
production to market.
In the 1980s about two-dozen large, vertically integrated companies
such as Motorola, DuPont, and IBM dominated the American scene. With
some notable exceptions (for example, GE), large vertically integrated
companies today have pared off activities and become not only smaller
but also more narrowly focused on core competencies. Under pressure from
financial markets, they have shed activities that investors deemed
peripheral—such as Timken’s steel.
This process has been fostered by great technological advances in
digitization, which have allowed companies to outsource and offshore
many of the functions they previously had to carry out themselves. In
the 1970s a Hewlett-Packard engineer who designed circuits for a new
semiconductor chip had to work together with a technician with a razor
blade to cut a mask to place on silicon. Now the engineer can send a
complete file of digital instructions over the Internet to a cutting
machine. The mask and the chip fabrication can take place in different
companies, anywhere in the world. A senior executive of Cisco told MIT
The separation of R&D and manufacturing has today become
possible at a level not even conceivable five years ago. Progress in
technology allows us to have people working anywhere collaborating. We
no longer need to have them located in clusters or centers of
excellence. We now have the ability to sense and monitor what’s
going on in our suppliers at any place and any time. Most of this is
based on sensors deployed locally, distributed control systems, and
new middleware and encryption schemes that allow this to be done
securely over the open Internet. . . . In other words, not only do we
monitor and control what’s happening inside a factory, but we’re
also deeply into the supply chain feeding in and feeding out of the
Digitization and the Internet continue in multiple ways to enable the
fragmentation of corporate structures that financial markets demand.
The breakup of vertically integrated corporations and their
recomposition into globally linked value chains of designers,
researchers, manufacturers, and distributors has had some enormous
benefits both for the United States and for developing economies. It has
meant lower costs for consumers, new pathways for building businesses,
and a chance for poor countries to create new industries and raise
But the changes in corporate structures that brought about these new
opportunities also left big holes in the American industrial ecosystem.
These holes are market failures. Functions once performed by big
companies are now carried out by no one.
Vertically integrated companies used to provide semi-public goods
through apprenticeships, basic research, funding to bring innovation to
scale, and diffusion of new technologies to suppliers. The resulting
spill-overs into the economy were enormously important: they subsidized
community college education, provided job training, and more generally
created an industry-wide ecology that fed job creation and growth.
Companies such as Alcoa, AT&T, DuPont, and Xerox used to support
long-term R&D in facilities such as Bell Labs. Over the past twenty
years, those laboratories have been shuttered or greatly reduced in size
and scope. As companies downsized, they could no longer, or would no
longer, keep these activities in house or pay for them.
Today companies harness R&D to specific business divisions and to
near-term product development. Most basic and precompetitive research
starts out in public and private laboratories isolated from
manufacturers. When cutting-edge innovations come out of such
laboratories, it is not clear where to find capital to bring their new
products and processes to market. Who will handle prototyping, pilot
production, testing, and large-scale commercialization? When DuPont
brought nylon into mass production in the 1930s and 1940s, it could draw
on its own retained earnings as well as established relations with
investors, bankers, factories, and suppliers. Today’s innovative small
company lacks virtually all of these resources. Investors excel in
providing venture capital funding for startup companies, but once these
companies reach the stage of commercialization and venture capital is no
longer available, they find few financial backers. Now that investors
have curbed their appetite for startups going public, acquisition by big
companies and recourse to foreign capital seem to be the main avenues
for bringing to market the innovations that begin life in university and
public laboratories. Both of these routes have troubling implications
for American innovation and jobs. When big companies acquire startups,
the MIT researchers found, much of the dynamism and promise of the new
technology can be lost in the process of integration. When
commercialization takes place outside the United States, opportunities
to learn about scaling new technologies are foregone. Over time, it
becomes more likely that innovation will shift to places where companies
have more experience with scale-up and commercialization.
The loss of apprenticeships and job training are similarly
problematic. Today’s companies do not intend to keep employees in
lifetime careers, so they no longer invest in the skills they
nonetheless need from employees. This not only creates challenges for
companies that once could rely on workers trained in house; it has a
negative effect throughout the economy. Even in the days of long job
tenure, significant numbers of workers who started in large firms moved
around, so big-company investments in training benefited the broader
More generally, with the shrinking of publicly available resources
once generated within big companies and with the disappearance of many
suppliers as production moved offshore, it has become more difficult for
all manufacturers to move new products and processes to market. It is
not only startups that face the hurdle of finding resources to
substitute for the capabilities and coordination once provided within
the four walls of the vertically integrated corporation. For established
small and mid-sized manufacturers, too, the process of commercialization
has become more challenging. To bring a new product or process to life,
a firm needs to find additional capital, skills, suppliers, and possibly
expertise. Today small and medium-sized companies find little that they
might combine with their own resources. They drip in money from retained
earnings and develop their products in small increments. Even promising
new projects move ahead haltingly, and few jobs are created.
The depletion of the industrial ecosystem is hardly inevitable in
advanced high-wage economies. Consider Germany. In 2010 manufacturing
employed 22 percent of Germany’s workforce and contributed 21 percent
of value-added to GDP. In the same year in the United States, just under
11 percent of the workforce was employed in manufacturing, which
contributed 13 percent of value-added to GDP. Many factors explain the
difference, including the role of government in supporting innovation
and Germany’s education system. But, importantly, German companies
operate in ecosystems rich in research consortia, Fraunhofer Institutes,
specialist suppliers, technical universities, apprenticeship training,
and local and regional banks.
This ecosystem supports innovation and commercial production through
diverse mechanisms. Through their connections to larger firms and to
each other, small and medium-sized companies are able to obtain
information that would otherwise be difficult to access. In research
consortia, companies come together to discuss road maps for new
technologies and to work collaboratively on them. The consortia build
equipment and facilities to be used by multiple firms that could not
afford to buy these themselves. They distribute public funds through
In such an environment, German companies find valuable complements to
their own legacy strengths when they move into new domains. In contrast,
small and mid-sized U.S. manufacturers are home alone when they try to
bring innovation to market.
There is no returning to the corporate structures of fifty years ago.
The question is how to fix the holes in the U.S. industrial ecosystem,
given that we now have companies with smaller domestic footprints who
face powerful and agile competitors around the world. In a globally
distributed economy, how can we generate the coordination, knowledge
diffusion, resources for scaling-up, and leadership that could
accelerate and deepen the flow of innovations into the market? The MIT
researchers looked for initiatives promising complementary
capabilities—skills, expertise, finance, services, technologies—that
can be drawn on by multiple firms in diverse sectors. The cases we
identified are experiments in rebuilding the American industrial
ecosystem. No one of these models would fit every situation, though they
do have common features of working to build trust among partners, reduce
and spread the financial risks of innovation, and convene private and
The depletion of the industrial ecosystem is hardly inevitable in
advanced high-wage economies.
A number of these initiatives have been spearheaded by state and
federal government. The Obama administration’s new manufacturing
innovation institutes form one such initiative. The federal government
announced a competition in which it would invest $30 million for a
center to work on additive manufacturing (3d printing) technologies. A
dozen groups made up of universities, companies of all sizes, and
economic-development organizations competed for the center, which
eventually was granted to a Northeast Ohio/Southwest Pennsylvania team
and was set up in 2012 in Youngstown, Ohio. The private sector has now
contributed more than $60 million to this project. Fifteen more
manufacturing innovation institutes have been announced. On the state
side, the Massachusetts Clean Energy Center, for example, acts as a
convener and coordinator in the renewable energy sector, bringing
universities, turbine makers, energy storage device makers, the
Massachusetts Maritime Academy, and others together in new projects.
None of these particular parties had worked together before. MassCEC
also invested $18.2 million in state funding to secure an additional
$26.7 million in federal Department of Energy funds to build a
world-class wind-blade testing facility.
While public-driven efforts to rebuild the industrial ecosystem are
the most visible, the MIT team also recognized that private sector
companies were taking steps to create resources that could be used in
combination with others. Indeed in the sample of firms we interviewed,
Timken stood out as one of the companies most engaged in such
initiatives. Before the shareholder-driven breakup, Timken and Stark
State College of Technology in North Canton, Ohio were building a test
center for ultra-large bearings for use in wind turbines. Students would
get hands-on experience in the center, which would also be used by
Timken for its own product testing. At the University of Akron, Timken
took the lead in expanding research and degree programs on engineered
surfaces. Timken transferred its coating laboratory equipment and staff
to the university and initiated an industrial consortium that other
firms could join—on condition that they too contribute to the
programs. Although coatings are vital to Timken’s products, they were
essentially a “stranded technology” in a company whose business
lines are bearings and special steels. At the new industrial consortium
at the University of Akron, coatings research can be developed into
startups; one has already emerged. Timken also became one of the most
active promoters of the coalition that eventually won the first federal
manufacturing innovation institute grant in additive manufacturing.
Timken obviously has a business interest in these initiatives:
sharing costs for activities that were once borne entirely in-house,
educating students who can be recruited for employment, gaining
eligibility for new state and federal grants. But in fulfilling its own
goals, Timken was also acting as a convener for industry and education.
It placed its own resources on the table in order to attract others to
do the same. As Timken prepares to split into two smaller publicly
listed companies, how likely is it that either of them will be so active
in strengthening the Ohio industrial ecosystem? Judging by the records
of other companies that have gone through similar restructuring, I am
With domestic shale gas and oil exploitation pushing energy prices
down, rising wages in China, and new corporate realism about the costs
involved in outsourcing and offshoring, there is a more favorable
climate for manufacturing in the United States today than there has been
in decades. Yet these changes are unlikely to have durable effects if
the basic weaknesses of the system are not repaired.
The new public-private partnerships to rebuild capabilities in the
industrial ecosystem seem to have enormous promise. But, as the Timken
case illustrates, the financial pressures that broke up American
companies in the ’80s persist.
The solution may be out of reach. Today California teachers need to
protect their pensions by dismantling Ohio manufacturers. The structures
of U.S. capital markets and fiscal policy reward investors whose
decisions are based on maximizing returns over the short-term. While the
Dodd-Frank financial reforms may cut down on some of the riskiest
securitization-based investment strategies, new regulations have not
created real incentives for the more patient investment that growing
production in America requires.
I can only congratulate to this perfect
" story telling " - analysis of causes and conseqences of
global deindustrialization of traditional industrialized economies and
nations in last 30 - 35 years . Best piece on this complicated subject I
have read in past 20 years ... - wholle world of Eaton/ Kortum , Helpman
, Melitz and even Costinot/ Arlokakis - world of highly theoretized
modern theory of /contemporary/ Ricardian comparative advantages -
international trade, imperfect market structures , finance and trade -
and not least - inequality and jobs - in just one such a perfect article
. No joke - even Acemoglu/ Jones/ Robinson with their rich universum of
eternal searching for " why nations fail and rise " should go
here back to schoolbanks ... Ms. Suzanne Berger - full respect and
thanks for this . Marián Vitkovič , economist , Slovakia .
Businesses follow financial incentives like
water flows downhill. Who decides? Your exquisite point, well made, is
that businesses could follow more propitious R&D... and probably
would... if their Business plans wasn't being controlled and manipulated
by investment portfolios half a world away.
It seems funny... in a 'Colbertian' sort of way... that the ideologues
that hate 'big government' are insisting this flawed investment pyramid
scheme with cash and leveraging... entirely for short-sided monetary
gain... and by doing so, ensuring the need for 'big government'
interventions. Though 'big government' is too fine a tool for anything
but the fine tuning of a market economy is increasingly apparent... Its
the only one we haven't sold to the highest international bidder.
We must thoroughly restructure our national business incentives and
objectives... to recreate and support the thriving middle class... and
perhaps more importantly... re-instill the 'brighter future' motif that
is so important to laboring inspiration and personal pride.
Thanks for the clarity with which you have
detailed the systemic reasons for the decline in manufacturing in this
country. It is not manufacturing alone, but many other industries that
are victims of similar systemic dysfunction.
It is of utmost importance to reveal these mechanisms and educate the
public - though i do see that this communicate is complicated and will
not be easy. However, we need to expose the fals logic and sometime
deliberate miscommunication of vested interests.
Thank you for showing how this reversal might be possible. It is so
timely since I was just talking about this to my daughter.
Please do similar exposes on other industries, and let us make our
industrial ecosystems whole, fill the holes, and make this country work
for all, here.
Finance does not have to be short-termist.
As Jack Bogle, creator of the Vanguard Fund and the first index fund,
argues in his latest book Clash of Cultures, long-termist funds like
Berkshire Hathaway outperform hedge funds; and as Frazini and Pedersen
show in "Betting against Beta", BH's advantage is robust
across industries, markets and regions.
I cannot help but think that the principal if not the only reason that
hedge funds and the like predominate in the non-pension institutional
investment world is that their owner-managers do much, much better than
the managers in the BH model do. They thus have a powerful incentive to
act like oligopolists and provide their investment services to pension
funds etc. only in a form that benefits them the most, even at the cost
The BH model is replicable, however. For instance, I am leading a team
creating a BH-like hybrid investment fund that, according to our
spreadsheets, and given identical investments, will systematically
outperform angel and venture funds (and even BH by a small margin). The
secret sauce is in the corporate structure, how it compounds shareholder
assets, and over what time period. It's not a get-rich-quick scheme,
it's a get-very-rich-slowly scheme - in that respect exactly like BH.
Here's the relevance of this to the gutting of manufacturing: An
investor who has to take the long view, as Dr. Berger indirectly makes
clear, prioritizes different business behaviors, policies and products.
It makes sense only in the short run and to very narrow interests to
dismantle a beneficial ecology (of whatever kind); a long-term investor
will be studying the ecology and making contributions to it if that
contribution promises to improve returns over the longer term. In our
case we are going to concentrate on climate change and public health
crisis mitigation, but the idea is applicable to any area of business. I
can easily imagine a fund like ours providing capital for the sorts of
alliances Dr. Berger describes, and in far larger amounts than provided
by cash-strapped state governments. And the fund would benefit hugely,
while throwing off all kinds of positive externalities. Win-win-win.
Yes, of course, finance will increasingly
control manufacturing. Finance maximizes margins, controls
investments and steers direction. Most importantly, and most
unfortunately, for the foreseeable future, the fact that developing
nations exists allows for the financial exploitation of labor and
The perception is that labor, i.e., materials and manufacturing, can be
done by robots and bodies. Thus manufacturing is cheapest where
the bodies can be paid the least and the robots can pollute the most.
As technology packages the routines of white-collar work, these tasks
will become--for all intensive purposes--automated and will also be
jobbed-out to robots and bodies.
This exploitative trend has already moved overseas: customer service as
call centers, India has taken-on testing, data entry and word processing
are big in Mexico, even basic coding is being swallowed-up by 2nd world
nations in Eastern Europe and South-East Asia.
Thus, either until international equality and environmental regulations
are passed or until that future day that the globe finally 1st world-izes,
finance will increasing push technologically packagable jobs into the
exploitable developing nations. Materials have already happened,
manufacturing is big news now. Meanwhile, the white-collar
migration is underway and ramping-up for more.
So long as shareholders sit in the driver's seat, steering decision will
always come-down to financial yield. This is a shame because, it
used to be that an investor bought stock in a corporation that produced
a product in which that investor believed. Due to its fine
product, the sharehold was making a long-term investment in the future
growth of that company.
Now it's a robo-trade, milk 'em and bilk 'em world. Now nvestors
treat firms like casinos on the Vegas strip...they jump from one slot to
the other lookin' for a hot one-armed bandit; they hit a blackjack
table, play it 'till the shoe's empty and move-on to the next.
Really, there ought to be a law.
Excellent piece about the
deindustrialization in the U.S. A similar analysis could be made about
Britain, also dominated by short-term finance and that casino economy.
Good point about Germany here too. Additional comments about countries
such as Sweden and Japan might be welcome.
May I refer to my book "The Seven Deadly Sins of Capitalism"
in which I elaborate about the subject (more at: http://www.mikeconomics.net/home/sevensins/.
Excellent article and almost too much
information in such a short piece. If I hadn't lived through it
for the last 30 years as a design and development engineer I think I
would have trouble digesting it all.
There are a number of examples of vast amounts of wealth being created
by the research departments in large corporations. I am old enough
that I watched the murder of these jewels by "rational"
Hewlett Packard gutted their research departments and survived for
decades off the inkjet printer technology they invented in the 1980's.
Too bad they didn't first outsource their finance department to China
before any other department.
Now Corning is making a fortune from Gorilla glass that came out of
their research department in the 1960's. Hopefully their
executives have relearned the value of basic research.
It is unlikely that either of these technologies would have been
invented in the US with today's corporate management.
There is another area that I have seen destroy our technology base that
deserves similar analysis.
Over time I have had the opportunity to work with the FCC and Consumer
ProductsSafety Commission. Both are extremely valuable and
important to our economy as well as our quality of life.
Unfortunately engineers have completely been pushed out of positions of
responsibility and replaced with lawyers and it seems their only concern
is the profitability of the corporations they should be regulating.
As a result the US has gone from having the best phones, television,
internet and product safety in the world to nearly the worst in the
It is a good thing that our founding fathers weren't Libertarians.
Otherwise they would have auctioned off our rivers and ports the same
way our leaders have auctioned off the electromagnetic spectrum.