Priorities for jumpstarting the U.S. industrial economy

Dominic Barton and
Dominic Barton Global Managing Director - McKinsey & Co.
Bruce Katz
Bruce Katz Founding Director of the Nowak Metro Finance Lab - Drexel University

February 2, 2015

The factory floor at Pittsburgh’s Aquion Energy doesn’t look much like the steel mills that once populated this Rust Belt city. Retooled industrial-age machinery sits alongside robotic-manufacturing equipment. Science and engineering professionals work closely with experienced technicians to produce next-generation batteries, not forged metal.

But just as U.S. Steel did in an earlier era of manufacturing, Aquion and innovative firms like it are spearheading economic and employment growth across the country. Spun out of Carnegie Mellon’s materials science research department in 2008, Aquion now employs 130 workers, manufacturing batteries to store electricity generated by intermittent renewable resources. This is the kind of technology—and the type of firm—that will make renewable energy more efficient and more cost-effective.

Aquion is a modern success story for American industry. But in order to create and foster more such firms, we need to recognize that today’s most cutting-edge industrial players are not monolithic; they straddle the lines between manufacturing and services, and production and innovation. Indeed, in a world where globalization and rapid technological changes are the norm, manufacturing, high-tech development, and innovation clearly require a different level of support.

To account for this shift, we believe a more holistic approach is needed to identify the highest-value, most strategically important industries that will drive U.S. competitiveness and growth in the 21st century. We call this super-sector “advanced industries.”

The defining characteristics of companies in this super-sector are a commitment to innovation and a focus on science, technology, engineering and math (STEM) skills in the workforce. The industries that we deemed “advanced” are those with research and development spending that exceeds $450 per worker and a workforce with greater than the U.S. average (20%) of highly intensive STEM occupations. Applying this standard, we identified 50 U.S. industries: 35 advanced manufacturing industries such as automotive and aerospace manufacturing, pharmaceuticals and semiconductors; three energy industries including electric power generation; and 12 service industries, from software design to telecommunications.

Together, these industries have an outsized impact on the U.S. economy. They employ 12.3 million people, or 9% of total U.S. employment, and they generate $2.7 trillion in output annually, adding up to 17% of GDP. Advanced industries are our most globally competitive industries, accounting for a full two-thirds of U.S. exports. And, critically, after years of decline, these industries have led the economic recovery—employment and output growth since the recession have been 1.9 and 2.3 times higher, respectively, than all other industries combined.

Increasing employment in advanced industries means not just more jobs, but better jobs. Average compensation in 2013 across the advanced industries sector was $90,000—nearly double that of workers in other industries. And at a time when wages have been stagnant for many, earnings in advanced industries are increasing—from 1975–2013, inflation-adjusted earnings in this set of industries grew 63%, while earnings in other industries grew only 17 percent.

Still, output and employment are not the only—and perhaps not even the main—contributions of advanced industries. Companies in this sector account for 80 percent of private-sector R&D investment, and so they are disproportionately responsible for the development of disruptive technologies that have affected the entire economy, decreasing transaction costs and waste, and increasing productivity and standards of living. A recent report from the McKinsey Global Institute identified a series of these disruptive technologies—from advanced materials to big data—that the firm projects will transform how we do business and live our lives. Many of these technologies are the direct products of advanced industries, even though their economic impact will radiate throughout a much more diverse set of industries.

Yet, there is a problem. Although the United States maintains world leadership in many advanced industries, that leadership position is eroding. Not only has the national government’s commitment to R&D investment become questionable but the nation’s skills pipeline—particularly for STEM workers—has become glaringly insufficient. At the same time, decades of off-shoring and neglect has left our network of regional high-tech and industrial supplier ecosystems patchy and thin.

So, what should the nation do to defend and expand its advanced industries? The first priority must be a renewed commitment to innovation. Federal investment in basic research cannot continue on its current downward trajectory, and Congress should act to establish something akin to a capital budget for R&D that prevents these critical investments from becoming a political bargaining chip. A recovering economy should also allow firms to reinvest in innovation. Ambition is crucial: Research from McKinsey finds that most low-performing research-intensive U.S. firms are merely “sleepwalking” through their R&D investment decisions, simply maintaining their existing R&D initiatives, unwilling to incur greater risk. New investment decisions should place more value on “open innovation,” which demands multichannel partnerships among firms, universities, and research labs. General Electric provides a good example of how this approach can work: It has partnered with the University of Louisville to create FirstBuild, an open-source factory for building next-generation appliances. Students, researchers, designers, engineers, and programmers gather under one roof to experiment with product concepts and tinker with everything from design to rapid prototyping. In a world in which consumer preferences and technological change are evolving more rapidly than ever, this open innovation model is intended to get new ideas from concept to product more quickly.

Equally important are bold reforms in workforce education and training systems. Despite the recent slack in the job market, signs still point to a stubborn STEM skills gap. To respond, industry must be more involved in shaping business-led, sector-specific regional training programs. Consider the program Pacific Gas & Electric (PG&E) has launched. According to some estimates, 50 percent of workers in the utility sector will soon be eligible to retire amid acute shortages of trained people to replace them. PG&E responded by developing the PowerPathway program, a partnership with local community college systems in selected U.S. markets. PG&E has co-designed curricula, offered direct instruction, and donated equipment for hands-on training of welders, technicians, and engineers. Through its leadership the company is making the ideal of industry-led regional training consortia real. Targeted government policy could encourage similar initiatives..

Shoring up innovation and skills systems, however, is just the start. We must also strengthen regional ecosystems that can facilitate and enhance industrial performance. These ecosystems improve productivity by gathering in one place cutting-edge suppliers, top-notch service-providers, and crucial innovation and workforce institutions. And yet, years of offshoring and industrial decline have hollowed out many of our manufacturing clusters: Since 1980, the number of metropolitan areas with more than 10% of their workforce in advanced industries has decreased from 59 to just 23. It’s time to replenish the nation’s industrial commons.

One promising strategy is the nascent National Network for Manufacturing Innovation—a federal initiative that offers seed money to chosen consortiums of universities, research organizations, and manufacturers to establish market-oriented research institutes. One recipient, the American Lightweight Materials Manufacturing Innovation Institute (ALMMII), recently opened its doors in Detroit, hoping to draw on the Motor City’s established auto-building ecosystem to accelerate innovation in materials manufacturing. ALMMII was cofounded by Ohio State University, the University of Michigan, and Edison Welding Institute, and counts Alcoa, Boeing, and Chrysler among its partners.

Defining and measuring the location of America’s advanced industries is just one step on the road toward an economic renewal; it’s also likely the easiest. With strong private-sector commitment; smart federal, state and local policy; and lots of collaboration, the nation can move to shore up and expand the advanced industries sector that will be a prerequisite of any rebuild of the U.S. economy.

This commentary was originally published by Harvard Business Review.