The Decline of the U.S. Machine-Tool Industry and Prospects for Recovery

The machine-tool industry is a small but vital sector of U.S. manufacturing. Machine tools--which cut and form metal--are essential for reproducing the technologies required in an industrial economy. Because machine-tool makers worldwide typically sell their newest products close to home, a weak domestic machine-tool industry means that U.S. manufacturers risk losing access to the latest manufacturing technologies. In addition, the industry helps foster innovation in manufacturing processes and plays a key role in defense production.

Because machine tools are central to manufacturing, the U.S. machine-tool industry's decline in the early 1980s caused considerable alarm. Entering the 1980s, the United States was the world's largest producer of machine tools. Furthermore, it had developed a new technology--computer numerical control (CNC)--that would soon revolutionize the industry. By the end of the decade, U.S. production amounted to less than half that of Japanese and German firms (see Figure 1), and the federal government felt compelled to protect the domestic market. Despite a recent resurgence, the industry is far from recapturing lost market share.

Concerned by this decline, Congress asked RAND's Critical Technologies Institute to conduct a comprehensive study of the machine-tool industry in the United States, Japan, Germany, and Italy. The study analyzed the causes of the U.S. decline and offered policy options for aiding the industry's recovery. It addressed four specific questions:

• What factors led to the machine-tool industry's decline in the early 1980s?

• Why did the industry fail to rebound?

• What are its prospects for recovery?

• What role should government play in assisting recovery efforts?

The study identified four factors that triggered the sharp decline in the U.S. machine-tool industry in the early 1980s:

1. Domestic consumption of machine tools, on which U.S. producers were overly dependent, fell sharply from a 1981-1983 high and never fully recovered.

2. The U.S. industry's response to historically volatile demand was to accumulate a backlog of orders, a strategy that backfired when demand picked up again and Japanese firms were able to fill orders more quickly.

3. Japanese firms captured the lead in both product technologies (through a reliable, relatively inexpensive control) and process technology (through modular production) that enabled them to establish a substantial productivity lead and gain a first-mover advantage in the growing CNC market.

4. The high value of the dollar during this period further undermined the U.S. industry's ability to compete with foreign rivals.

While these factors account for the industry's decline in the early 1980s, they do not explain its failure from 1983 to 1992 to rebound or to adapt to the new market conditions. Why, for example, were Japanese firms the first to convert U.S.-invented CNC technology into successful products for the mass market? And why, as the dollar weakened in the latter half of the 1980s, were U.S. machine-tool makers unable to take advantage of a surge in worldwide machine-tool demand?

The failure to rebound points to a more fundamental set of problems within the industry. The basis of competitive advantage in the industry has now permanently shifted because of two trends: the rapid change in machine-tool technology and the shift to global competition. This shift requires machine-tool makers to develop new capabilities. Lacking these capabilities, U.S. firms continued to lose their share of world markets.

Furthermore, there are formidable barriers to creating such capabilities, including the following:

• Not enough large firms and little cooperation among small companies. Competing successfully on a global basis requires major investments in capital goods, training, export marketing, and other areas. Compared with its major competitors, the U.S. industry lacks both a sufficient quantity of large firms that can build these capabilities in house (see Figure 2) and strong mechanisms for creating cooperation among smaller firms.

Figure 2--Size of U.S. Machine-Tool Firms Compared with Those of Other Major Producers

• Difficulty obtaining capital. U.S. machine-tool makers, like many small, mature manufacturers, have had difficulty obtaining capital to purchase new machinery and finance export sales. The sources of this problem include high transaction costs, lack of long-term relationships with banks, and the overcapacity and low profitability of this sector following the crisis in the early 1980s. U.S. firms are at a further disadvantage in that their foreign competitors benefit from sustained government incentives to invest in advanced industrial equipment. Although the U.S. government has at different times offered temporary tax incentives that have stimulated demand for machine tools, these have not increased capital investment over the long term.

• Inadequate supply of skills and disincentives to invest in training. The skill levels of the industry's labor force are low compared with those of foreign counterparts. This skill gap is apparent from the poor basic qualifications of many existing workers, the collapse of the apprenticeship system that was the main source of skilled labor, and the lack of graduate engineers in this sector. In addition, the structure of labor markets and poor track records of government training programs have discouraged U.S. firms from making the major investment in worker training that have been made in Japan and Germany.

• Poor performance in translating technological research into market advantage. Despite its recognized lead in many areas of basic technological research related to machine tools, the United States was less successful than its main rivals in translating research success into commercially viable technologies. Among the reasons for the failure of the technology transfer process are generally weak links between universities and machine-tool firms; the focus of government research on the most sophisticated applications, which often have limited market potential; and the weak cooperation between machine-tool users and their customers.

• Unsophisticated domestic demand. Domestic users have generally been slow to demand the latest technologies. The major exception to this is in specialized tools for the defense industry, a market in which the U.S. machine-tool industry remains very competitive.

• Weak export capacity and infrastructure. There was a dramatic increase in worldwide demand for machine tools in the latter half of the 1980s, which U.S. firms failed to capitalize on. Because of the lack of a strong export orientation, U.S. firms have barely penetrated the world's largest machine-tool markets (see Figure 3). Firms' ability to export has been hampered by a time-consuming export licensing regime, tight government enforcement of export regulations from the 1950s governing defense-related technologies, and an absence of export supports (e.g., subsidized trade fairs, low-interest loans) similar to those that aid firms in other countries.

Though these barriers make it unlikely that the United States can reclaim lost markets, there is some cause for optimism. U.S. machine-tool makers are currently benefiting from the results of internal restructuring, from a recent surge in domestic demand, and from deep crises in their chief rivals in Japan and Germany. In addition, Japan's lead in CNC technology is beginning to erode, and the United States has the research lead in a number of technologies that are likely to be crucial to machine-tool production over the next several years. The challenge for the industry and policymakers will be to turn this technological lead into a market success that lasts beyond the recent resurgence.

Recommended Government Policies

The study concludes that government has a role to play in meeting this challenge and that the problems of the machine-tool sector are best addressed by a wider effort to improve manufacturing process technologies in the United States. This effort would include a three-part strategy:

1. Foster development of local cooperative networks among machine-tool makers, users, and suppliers to improve the adoption of new technology. The networks can provide a package of services beyond the capacity of most individual companies.

2. Increase investment in the manufacturing infrastructure (such as applied research and transferable metalworking skills) and channel federal R&D toward improving production processes and building closer ties between research institutions and firms.

3. Help U.S. machine-tool makers compete internationally by further streamlining export licensing procedures, supporting international sales efforts, and avoiding past protectionist policies. A global presence is critical if U.S. machine-tool firms are to become prosperous in the long run.

RAND research briefs summarize research that has been more fully documented elsewhere. This research brief describes work done in the Critical Technologies Institute. Research results are described in detail in MR-479/1-OSTP, The Decline of the U.S. Machine-Tool Industry and Prospects for Its Sustainable Recovery: Vol. 1, by David Finegold, Keith W. Brendley, Robert Lempert, Donald Henry, Peter Cannon, Brent Boultinghouse, and Max Nelson, and MR-479/2-OSTP for the related appendices. You may also order a copy by clicking on the document number. RAND is a nonprofit institution that helps to improve public policy through research and analysis. RAND's publications do not necessarily reflect the opinions or policies of its research sponsors.

Inquiries regarding this document or CTI should be addressed to Stephen M. Drezner, RAND Senior Vice President and Director, Critical Technologies Institute, 2100 M St., N.W., Suite 600, Washington, D.C., 20037-1270, (202) 296-5000, extension 5351.

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