The Decline and Potential Revival of American and German Manufacturing: Challenges and Solutions

Introduction

The once-dominant manufacturing sectors of the United States and Germany have experienced significant declines over recent decades, transforming these former industrial powerhouses.

This erosion of manufacturing capacity has profound implications for economic security, employment, and national identity.

As both nations grapple with China’s manufacturing dominance and global supply chain vulnerabilities, policymakers, economists, and business leaders debate strategies to revitalize domestic manufacturing capabilities.

FAF examines the causes behind manufacturing decline, evaluates potential revival strategies, including tariffs, and assesses realistic pathways forward.

The Hollowing Out of American Manufacturing

The United States began experiencing a significant decline in its manufacturing sector during the 1980s, initiating a trend that would accelerate in subsequent decades.

During President Reagan’s administration, a deep recession hit industrial sectors particularly hard, marking the beginning of American manufacturing’s hollowing out.

Financial markets pressured large corporations to abandon their vertically integrated models in favor of outsourcing and offshoring.

Companies that had previously maintained complete control of their production processes—like Texas Instruments, Alcoa, and DuPont—were pushed to break up these enterprises and subcontract or offshore any operations not considered core competencies.

This marked an extraordinary fragmentation of America’s industrial manufacturing base, previously the world's envy.

The early 2000s brought an even more dramatic collapse in manufacturing employment. Between 2000 and 2010, the United States lost approximately 5.8 million manufacturing jobs—a staggering 34% decline.

This coincided with a sharp appreciation of the U.S. dollar and a widening trade deficit. Contrary to popular belief, this massive job loss wasn’t primarily due to automation.

Research by Susan Houseman challenges the widespread view that high productivity growth allowed manufacturing output to expand even as the workforce dwindled.

In reality, manufacturing output growth was lower than in most private sectors, meaning productivity gains couldn’t explain the enormous job losses.

Germany’s Manufacturing Challenges

Unlike the United States, Germany maintained a stronger manufacturing base for extended periods but has faced its challenges more recently.

German industrial production peaked in 2018 before subsequent shocks, including the COVID-19 pandemic, supply chain disruptions, and the European energy crisis. Since the pandemic began, Germany has lost nearly a quarter of a million manufacturing jobs.

Several factors have contributed to Germany’s manufacturing decline

Energy dependency

For years, German industry relied on cheap Russian natural gas to power its factories. Russia’s invasion of Ukraine in 2022 abruptly ended this arrangement, forcing Germany to seek more expensive alternatives like liquefied natural gas (LNG). Higher gas prices have increased electricity costs, making German manufacturing less competitive.

Demographic challenges

As the baby boomer generation exits the workforce, Germany faces an intensifying shortage of skilled workers. This demographic shift “reduces potential output growth in Germany to a crawl,” according to Klaus-Jürgen Gern, a researcher at the Kiel Institute for the World Economy.

Homegrown problems

Regulatory burdens, declining public infrastructure, and uncertainty around economic policy have all contributed to Germany’s industrial slowdown. These internal challenges compound external pressures from global competition.

Root Causes of Manufacturing Decline

The decline of manufacturing in both countries resulted from intertwined factors, including economic policy decisions, globalization dynamics, and changing industrial structures.

Financial Market Pressures and Changing Corporate Models

Financial markets fundamentally reshaped how large companies operated in the 1980s. MIT Professor Suzanne Berger noted, “Financial markets put enormous pressure on large companies to get rid of their U.S. workers and plants and move away from being vertically integrated companies.”

Investors favored companies focused on core competencies rather than those maintaining complete supply chains, driving the fragmentation of manufacturing operations.

This shift in financial markets and lending practices throughout the 1980s diminished investment in vertically integrated manufacturing models that had been the backbone of American industrial strength.

Companies were pressured to optimize their balance sheets rather than maintain robust domestic manufacturing capabilities.

Isolation from Innovation Ecosystems

In the post-WWII era, the United States focused on building an innovation system but failed to integrate manufacturing into this ecosystem. “Manufacturing declined due to conditions we created in the United States.

Ultimately, the root cause of American manufacturing's decline is that it was left adjacent to the new American innovation system after WWII. “

This contrasted sharply with countries like Japan, Germany, and later China, which made fundamental investments integrating their industrial bases with innovation systems.

Global Competition and Trade Policies

The emergence of China as “the world’s factory” dramatically altered global manufacturing landscapes. In 2023 alone, China exported over three trillion U.S. dollars of manufactured goods—nearly a third more than a decade earlier.

This massive production capacity and export capability created intense competitive pressure on American and German manufacturers.

Trade deficits widened as imports from China and other manufacturing centers increased. The misalignment of trade policies, currency values, and competitive advantages accelerated manufacturing job losses, particularly in the United States.

The Potential for a Manufacturing Renaissance

Despite decades of decline, recent years have shown promising signs of a potential manufacturing revival, particularly in the United States.

The Reshoring Movement

Reshoring—bringing manufacturing operations back to home countries—has gained significant momentum.

According to the Reshoring Initiative, U.S. companies brought back over 260,000 jobs from overseas in 2021 alone, the highest number on record. Several factors have driven this trend:

Supply chain vulnerabilities

The COVID-19 pandemic exposed the fragility of global supply chains, leading companies to reconsider the benefits of domestic production.

Rising costs abroad

Increasing labor costs in traditional manufacturing hubs like China have reduced the cost advantages of offshoring.

Geopolitical tensions

Trade conflicts and political instability have made companies wary of concentrating production in potentially volatile regions.

Consumer preferences

Growing consumer demand for domestically produced goods has incentivized some reshoring decisions.

Between the first quarter of 2020 and the third quarter of 2023, executive discussions about onshoring, reshoring, and nearshoring during earnings calls increased by nearly 3,000%.

This dramatic shift in corporate thinking has translated into tangible construction activity, with companies building U.S. manufacturing facilities at a pace not seen in decades.

Government Policies Supporting Domestic Manufacturing

Recent U.S. legislation has created more substantial incentives for domestic manufacturing, including:

The 2021 Bipartisan Infrastructure Law

The 2022 CHIPS and Science Act

The 2022 Inflation Reduction Act

These laws contain provisions that benefit companies manufacturing domestically through direct subsidies, tax incentives, or procurement requirements.

These policies represent a significant shift toward more active government support for industrial development.

Tariffs: Solution or New Problem?

The Trump administration has embraced tariffs as a central tool for reviving American manufacturing. The underlying theory is that tariffs will “reward companies that make things in this country and punish those that don’t.” Tariffs aim to incentivize domestic production and job creation by raising costs for imported goods.

The Economic Impact of Tariffs

While tariffs may protect some domestic industries, economists generally agree that their costs are largely passed on to consumers.

This burden falls disproportionately on lower-income Americans, who spend more on goods. Research has found that “U.S. consumers have indeed ‘borne the brunt’ of the tariffs on Chinese goods through higher prices.”

Tariffs can also harm American exporters when other countries implement retaliatory measures.

For example, China recently responded to U.S. tariff increases by raising its duties on American goods to 84%, up from 34%. This escalation threatens commerce between the world’s two largest economies, particularly impacting American agricultural and manufacturing exporters.

Supply Chain Complexities

The Trump administration’s wide-ranging tariffs target multiple countries, including Vietnam, India, and Mexico, which had previously served as alternative manufacturing locations when tariffs were first imposed on China in 2018.

This broad approach limits the ability of manufacturers to adapt their supply chains.

As Deutsche Bank economists note, “Broad tariffs across global trading partners, unlike prior narrower bilateral ones, limit the ability of the worldwide trading system to adapt.

This comes at the cost of fundamentally undermining global supply chain models that have emerged over the past several decades”.

Many manufacturers are reluctant to move operations to the United States due to higher labor costs.

According to an Apollo analysis, the typical U.S. manufacturing worker earns nearly $6,000 monthly, making domestic production significantly more expensive than in many alternative locations.

Strategic Approaches to Manufacturing Revival

The United States and Germany could benefit from more comprehensive approaches to revitalizing their manufacturing sectors rather than relying solely on tariffs.

Germany’s Industrial Policy Success Factors

Germany has maintained a stronger manufacturing base than many other developed economies through several key strategies:

Societal dialogue and long-term roadmaps

Germany has a tradition of bringing together various stakeholders to develop shared visions and coordinate strategic actions for managing economic transitions.

Strong institutions for specific technologies

Rather than limiting itself to horizontal policies, Germany has built robust institutions supporting particular technologies and industries.

Corporatist tradition

Employers and unions negotiate conflicting interests until reaching a consensus, creating more stable industrial relations.

Public-private cooperation in skills development

Germany’s renowned apprenticeship system ensures a steady supply of skilled workers for manufacturing industries.

Embedding firms in the national innovation system

German manufacturers maintain close ties with research institutions and universities, facilitating technology transfer and innovation.

Supply Chain Diversification

Rather than attempting to restore all manufacturing, companies are increasingly pursuing supply chain diversification strategies.

A Deloitte study shows that 81% of manufacturing supply chains pursue multiple or regionally diverse suppliers. This approach provides greater resilience against disruptions while maintaining cost efficiencies.

According to McKinsey research, organizations with resilient supply chains can recover up to 40% faster from major disruptions than their less-prepared counterparts.

Diversification serves as a critical safeguard while allowing businesses to maintain competitive operations.

Successful Import Substitution Strategies

Several countries have successfully implemented import substitution industrialization (ISI) policies that could provide lessons for the United States and Germany:

Brazil

In the 1960s, the Brazilian government provided tax exemptions and credit subsidies to local businesses, helping them boost production and increase competitiveness. By the 1970s, Brazil had become self-sufficient in producing many previously imported goods.

India

India implemented high tariffs on imported goods while providing subsidies to domestic businesses, helping develop a strong manufacturing sector by the 1970s.

Malaysia

Malaysia combined incentives for domestic businesses with targeted tariffs, leading to rapid economic growth and industrial development.

These examples suggest that successful manufacturing revival requires a combination of protective measures and positive supports for domestic industries, including:

Identifying strategic industries for focused development

Investing in research and development

Providing incentives and support for domestic manufacturers

Developing human capital through education and training

Fostering collaboration between companies, suppliers, and research institutions

Conclusion

Balancing Protection and Innovation

Revitalizing manufacturing in the United States and Germany requires balanced approaches beyond simple protectionism.

While tariffs may provide short-term relief for some industries, they create significant economic costs and complicate global supply chains. They also risk triggering retaliatory measures that harm exporters.

More promising strategies include

Comprehensive industrial policies that identify strategic sectors and provide targeted support through research funding, tax incentives, and infrastructure investments.

Workforce development to address skilled labor shortages through education, training, and immigration reforms.

Public-private partnerships that facilitate collaboration between government, industry, and academia to drive innovation and technology transfer.

Supply chain diversification rather than complete reshoring creates more resilient supplier networks across multiple regions.

Energy policy reforms are needed to ensure affordable, reliable energy for manufacturing industries, particularly in Germany.

The decline of manufacturing in the United States and Germany resulted from complex historical forces, policy choices, and global economic shifts.

Reversing this decline will similarly require multifaceted approaches adapted to each country’s unique circumstances.

While the challenge is substantial, recent reshoring trends and policy innovations suggest that a manufacturing renaissance is possible. However, it will likely look different from the vertically integrated industrial models of the past.

Both countries must balance the legitimate desire to protect and rebuild their industrial bases with global economic integration and consumer welfare realities.

Tariffs alone cannot restore manufacturing greatness. However, thoughtful industrial strategies combined with investments in innovation, infrastructure, and human capital might create the foundations for a new era of manufacturing prosperity.