For decades, America’s economics and business elites have been confidently assuring their countrymen that the alarming decline of the U.S. manufacturing sector was nothing to worry about. Dying industries and mass layoffs represented a great human tragedy, of course, and manufacturing boasted a long, distinguished history, but in the grander scheme of things all that misery and dislocation was for the best. The demise of manufacturing simply heralded the rise of alternatives better suited to modern circumstances—chiefly, the spectacular progress of information technologies and the impressive advances in the psychology and mathematics of finance.

American leaders, the Establishment insisted, should therefore resist sentimental temptations to prop up home-grown industries or prevent their migration abroad. Economic theory reinforced the idea that manufacturing was passé, and Wall Street issued authoritative reports emphasizing that “a strong manufacturing sector is not a requisite for a prosperous economy.” Former Federal Reserve Chairman Alan Greenspan even condescendingly referred to manufacturing as “something we were terrific at fifty years ago,” “essentially a nineteenth- and twentieth-century technology.”

Politicians clearly were convinced. “The progression of an economy such as America’s from agriculture to manufacturing to services,” said Ronald Reagan in 1985, “is a natural change.” It seemed that a Darwinian process was revealing a better basis for a national economy, and especially for a high-income country such as ours: the adroit leveraging of a wide variety of both hard and financial assets, plus the provision of non-financial services like entertainment, transportation, health care, research, and “symbolic” analysis. Industrial policies meant to promote manufacturing therefore were not only misguided but unnatural. The only exceptions, of course, were items needed for the military.

In the early years of this decade, the conventional wisdom about the coming “post-industrial” society and its wonderful service economy reached its pinnacle. Through unprecedented loose money policies and deliberately lax regulation, the managers of our economy sparked a six-year expansion fueled by record financial and housing leverage and debt-fueled household consumption.

Today, the idea of maintaining genuine American prosperity without a vibrant manufacturing sector stands exposed as a fairy tale. In December 2007, our production-light economic expansion officially collapsed into the worst worldwide downturn since the Great Depression. The recessionary forces unleashed by the crash are so powerful that they are keeping private-sector U.S. growth negligible despite trillions of dollars of government bailouts—not to mention interest-free borrowing for the country’s biggest banks and record-low interest rates for the rest of the economy. Indeed, the Federal Reserve considers healthy growth (as opposed to the unsustainable government-created kind it is still fostering) such a remote prospect that it expects to maintain its economic life-support programs indefinitely.

Faced with economic armageddon, and recognizing the origins of the crisis in bloated finance and real estate sectors, American business leaders are cooling their long infatuation with “post-industrialism.” Manufacturing is suddenly all the rage. After forty years of outsourcing and globalization, business leaders are beginning to understand that real, self–sustaining American recovery and prosperity require a manufacturing base that is not only highly productive and innovative but is a much larger share of gross domestic product. Leading the new revival is Jeffrey Immelt, the CEO of thoroughly globalized General Electric, and he has been echoed by Ford’s chairman, Bill Ford, and Andrew N. Liveris of Dow Chemical. Even service magnates like James H. Quigley, the “Global CEO” of consultants Deloitte Touche Tohmatsu, have jumped on the bandwagon: “It’s extremely important for the United States to have a robust manufacturing base—including a vibrant domestic auto industry—both for our economic prosperity and national security.”

Immelt’s newfound enthusiasm for domestic manufacturing is decidedly ironic. His legendary predecessor, Jack Welch, turned GE into a champion outsourcer, and as recently as three years ago, after Welch’s retirement, the company proudly told investors that by 2010 more than half of its manufacturing would be performed outside the United States. Immelt now admits that “in some areas, we have outsourced too much.”

Unfortunately, an actual manufacturing revival is a goal that is not only distant but receding. And the prospects for one will remain bleak as long as so many new advocates, including President Obama, keep shying away from the bold policy departures that are needed—especially in America’s international trade policies.

The cold-eyed economic case for reviving manufacturing is overwhelming. Americans rightly want a high-tech national economy full of “knowledge workers,” but this goal is unachievable without major re-industrialization, because manufacturing companies and their workers perform an estimated 70 percent of America’s research and development. Americans also want a big, vibrant middle class, and a much bigger domestic industrial base is crucial for this goal as well, since only manufacturing has ever lifted large numbers of working-class Americans into these ranks.

Most important, a major manufacturing resurgence is key to overcoming America’s debt-fueled economic crisis and to re-establishing prosperity based on wealth creation and earnings. Despite a mainly recession-induced fall in imports, manufacturing still accounts for every bit of America’s trade deficit—the huge, chronic shortfall between America’s purchases from abroad and its overseas sales. Meaningfully reducing the biggest source of excessive U.S. foreign debt requires a massive commitment to boosting manufacturing, both to expand exports and to replace much of the vastly greater import flow with domestically produced goods.

Unfortunately, exactly the opposite has been happening. The enormous job loss within American industry has been widely noted: manufacturing represented a little over 14 percent of real GDP in 2007, but since the recession’s onset, through October 2009, it has suffered nearly 29 percent of total job losses, about twice its share. (And the Obama Administration’s own questionable data indicates that the 640,000 jobs it claims were created or saved by the stimulus bill included only 2,500 in manufacturing.) Yet even less attention has been paid to the far more important trends in manufacturing output. After all, unless their output is growing vigorously, highly productive industries—in which technology is substituted for labor all the time—will never see any real job growth.

And manufacturing is still shrinking as a share of the U.S. economy. In 2008, for example, the overall U.S. economy logged only 0.74 percent growth after inflation. But real manufacturing output fell by 2.74 percent. That’s better than the 5.61 percent nosedive in construction or the 3.03 percent plunge in finance and insurance, but unlike those two sectors, manufacturing was never the subject of a speculative bubble. Worse, since the recession began in December 2007, inflation-adjusted manufacturing output has plummeted nearly five times faster than total economic output.

Nor is the problem limited principally to the decimated automotive sector. Real output in manufacturing generally today (as of October) is no higher than it was a decade ago, and production in numerous individual industries is currently at multi-year and even multi-decade lows. According to the Federal Reserve, inflation-adjusted American production of steel and other primary metals—down more than 34 percent since the recession began—is back to levels first hit in October 1982. Paper output is back to late-1983 levels. Machinery production is down to levels hit in early 1974, electrical equipment and appliance production has fallen to where it stood in February 1988, and plastics and rubber-goods production is down to October 1994 levels.

American manufacturing has big global competitiveness problems too. Our tremendous trade deficits are one key measure, but they may not be the most important. Over the past decade, domestic manufacturers have also been losing big, rapidly expanding chunks of their own home market in the United States to foreign competition. In other words, U.S.-based producers of manufactures (whether U.S.- or foreign-owned) have been losing out head to head against overseas-based rivals (whether U.S.- or foreign-owned) in the market they should know best, and where they face no trade barriers whatever. Worse, imports not only dominate U.S. markets for garments and toys and consumer electronics; they are becoming pervasive in a wide variety of more sophisticated manufactures where American producers are supposed to be doing much better. For example, as of 2007 (the latest available data), imports had taken over 90 percent of the U.S. market in plastics production machinery and in metal-forming machine tools. They represented between 60 and 70 percent of Americans’ purchases of goods like turbines and turbine-generator sets, computer storage devices, and miscellaneous electric components.

Unfortunately, despite our economic wise men’s newfound respect for manufacturing, most of their ideas about expanding the sector remain far too timid to succeed. Immelt’s recommendations are typical. He calls for greatly boosting public and private investment in research and development. But he ignores the powerful incentives that have led U.S. multinational companies, like his own GE, to move ever more laboratories and the advanced manufacturing they promote to low-income countries like China and India. These incentives include not only a wage-depressing glut of even skilled workers but also subsidies for everything from land and water to energy and the act of exporting itself. They also include trade deals like NAFTA, which make possible a business model based on supplying the high-priced U.S. market from extremely low-cost and lightly regulated countries. The same incentives to offshore production could easily neuter Immelt’s recommendation to boost domestic manufacturing by promoting new environmentally friendly industries and more affordable health-care products, a problem also glossed over by President Obama’s promise to create green “jobs that can’t be outsourced.”

Although more net exports would be welcome, Immelt’s belief that U.S. growth can be “driven” largely by overseas sales ignores the still formidable size of the trade gap, along with decades-old realities of the world economy. Deep structural differences between free-spending America and its savings-obsessed trade partners have been impeding U.S. exports for many years. And despite their recent complaints about resurgent U.S. protectionism, those countries have long maintained much higher trade barriers than we have. With growth overseas sluggish at best, and already protected foreign markets closing further, export-led U.S. growth seems less promising than ever.

The best solution, as Immelt advises, is to “observe the example of China”—but not its continuing obsession with exports, or its allegedly simple resolve to “invest in technology and make things.” Rather, Americans must realize that China’s priorities pay off because Beijing has aggressively exploited the lure of access to its home market.

China successfully presses American and other foreign businesses to transfer their capital and best technology to domestic firms, thus ensuring that advanced (and especially export-oriented) innovation and production develop and expand in China. Decades before the PRC added Buy Chinese requirements to its stimulus program, Beijing required foreign investors to keep raising the Chinese content of their products. Meanwhile, myriad formal and informal barriers have depressed both domestic consumption and imports.

Still the world’s importer and consumer of last resort, the United States enjoys far more market power than China. Using this leverage to attract technology and production and then to keep them at home would help replace imports (which mainly increase U.S. spending and debts) with domestically made goods (which produce growth). Even stabilizing the import share of the domestic manufactures markets over the past decade would have generated hundreds of billions of dollars of new sales annually for domestic industry—nearly the size of the Obama stimulus bill.

What specific policies would make up this new strategy and achieve these goals? Here are just a few. The administration and Congress already have moved to take advantage of the government’s huge purchases of goods and services by including Buy American provisions in the $787 billion stimulus bill. Mandatory purchases of U.S.-made goods for building or repairing infrastructure systems and government facilities should boost manufacturing output. Specifically, the policy would ensure new orders for American production of everything from steel to sensors (for so-called smart bridges and roads) to heating and cooling apparatus. But the full potential of the Buy American approach has been limited by U.S. treaty obligations under NAFTA, and by our membership in the World Trade Organization. Hence, at the very least, the United States should declare these obligations suspended until the economic crisis has been vanquished. Buy American measures also should govern all federal support programs for specific companies and industries (e.g., the auto rescue), and industries-to-be slated for subsidies (e.g., alternative energy systems and other “green” manufactures). In addition, strategies are needed for attracting advanced production to the United States in areas where Buying American is no longer possible. Meekly accepting the existing global manufacturing landscape will ensure American economic failure.

Currency manipulation by China and other countries—mainly in East Asia—has also harmed domestic manufacturers and workers by creating wholly artificial price advantages for the manipulating countries’ goods in markets around the world. The precise extent of these unquestionably protectionist price breaks is unknowable, but most estimates range from 25 percent to 50 percent. Legislation before Congress, and endorsed last year by candidate Obama, could effectively fight such manipulation. It should be passed and signed immediately. Another gigantic but barely recognized barrier to balancing America’s manufacturing–dominated trade flows is the use of value-added taxes (VATs) by virtually all U.S. trade partners. VATs are applied only to goods consumed domestically, and since the United States lacks such measures, foreign VATs clandestinely subsidize exports to the United States by subtracting the cost of foreign governments for everything that is not consumed locally. In addition, they hamper products entering these countries from the United States, because those costs are imposed on any item consumed in that country. Of course, America’s VAT-less tax system requires all goods produced in the United States, wherever sold, to carry the costs of the U.S. government. The global VAT discrepancy may account for up to half the U.S. trade deficit in goods. Congress should respond by passing a new bill that would counter the VAT effect with a border adjustment tax on imports from VAT-using countries.

Two critical “do no harm” steps can further reduce American multinationals’ strong incentives to move production and jobs offshore. First, Washington should declare a moratorium on all new trade agreements until it figures out how to ensure that they promote more domestic production and employment. Second, if Congress does pass a climate-change bill, it must include stiff carbon tariffs. Otherwise, more and more American manufacturers will relocate to countries that lack complicated cap-and-trade programs or other limits on greenhouse-gas emissions.

Such a trade-policy overhaul would maximize the benefits of the largely domestic measures—for example, a variety of tax credits and increases in government research spending—urged by many mainstream manufacturing revivalists. Of course, America’s trade partners would scream bloody murder at the trade elements of this new program, and so would U.S. retailers and other importers and our offshoring multinational companies. But the persistence of the global crisis, underscored by growing talk of yet more U.S. government stimulus spending, means that fundamentally new thinking on trade will be needed for America, or any country, to have much hope of a real economic recovery.