The decline of the heavy manufacturing industry in the American “Rust Belt” is often thought to have begun in the late 1970s, when the United States suffered a significant recession. But theory suggests, and data support, that the Rust Belt’s decline started in the 1950s when the region’s dominant industries faced virtually no product or labor competition and therefore had little incentive to innovate or become more productive. As foreign imports increased and manufacturing shifted to the American South, the Rust Belt’s share of manufacturing jobs and total jobs declined dramatically. Eventually the region’s manufacturers began to innovate, resulting in a stabilization of employment share at a significantly lower level. Our model suggests that this factor—lack of competitive pressure—accounts for about two-thirds of the Rust Belt’s decline in employment share. These results imply that vigorous competitive pressure in both product and labor markets is important for creating the incentives for firms to continuously innovate, create and grow, and that government policy should encourage such competition.
