In this edition of Expert’s Corner, Cliff Waldman, an economist and council director at the Manufacturers Alliance/MAPI, discusses the challenges and opportunities manufacturers can expect to face in 2010 and beyond.

Reports on the economy and the industrial sector were mildly encouraging at year’s end, but the pace of recovery is slow and activity remains far below pre-recessionary levels. Now everyone’s attention is turned to 2010, with hopes for a sustained recovery to take shape.

In our continuing series that highlights the views of industry experts, IMT recently spoke with Cliff Waldman, an economist and council director at the Manufacturers Alliance/MAPI. Here Waldman explains what he sees as the major challenges manufacturers will continue to confront in 2010, and what opportunities for innovation should be met this year and beyond.

IMT: The economy’s impact on demand, production and employment remained 2009′s biggest story in manufacturing. Moving forward, what are the top near- and long-term challenges U.S. manufacturers face?

CW: The short-term challenge is the continuing challenge of economic recovery. The problem is that this recession had a financial bust at its root, and that becomes a difficult matter to recover from because the financial bust, in effect, compromises the sources of demand. The consumer has to deleverage and will be in that process for some time.

Businesses are shaky and uncertain because of the consumer pulling back, hibernating and rebuilding. Businesses are seeing a tremendous amount of excess capacity. There are a lot of machines sitting around doing nothing at the moment, so investment is not going to be great. And while export growth has certainly returned to recovery, the global economic recovery at best is going to be uneven, weighted toward a few large emerging nations, notably China, India and Brazil, though I would also put South Korea in this group.

We’ve seen some good numbers on manufacturing output since June, when the manufacturing downturn really hit bottom, but a lot of that is an inventory swing, which normally happens in the period going from recession to recovery. Manufacturers found themselves with huge excess capacity after demand dropped precipitously in the wake of the financial shock in the latter part of 2008. They had to liquidate inventories quickly. Now they’ve gotten to the point where they either want to keep them unchanged or raise stocks a bit. Inventory restocking requires some positive output activity, which, along with fiscal stimulus, has produced some good numbers on manufacturing.

I think a sustained, strong manufacturing recovery is going to be difficult to achieve. I don’t see a second downturn, but I think it’s going to be a modest recovery, at least for this year. In sum, the challenge for manufacturing is the less-than-strong recovery that’s ahead for at least this year, and probably into 2011.

IMT: And the biggest long-term challenge for American manufacturers?

CW: The long-term challenge and opportunity for manufacturing centers around the new big players in the world: China, India and Brazil. First, let me say that we talk about competition as if it was a simple matter. But these new nations are both competitors and collaborators. We compete with them in some ways, but we’re also building manufacturing supply chains where all these countries are collaboratively involved in building the same product. So we have to respond. But we have to respond correctly.

We have to use the opportunity created by the economic awakening of large populations in the world — I think, for example, the Chinese consumer is going to be stronger than people think — but we also have to realize that we’re in a competitive global environment. Domestic manufacturers must keep their costs under control, and innovate by creating new products, processes and markets.

IMT: What will be the key drivers to U.S. factory output absorbing historic excess capacity? What steps can be taken to improve the backlogs and/or current inventory levels for the long-term future?

CW: Manufacturers have been working on their inventories over the long term by implementing a new production paradigm called lean manufacturing, which is a way of producing that’s less wasteful and more coordinated. Lean manufacturing creates a more customer responsive supply chain that works to minimize inventory. The ratio between inventories and sales has been falling since the 1990s, partially due to the implementation of leaner supply chains, a customer responsive, more “pull-oriented,” supply chain.

For the time being, over the short term, there’s not much that manufacturers can do except hope that the U.S. economy gets past the point where only inventory and fiscal stimulus is prompting positive output.

IMT: Employment continues to live up to its reputation as a lagging economic indicator. What is MAPI’s outlook for employment in manufacturing?

CW: The manufacturing sector has not had much in the way of net job creation — the balance between hiring and firing — for many years. Every sector of the economy plays a different role. The manufacturing sector innovates, creates a global presence for U.S. products and helps to create global economic stability, but it’s not really going to be a job generator. Our manufacturing sector competes by being productive, by automating, by using robots, by using computers. U.S. manufacturing is a sector that’s totally productivity-oriented. Nonetheless, we would certainly like to see manufacturing employment growth improve, at least to some extent. I think we can with the right policies.

The economy has been starting to grow again, somewhat slowly, but it has certainly turned from contraction to growth. The employment situation is going to lag, and improve after everything else improves. This is always the case in every business cycle. But we’re going to experience an especially long employment-growth lag this time.

For a while, the unemployment rate is going to be stuck at levels that we don’t like to think about. The U.S. economy will return to modest job growth, but it’s not going to be anything exciting for a while.

IMT: Policymakers worldwide continue to struggle with ways to effectively manage multiple economic shocks while preparing their industries to perform successfully in a volatile economic landscape. What policy and regulatory decisions are likely to encourage innovation among small businesses in the U.S. and strengthen the nation’s competitiveness?

CW: First of all, the one thing to be clear about in terms of innovation is that innovation is not just R&D [research and development]. The economics literature and even popular, less-academic writing has always equated innovation with R&D. R&D matters, but it’s only one part of the innovation ecosystem.

One of the most important things a government can to is invest in science… fundamental, basic science at the university and college level. A lot of evidence reveals that there’s a lot of economic bang for the buck in investing in scientific research at the university level.

There is also a lot of evidence showing that we do indeed need to worry about how many engineers and scientists we have. It does matter for productivity as well as manufacturing and economic growth.

These are the two most important things: investing in basic scientific research of the type that’s really only done at universities, and worrying about graduating our share of engineers and scientists.

Cliff Waldman is an economist and council director at the Manufacturers Alliance/MAPI. He is the author of MAPI reports in the areas of the labor market and currency risks in China, U.S. exports, employment and monetary policy. Waldman was president of Waldman Associates, an economist at the National Federation for Independent Business and an economist for the New Jersey Department of Labor. He has written and continues to write papers on innovation.