MANUFACTURING MATTERS The Myth of the Post-Industrial Economy Stephen S. Cohen and John Zysman Basic Books. 297 pp. $19.95

ORTHODOX ECONOMICS has proposed a strategy for restoring America's place in the world ecomony. If only we could get our budget in balance and increase the quality of our workers, the time horizons of our managers and the savings rates of our consumers, the invisible hand will do the rest. The United States will gradually shift from manufacturing into a postindustrial economy based on "services," while continuing to dominate the very highest rungs of "high technology."

Steven S. Cohen and John Zysman are here to tell you that this prevailing view is disastrously wrong. First, they argue persuasively, manufacturing matters immensely in determining and creating the wealth of nations. The actual production of goods, they explain, is where the lion's share of value is added in an economy. More subtly, it is where "the rent on innovation is captured." In other words, if America develops new technology, but Japan commercializes it, over time there will not be the stream of income to keep plowing back into U.S. technological leadership.

Moreover, although windows of opportunity to develop new technologies periodically open, they often shut. For example, dominance in one generation of consumer electronics positions a nation to achieve a commanding position in the next generation of such technology. By giving up color televisions, American industry gave up VCRs and compact disks. By giving up much of consumer electronics, we lost both a market for semiconductors and a laboratory for further product development. By giving up much of mass production, we give up the opportunity to develop collaborative relationships among managers, workers and investors which are necessary to regain competitive advantage. "Can Americans ever make semiconductors or hubcaps better than the Japanese," they ask, "if most of our production equipment (and vital pieces in particular) has to come from Japan?"

Secondly, say Cohen and Zysman, the idea that America can compensate for the loss of manufacturing based on leadership in "services" is a fantasy. Most of our trade surplus in services is actually mothing more than the financial return of past capital investments overseas. (The statistical convention is that shipment of capital overseas is a "service.") Obviously, this form of comparative advantage in services will not continue, because the United States is rapidly becoming a major debtor nation. Many other service exports, such as construction engineering or telecommunications, are of course tightly linked to leadership in manufacturing. "Exports in these critical service areas are not substitutes for manufacturing strength, they are complements. They depend on the technological and competitive strength of U.S. industry." In any case, exports of actual services (as opposed to returns on exported capital) are far too small to offset the enormous trade imbalance in manufactured goods.

Further, even domestic employment in services is tightly linked to the manufacturing economy. According to a U.S. government estimate, they report, some 25 percent of U.S. gross national product depends on services closely linked to the manufacturing sector -- or more than the value added to GNP by manufacturing itself. Although manufacturing continues to hold something close to its historic share of GNP, Zysman and Cohen suggest that the composition of that manufacturing component is deteriorating. Either it is military in origin, or it is increasingly concentrated in the low end of the production hierarchy, as competitors drive American firms out of the most dynamic industries.

WHAT TO DO about this dismal picture? Zysman and Cohen suggest that the United States must get back into the game by developing a high-wage, advanced workforce in the United States, not by moving more production offshore or by competing, Third-World style, with cheap labor. Although they don't put too fine a point on it, they advocate a generic sort of industrial policy, in which government helps to structure markets and to subsidize and to diffuse advanced technology, but not to pick specific products.

They are astute at puncturing the orthodox story about the relative roles of government and free market. Governments, in the modern world, have multiple effects on conpetitiveness, even if they shun an explicit role. By deregulating telecommunications, for example, the United States gave free entry to the American market to our competitors, undercut a national technological resource in Bell Labs and demanded nothing in return. Japan, in contrast, denationalized its state telephone company but after careful deliberation decided to retain a national integrated telecommunications system and redoubled its efforts towards technological and commercial dominance.

"The one thing policy is least able to do is to have no impact on a nation's competitive position," write Cohen and Zysman. "And that, of course, is what conventional economics sternly prescribes for it." In the conventional policy debate, they observe, foreign nations' collaborative efforts between government, industry and labor to upgrade their economies have been understood by most Americans not as legitimate paths to development, but as illegitimate "targeting" that violates our idealized conception of the trading system. Zysman and Cohen are equally devastating in their rebuttal of the usual theory of comparative advantage. However, while professing the obligatory allegiance to free trade rather than protectionism, they are not explicit on how the trading system might be altered to allow the national competitiveness strategies they advocate while still remaining residually "free."

This careful volume is useful on several levels. It is a valuable and sensible contribution to the policy debate about competitiveness, far more scholarly and astute than most of the pop self-improvement books on what ails America. It is also an important addition to the small but growing dissenting literature challenging the way orthodox economics comprehends industrial change. Cohen, trained as an economist, and Zysman, a political economist, understand the dynamic evolution of technology and the importance of the social organization of production, in a manner that conventional economics simply ignores. Nobody should be awarded a PhD in standard economics without being made to come to terms with these arguments.

Like most original books, this one is occasionally quirky. Cohen and Zysman direct the Berkeley Roundtable on the International Economy, and their prose indulges occasional California-speak. Competitiveness, they declare, requires "organized smarts." They juxtapose arcane terms and metaphors that send the reader to the big Webster's with coy phrases like "for starters." In their eagerness to persuade the reader, they also have an annoying habit of pausing to recapitulate the previous argument, and redundancies slip in. In the space saved by eliminating duplication, I would have liked more detail on just how much of the still-large U.S. manufacturing economy is linked to the military or to stagnant, low-end sectors. But these are quibbles. This is the most complete and compelling book to date that persuasively challenges the dominant view that only macro-economics matters and that manufacturing will take care of itself. It won't, and we had better pay attention to this important book. :: Robert Kuttner, who often writes on economic matters for Book World, is the author of "The Life of the Party: Democratic Prospects in 1988 and Beyond," to be published this fall.