Tuesday, March 26, 2013

Chinese Innovation Mercantilism and American Corporate Offshoring

by Dietrich Schmitz

Folks, I grew up and remember vividly how robust our economy was in the 60's and 70's.  It was a time when most American's could find a good paying job and the Father of a family was considered the 'bread winner', who could in many cases hold a job with one company up until retirement.

How times have changed.  What happened?  I am totally aghast at how much rhetoric and vitriol is aimed at our current President Obama as though he caused our country's current economic malaise. (Image Credit: Thomas Porostocky)

The obvious is significant enough not to be by chance.  Core manufacturing has left our country and moved overseas.

The loss of jobs in the millions leaves a weak technology and manufacturing base and service-oriented business on the fringes, insufficient to prop up and inject cash flow to revitalize and energize the American economy.

All indicators point to a simple fact.  Our elected officials legalized American Corporations to move labor costs overseas.  To guarantee short-sighted quarterly profit objectives, Corporate America made the overt choice to divert labor abroad, blessed by Government treaty and World Trade Organization Free Trade, never to return to American soil.

The damage has been done.  And we have only ourselves to blame.  Is the damage of offshoring permanent?  The answer is happily a 'No'.  Allow me to explain further.

What is the largest employer in the U.S.?: Walmart

How does Walmart succeed and prosper?:

By being an effective broker.  Simple.

They merely have a fully computerized just-in-time (JIT) system which allows them to buy in volume and broker goods at the lowest possible price.  But is it more subtle than that?

Well, yes it is actually.  Not only is Walmart an efficient broker, they have exploited the prevailing economic conditions to their benefit.  Specifically, they broker in large part over 90% of their finished good from overseas with China being their largest country of origin for finished goods.

Let's follow a hard-earned American dollar from the cash register in the Walmart checkout which just paid for a made in China product.

That dollar goes into the Walmart till, and into a Walmart bank account.  The dollar then goes to pay the Accounts Payable invoice from the 'Vendor' (located in China).  The American dollar then is converted to an intentionally trade manipulated Yuan which keeps its price low against the dollar and the resultant cost of Chinese goods artificially low by as much as 20-30% (China does not let their Yuan float freely to follow market conditions on the money market exchange rate and intentionally keeps it fixed artificially low).

That dollar then goes into the Chinese Manufacturer's bank account and part of each dollar received from the U.S. is used to pay their manufacturing plant employees, who in turn take their hard-earned pay currency and spend it in 'their economy'--not ours.

Walmart business is good--so good that, as previously mentioned, they have ironically become the largest employer in the U.S.  If that seems odd to you or gives you a sinking feeling in the pit of your stomach it should.

Walmart the efficient broker prospers at the continuing demise of America.  If that seems harsh, read on.

Walmart isn't the antagonist here.  They are the single largest 'symptom' of an ailing economy.

As the Trade Deficit with China continues to grow, Walmart acts as broker efficiently processing the cash outflows of those dollars that flow into the Chinese economy where they recirculate.

There is no trickle-down substantially of American dollars spent on goods made overseas.  Those dollars are being siphoned off as more jobs continue to move overseas perpetuating the process that has made China stronger.

At the same time, the looming American Federal Budget Deficit, which is over a trillion dollars is being financed by the U.S. government selling U.S. Treasury Bonds (IOUs).  Guess who is the single largest purchaser of U.S. Treasury Bonds?:  China.  China is paying to keep our government afloat.

Corporate America has taken a short-sighted approach to profit at the demise of the welfare of America.  A minority of wealthy 1%'ers enjoy the benefits of corporate sponsorship for doing business with China and offshoring labor costs.

Let us examine what that means in practical terms.

In a story entitled Chinese Innovation Mercantilism is Hurting American Manufacturers+Michele Nash-Hoff writes:

On Wednesday, December 5, 2012, Robert D. Atkinson, President of the Information Technology and Innovation Foundation (ITIF), testified before the House Science Committee Subcommittee on Investigations and Oversight in a hearing on “The Impact of International Technology Transfer on American Research and Development.” His testimony was based on his book, Innovation Economics: The Race for Global Advantage (Yale University Press, 2012) and the ITIF report, “Enough is Enough:  Confronting Chinese Innovation Mercantilism,” released February 2012.
Atkinson began his testimony by stating, “A nation’s investments in research and development (R&D) are vital to its ability to develop the next-generation technologies, products, and services that keep a country and its firms competitive in global markets. Until recently, corporate R&D was generally not very mobile, certainly not in comparison to manufacturing. But in a “flat world” companies can increasingly locate R&D activities anywhere skilled researchers are located…. the United States has seen its relative competitive advantage in R&D and advanced technology industries decline. While the United States still leads the world in aggregate R&D dollars invested, on a per-capita basis it is falling behind.” 
He testified that the “decline in America’s innovative edge is due to a number of factors, not the least of which are failures of federal policy, such as an unwillingness to make permanent and expand the R&D tax credit, limitations on high-skill immigration, and stagnant federal funding for R&D. But the decline is also related to unfair practices by other nations that collectively ITIF has termed as ‘innovation mercantilism.’” 
The ITIF report cited above states that these policies “include currency manipulation, relatively high tariffs (three times higher than U.S. tariffs), and tax incentives for exports.” In addition, “some policies help Chinese firms while discriminating against foreign establishments in China. These policies include “discriminatory government procurement; controls on foreign purchases designed to force technology transfer to China; land grants and rent subsidies to Chinese-owned firms; preferential loans from banks; tax incentives for Chinese-owned firms; cash subsidies; benefits to state-owned enterprises; generous export financing; government-sanctioned monopolies; a weak and discriminatory patent system; joint-venture requirements; forced technology transfer; intellectual property theft; cyber-espionage to steal intellectual property (IP); domestic technology standards; direct discrimination against foreign firms; limits on imports and sales by foreign firms; onerous regulatory certification requirements; and limiting exports of critical materials in order to deny foreign firms key inputs.”
The report explains that “in the last decade China has accumulated $3.2 trillion worth of foreign exchange reserves and now enjoys the world’s largest current account balance. In 2011, it ran a $276.5 billion trade surplus with the United States. This ‘accomplishment’ stems largely from the fact that China is practicing economic mercantilism on an unprecedented scale. China seeks not merely competitive advantage, but absolute advantage. In other words, China’s strategy is to win in virtually all industries, especially advanced technology products and services… China’s policies represent a departure from traditional competition and international trade norms. Autarky [a policy of national self-sufficiency], not trade, defines China’s goal. As such China’s economic strategy consists of two main objectives: 1) develop and support all industries that can expand exports, especially higher value-added ones, and reduce imports; 2) and do this in a way that ensures that Chinese-owned firms win.” 
The report states that “because China is so large and because its distortive mercantilist policies are so extensive, these policies have done significant damage to the United States and other economies…The theft of intellectual property and forced technology transfer reduce revenues going to innovators, making it more difficult for them to reinvest in R&D. The manipulation of standards and other import restrictions balkanizes global markets, keeping them smaller than they otherwise would be, thereby raising global production costs…if Chinese policies continue to be based on absolute advantage and mercantilism…the results will be more of the same: the loss of U.S. industrial and high-tech output, and the jobs and GDP growth that go with it.” 
It may come as a surprise to many but this is not new and has been going on in an erosion process for decades set into motion by our Government-sponsored membership in the World Trade Organization and enabling of Free Trade treaties like NAFTA, CAFTA and KORUS FTA agreements.  Each agreement was carefully crafted in the interest of corporate shareholders and protection of profit centers, not the average American.  Ross Perot was right when he warned of the huge sucking sound which would result if NAFTA was enacted.  NAFTA was indeed enacted, the sucking sound ensued as jobs evacuated America landing in first in Mexico, Canada, and later in Asia where American Corporate accountants calculated spreadsheet projections that showed finished goods being made at 1/10 the cost of American labor.  The urge to move was too strong and incentivized by the U.S. government.

The short term profit targets were met and shareholders' interests were satisfied, but the accumulated shift of labor to overseas has exacted a serious long-term cost to America.

But now there is a glimmer of hope represented by a story concerning the single largest offshoring corporation in America, General Electric.

In a story entitled The Insourcing Boom, Charles Fishman writes:

For much of the past decade, General Electric’s storied Appliance Park, in Louisville, Kentucky, appeared less like a monument to American manufacturing prowess than a memorial to it. 
The very scale of the place seemed to underscore its irrelevance. Six factory buildings, each one the size of a large suburban shopping mall, line up neatly in a row. The parking lot in front of them measures a mile long and has its own traffic lights, built to control the chaos that once accompanied shift change. But in 2011, Appliance Park employed not even a tenth of the people it did in its heyday. The vast majority of the lot’s spaces were empty; the traffic lights looked forlorn.

In 1951, when General Electric designed the industrial park, the company’s ambition was as big as the place itself; GE didn’t build an appliance factory so much as an appliance city. Five of the six factory buildings were part of the original plan, and early on Appliance Park had a dedicated power plant, its own fire department, and the first computer ever used in a factory. The facility was so large that it got its own ZIP code (40225). It was the headquarters for GE’s appliance division, as well as the place where just about all of the appliances were made. 
By 1955, Appliance Park employed 16,000 workers. By the 1960s, the sixth building had been built, the union workforce was turning out 60,000 appliances a week, and the complex was powering the explosion of the U.S. consumer economy. 
The arc that followed is familiar. Employment kept rising through the ’60s, but it peaked at 23,000 in 1973, 20 years after the facility first opened. By 1984, Appliance Park had fewer employees than it did in 1955. In the midst of labor battles in the early ’90s, GE’s iconic CEO, Jack Welch, suggested that it would be shuttered by 2003. GE’s current CEO, Jeffrey Immelt, tried to sell the entire appliance business, including Appliance Park, in 2008, but as the economy nosed over, no one would take it. In 2011, the number of time-card employees—the people who make the appliances—bottomed out at 1,863. By then, Appliance Park had been in decline for twice as long as it had been rising.

Yet this year, something curious and hopeful has begun to happen, something that cannot be explained merely by the ebbing of the Great Recession, and with it the cyclical return of recently laid-off workers. On February 10, Appliance Park opened an all-new assembly line in Building 2—largely dormant for 14 years—to make cutting-edge, low-energy water heaters. It was the first new assembly line at Appliance Park in 55 years—and the water heaters it began making had previously been made for GE in a Chinese contract factory.
On March 20, just 39 days later, Appliance Park opened a second new assembly line, this one in Building 5, to make new high-tech French-door refrigerators. The top-end model can sense the size of the container you place beneath its purified-water spigot, and shuts the spigot off automatically when the container is full. These refrigerators are the latest versions of a style that for years has been made in Mexico. 
Another assembly line is under construction in Building 3, to make a new stainless-steel dishwasher starting in early 2013. Building 1 is getting an assembly line to make the trendy front-loading washers and matching dryers Americans are enamored of; GE has never before made those in the United States. And Appliance Park already has new plastics-manufacturing facilities to make parts for these appliances, including simple items like the plastic-coated wire racks that go in the dishwashers. 
In the midst of this revival, Immelt made a startling assertion. Writing in Harvard Business Review in March, he declared that outsourcing is “quickly becoming mostly outdated as a business model for GE Appliances.” Just four years after he tried to sell Appliance Park, believing it to be a relic of an era GE had transcended, he’s spending some $800 million to bring the place back to life. “I don’t do that because I run a charity,” he said at a public event in September. “I do that because I think we can do it here and make more money.”
This insourcing story goes on for three pages and details the reasons that accrued to a decision to return manufacturing to American soil:

What has happened? Just five years ago, not to mention 10 or 20 years ago, the unchallenged logic of the global economy was that you couldn’t manufacture much besides a fast-food hamburger in the United States. Now the CEO of America’s leading industrial manufacturing company says it’s not Appliance Park that’s obsolete—it’s offshoring that is.

The author clarifies how rising costs influenced the corporate mindset to reassess insourcing:

Outsourcing, says Jeffrey Immelt, is quickly becoming “outdated as a business model for GE Appliances.” 
But beginning in the late 1990s, something happened that seemed to short-circuit that cycle. Low-wage Chinese workers had by then flooded the global marketplace. (Even as recently as 2000, a typical Chinese factory worker made 52 cents an hour. You could hire 20 or 30 workers overseas for what one cost in Appliance Park.) And advances in communications and information technology, along with continuing trade liberalization, convinced many companies that they could skip to the last part of Vernon’s cycle immediately: globalized production, it appeared, had become “seamless.” There was no reason design and marketing could not take place in one country while production, from the start, happened half a world away. 
You can see this shift in America’s jobs data. Manufacturing jobs peaked in 1979 at 19.6 million. They drifted down slowly for the next 20 years—over that span, the impact of offshoring and the steady adoption of labor-saving technologies was nearly offset by rising demand and the continual introduction of new goods made in America. But since 2000, these jobs have fallen precipitously. The country lost factory jobs seven times faster between 2000 and 2010 than it did between 1980 and 2000. 
Until very recently, this trend looked inexorable—and the significance of the much-vaunted increase in manufacturing jobs since the depths of the recession seemed easy to dismiss. Only 500,000 factory jobs were created between their low, in January 2010, and September 2012—a tiny fraction of the almost 6 million that were lost in the aughts. And much of that increase, at first blush, might appear to be nothing more than the natural (but ultimately limited) return of some of the jobs lost in the recession itself. 
Yet what’s happening at GE, and elsewhere in American manufacturing, tells a different and more optimistic story—one that suggests the curvature of Vernon’s product cycle may be changing once again, this time in a way that might benefit U.S. industry, and the U.S. economy, quite substantially in the years to come.

Three key cost factors have tipped the scale in favor of insourcing, the story's author reports:

Oil prices are three times what they were in 2000, making cargo-ship fuel much more expensive now than it was then. 
The natural-gas boom in the U.S. has dramatically lowered the cost for running something as energy-intensive as a factory here at home. (Natural gas now costs four times as much in Asia as it does in the U.S.) 
In dollars, wages in China are some five times what they were in 2000—and they are expected to keep rising 18 percent a year. 

In summary and retrospect GE Executive Immelt sees American Manufacturing in resurgence and offered his perspective during a public event in September 2012.  He said:

“I think the era of inexpensive labor is basically over,” he said. “People that are out there just chasing what they view as today’s low-cost labor—that’s yesterday’s playbook.”
The hope for return of manufacturing (insourcing) is buoyed by what is now happening now at GE's Louisville Appliance Park.  But the U.S. Chinese Trade Deficit remains American Enemy #1 and recovery from years of damaging offshoring practices will take decades to recover from.

In retrospect, and continuing from the GE Appliance Park story, one General Electric corporate manager, Lou Lenzi, comments:

What is only now dawning on the smart American companies, says Lenzi, is that when you outsource the making of the products, “your whole business goes with the outsourcing.” Which raises a troubling but also thrilling prospect: the offshoring rush of the past decade or more—one of the signature economic events of our times—may have been a mistake.
Offshoring is a mistake.  May the insourcing trend continue.

-- Dietrich

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1 comment:

  1. Gonzalo Velasco C.March 27, 2013 at 6:58 PM

    Times change, and the economy of one era is never like the others'. On the other hand (for worst) we live in the world/era of corporations. Countries and governments are less powerful than Unilever, Colgate-Palmolive, Sony, Coca-cola, Pepsico, Wallmart, Monsanto, P&G, Nestle...