Why not Make Phones and iPods Here? Part 2

October 1, 2012

I have been writing about the many thoughtful responses to my column “Apple, Offshoring and the Decline of the American Middle Class.”

Michael Reinhold wrote: “The cost of doing business is higher in the United States even without the labor differential. Ten years ago, I moved printer manufacturing from the United States to China for a $24 million annual cost savings. It was $5 per printer less expensive in China even when our total U.S. labor content was only $2 per printer. The government here doesn’t understand they are the biggest cause of the cost differential.”

I agree completely that the labor differential alone does not account for the cheaper prices available from Chinese suppliers—that was the core argument of my article. But, the cost difference is not entirely the fault of our government. More accurately, our government is a better global citizen than the Chinese government, and there are costs to being a good global citizen.

Here are a few reasons why Chinese suppliers can sell for less than our manufacturers:

Pollution regulations. We have them; much of China doesn’t. We demand clean air and clean water, but maintaining that clean air and water is expensive. The costs involve more than the obvious factory filtering and scrubbing. Electricity and water—typically major manufacturing costs—are more expensive because utility companies also must meet pollution requirements. The air on China’s industrial east and south coasts verges on toxic. I have spent weeks in Shanghai and never saw the sun. Senior government officials have air purifiers in their offices and homes; the rest of the population gets by with masks or nothing at all.

Worker safety. A worker death or serious injury here can easily cost millions of dollars, but the costs of practices and technologies for preventing injuries or death are themselves significant. Much high-risk maintenance and handling here are performed by machine, but Chinese workers commonly perform tasks that would be inconceivable to us here. In China, I never see signs showing how many days the plant has operated without an industrial accident.

Currency manipulation and other government subsidies. Like Japan 30 years ago, China pegs its currency at a very low value relative to the U.S. dollar. As a result, all inputs from labor to raw materials (except imports) cost Chinese manufacturers much less than they would with a fairly priced currency. Japan used currency manipulation for several decades to support its manufacturing “miracle.” This is a very big deal.

The government as partner. Many Chinese companies combine private and public sector shareholding. Maximizing profit, which drives Western industry, is often a secondary objective for those companies.

Protected domestic market. Chinese trade flows basically in one direction—out. That’s the reason China owns so much U.S. government debt. Japan did the same thing, except it bought U.S. real estate (at greatly inflated prices) in the ’70s and ’80s. The lack of foreign competition in domestic markets subsidizes domestic manufacturers.

Certifications. ISO certifications (there are so many now) are only the tip of the qualification-cost iceberg. I see all the usual certifications (and some I have never encountered before) everywhere in China, but the real ones don’t cost nearly as much, and many of them are clearly not genuine. The certification demands buyers impose on domestic suppliers are out of control.

Cheap and available capital. The Chinese government ensures that manufacturing companies get whatever operating capital they need at low to no interest. The official cost of money here is also close to free, but our banks don’t lend. Except for the largest corporations here, most companies fall back on expensive sources like credit cards and factoring.

Which of those costs can our government eliminate? Not pollution and worker safety. Americans tend to expect that we won’t be killed by the air we breathe, the water we drink, the medicines we consume, and the tools we use. Similarly, workers expect to survive their jobs with all body parts intact. As long as China allows its factories to pollute at will and ignore basic worker safety, those factories will have lower operating costs than competitors in the West.

Pressure to end currency manipulation and other bad trade practices is exerted at every bilateral meeting right up to the presidential level. Our government does have some ability to impose sanctions on products from countries that compete unfairly, but approval from the World Trade Organization is typically required before penalties can be imposed. The United States has filed 14 complaints with the WTO against China during the Obama presidency and has won six. The remaining eight complaints are still being adjudicated. (A very good review of U.S. claims against China can be found here.) Nonetheless, a strong case could be made that domestic manufacturing has been sacrificed in favor of better diplomatic relations.

The certifications burden is real, but it’s not imposed by government. Purchasing agents have run amok. Part of the reshoring movement must involve educating purchasing agents about the needless cost burdens they are placing on domestic suppliers.

That leaves the availability and cost of capital. If you haven’t noticed, our financial system is a mess. There’s certainly a need for government to get capital flowing again. More government backing of company loans would be the logical step, but the anger over the collapse of Solyndra has spooked the politicians for now.

The bottom line is that government requirements do impose a cost burden on our manufacturers. But most of the requirements are unavoidable. We simply place a much higher premium than China on health and safety.

The picture seems bleak. Happily, the advantages of domestic production—avoiding long lead times, communication problems, labor strife, quality issues, and suppliers that turn into competitors—increasingly outweigh the lower piece prices available from China. Moreover, it is by no means certain that China’s piece-pricing advantage will continue. Mr. Reinhold might find much smaller savings if he compares the full costs of domestic sourcing today compared with the difference of a decade ago. Within the next five years, the all-in cost advantage of sourcing from China will be minimal.

What do you think? Am I being too easy on government? If so, where should the corrective actions begin?

Editor’s note: Before “Shipulski on Design,” “Leading Lean,” and “Uncommon Sense,” there was ASSEMBLY magazine’s longest running and most controversial back-of-the-book column, “Unconventional Wisdom” by Jim Smith. A nationally known expert on electronics assembly, Smith never hesitates to question the sacred cows of manufacturing and economics. You can read more from him at his “Science of Soldering” blog.

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no easy answers

October 2, 2012
Good commentary, Jim. For sure this whole issue is complex, and there are no magic bullets. I guess that a level playing field might involve China being pressured to follow the same water/air quality and worker safety rules as we do. As it is, U.S. government regulations attack OUR air quality as if it is all OUR fault. Recent studies of air quality at a measurement station in the Rocky Mountains in Colorado shows that 70% of the pollution moving along the jet stream over the Western U.S. comes from China. They know that from the levels/type of sulphur dioxide from the coal that China burns in many of its coal-fired power plants. Are we being unfairly targeted as manufacturers for something that is not entirely our fault? Probably so. That said, we're back to the complexity of this issue with no easy answer.

change tax policy

October 3, 2012
The answer is complex. (Actually impossible is a better word.) I suggest that the U.S. modify tax policy to shift from business income taxes to a value-added tax, but everyone says, "No we can't do that! It adds to the cost of products!" If you go to Germany, Japan, Sweden and other countires with major manufacturing export capabilities, you can't go into a big-box store and buy a Chinese-made toaster for $9. That is the type of thing that the U.S. is unwilling to give up to save manufacturing and a decent standard of living. Other ways to help the manufacturing environment include government cost sharing of regulatory compliance costs (a.k.a. corporate welfare), federalizing product liability, and limits on consumer debt to free up capital for investment. These also seem impossible to even discuss.

you're right about automation and worker safety

October 9, 2012
You're right about worker safety. I frequently travel to India, and there's little or no regard for workers there. I was appalled by the safety conditions at a construction site in Mumbai. When I asked my Indian colleague about it, he said, "We have 1.2 billion people. If a worker gets killed on the job, there are plenty of people to take his place." Throw in the caste system, and life is cheap, indeed. You're also right about automation. I visited a historic site in India and witnessed a small army of people literally cutting the grass with hand shears. I asked, "Why don't you use lawn mowers?" And again, my colleague replied, "We have 1.2 billion people. If we bought a machine that allowed one man to do the work of five, what would the other four men do?" Got the same answer when I asked about an army of women sweeping a major street with brooms. Can't argue with that, I guess. But how do you compete with it?

It's a group effort

AJ Sweatt
October 9, 2012
I do believe that it was a group effort--government, U.S. industry, and international (Western) influences working in tandem. I think the motives were reasonably pure, in that 3rd world or developing countries would benefit from the creation of middle classes, consumption, etc. But the laws of unintended consequences and polly-annaish naivete (the cost of everything & the value of nothing) came home to roost, particularly in the past decade. That's a simplistic view over a complex issue, but that's at the heart of it.

Our governments played a role

October 11, 2012
In Canada, our government has played a huge role in the “Death By China” syndrome. We have instituted environmental policies, health and safety initiatives, and minimum wages all designed to be fair to our workforce and keep them safe on the job. We then allowed Canadian business to move manufacturing offshore to avoid the increased cost of manufacturing at home. CEOs profit, and the rest of the economy pays for it. The Chinese government allows child labor, toxic waste dumping, coal-fired power, IP theft, corporate espionage, and devaluation of their currency. They have put North Americans out of work and made us dependent on the cheap, low-cost garbage sold in Big Box stores, as that is all we now can afford to purchase. Our landfills grow, as does China’s demand for the worlds resources. Our governments should hold China accountable for their deeds, instead of kissing their asses. Tariff the garbage hitting our shores, tax the hell out of Apple and products made in China’s sweatshops. Only our governments can impose rules that China will be forced to follow. They need our oil, and they need our grain. We don’t NEED an iPhone or iPod. We need JOBS. Let us take them back.

no loyalty

October 11, 2012
Blame the State Department and American businesses that have no loyalty to their own country.

Trade has always been a handmaiden to other foreign policy concerns.

John K.
October 11, 2012
First off, this is not a problem of the last decade. The last year that the U.S. did not run a trade deficit was 1975, and most of the 10 years before that there was a deficit. Trade has always been a handmaiden to other foreign policy concerns. In his memoirs, Henry Kissinger admits that allowing the Japanese to dump consumer electronic products starting in the ’60s was a foreign policy decision. It was done because of fear of labor unrest in Japan. (If you check postwar history, you may be surprised to learn that strikes were an everyday occurance in Japan, and labor unions were a hotbed of anti-American communist agitation.) The U.S. government was also afraid that Japan would block the use of their ports and facilities during the Vietnam War, which was deeply unpopular in Japan. Even today, you can find op-ed pieces decrying even the token tarrifs on Chinese solar cells, because we don’t want to offend our “trading partner,” whom we “need” in the U.N. to support sanctions on Iran.

you win some and you lose some

October 15, 2012
@ Chris: It's a little more complicated than that. Some of the uncompetitive legislation that you rail against was passed by the provincial legislatures, primarily in Ontario. Some of this legislation is good. It protects workers and provides fairness. Some of it creates unnecessary costs. In terms of the government "allowing" manufacturers to move offshore, they really didn't have any choice. We live in a free society, and Canada is well on its way to becoming one of the most free trading nations in the world--to the benefit of most Canadians. We can't force manufacturers to stay here. In a competitive environment, you win some and you lose some. For too long, tariff barriers resulted in high prices for Canadian consumers, as inefficient producers gouged captive customers. I, for one, don't want to go back to those days. Some of my clients have Chinese affiliates that perform the high labour work while they peform the value-adding work here. Those that have twigged into this are doing very well thank you. I even have a client that is exporting manufactured goods to China. In the end, it doesn't matter who you blame, we all have to work to solve the problems that we face.

revise tax code

John K.
October 18, 2012
I don't accept the canard that all we can do is throw up our hands and say "those jobs are gone for good" when it comes to imports. All that is required for a producer to decide to produce locally are government policies that equalize the cost of regulations and labor standards accross the border, and production will occur domestically. Profits may not even suffer in the long run, as higher worker incomes may increase demand even in the face of increased prices. (I don't think Canada wants to follow the U.S. in its current spiral of lower prices, lower wages and more debt.) What is the sense of passing regulations, say on emmisions, if manfacturers just move operations accross the border? The pollution still goes in the air. How protected are workers when an expensive safety standard causes them to lose their jobs. Those regulations may be fine, but local prodcuers must be protected against countries who try to use those regulations against them. In Canada, the GST should be replaced with a VAT that allows producers to deduct complinace costs either from the value added or better yet as a credit against tax payments. In the U.S., the corporate income tax should similarly be replaced.

October 18, 2012
Great comments. As I've said numerous times, it doesn't do California any good at all to pass all of the economy-killing, job-killilng, EPA kowtowing anti-pollution regulations because 70% of the air pollution in the Western states come from CHINA!! DUH!! You'd think that the EPA folks and the idiots in California believe that the air stands still--they never heard of the "JET STREAM?" An air testing system on a mountain in Colorado tests the air and can tell where it comes from by measuring the amount and type of sulphur--China uses a type of coal that has a high sulphur content of a specific type. That's how they got the 70% from China number. Maybe California should try a VERY BIG CURTAIN along the coast. That might help.

everyone should do their part

October 21, 2012
As a California idiot, I have to ask: Should we all try to match China for pollution? I think we believed that everyone could do their part to reduce pollution.

don't forget about volcanoes

October 21, 2012
And we have! The U.S. currently produces some of the lowest pollution rates of any country in the West. However, there are other major polluters that people are not made aware of by the mainstream media, such as the 21 active volcanoes in the world that spew thousands of tons of CO2 into the atmosphere every day. There’s a volcano in Africa that scientists estimate spews more CO2 in the atmosphere into air every day that all the cars in the United States in a month. They call it a “killer volcano,” because, of course, volcanoes also spew heavy amounts of sulphur dioxide. The residues from these volcanoes also reflect sunlight back into the atmosphere, which can create global cooling, which scientists now say could be a good antidote for global warming. In fact, 1816 was known as the “year without a summer” because of the extreme amounts of ash and residue from a volcano in the ring of fire—I believe it was Pinatubo? Additionally, scientists just released a report that the forest fires in the west this past summer have produced more CO2 and other pollutants than all the cars and energy plants combined to date this year. So, I think that while we all need to be cognizant of pollution, there is much pollution that we can’t do anything about. We could do something about the forest fires if the Forest Service personnel were allowed to thin the forests, remove the thick undergrowth and otherwise care for the forests so that we wouldn’t have such devastating fires that produce such huge amounts of smoke. That smoke was tracked as far away as Russia this year. Amazing stuff for sure, but we need to use common sense. I doubt there is any good way to plug up the volcanoes so they don’t pollute.

counter regulations with tax credits

John K.
October 21, 2012
Yes, we want regulations to protect workers and the environment. The problem is that without compensating tax credits or protective trade measures, it is economic suicide. In addition, in many cases, regulation isn't used to protect anything. Rather, it's used as a legal club to stop something (a mine, a bridge, a power plant or a factory) that environmentalists or local property owners don't want.



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