by Vaclav Smil, reading notes
I bought this book quite a while ago after a recommendation from Bill Gates. Personally, I’ve been quite curious about the trading deficit and Made in the USA debates. We often hear two drastically opposite opinion in the news — (1) trading deficit is killing the States and folks are losing their jobs; (2) for most of the trade deficit, they come from outsourcing and the countries that manufacture the products only take a small fraction of the overall margin. It sounds like *Fortress Besieged* from *Zhongshu Qian* — developing countries want to uplift their economy from low value adding manufacturing to a higher value adding service sector; on the other hand, developed countries are pulling back their relatively lower value adding manufacturing sector back home.
This book offered many interesting perspectives to look at this problem and it talks about the rise and retreat of American manufacturing over the past 150 years. Not necessarily all points are valid, but the ideas mentioned in the book do spark thinking and discussions.
One unexpected learning from this book was that the Globalization vs Protectionism debate is kind related to the recent Buy vs Build discussion we had recently for infrastructure teams. In the cloud environment, for a service we provide to internal customers, shall we build it ourselves or shall we buy from a 3rd party vendor? Quoting Jeffrey Immelt, the CEO of GE, “outsourcing based only on labor costs is yesterday’s model”
After reading the book, there can be a misconception that everything should be built in the sovereign country. This doesn’t make sense either. I discussed with a few leaders on this, the conclusion we converged is -
For a human organization, the most important thing is to figure out what is unique about ourselves and own the things in the chain to build that unique advantage. Every human society has limited resources, so it is not possible to do everything, we have to tailor the investment based on the unique advantages we have. It can be some historical heritage, natural resources, talents, aggregated data, etc.
Excerpts
What I will do — convinced that no advanced modern economy can truly prosper without a strong, diverse, and innovating manufacturing sector whose aim is not only affordable, high quality output, but also to provide jobs for more than a minuscule share of the working population — is review some of the recent calls for change made by those concerned about the future of US manufacturing and explain in some detail some of their principal recommendations.
1 Why Manufacturing Matters
The is why Tassey argues that we should think of manufacturing as a value stream rather than a static category — but operational definitions and data collection procedures used by national governments and international organizations are not designed to reflect these complex realities.
Losing manufacturing means reducing opportunities for skill-oriented education, and as the sector accounts for about 2/3 of R&D.
Denison (1985) found that 55% of the US economic growth between 1929 and 1982 was due to advances in knowledge, 16% to labor shifting from farming to industry, and 18% to economies of scale.
Manufacturing has been the dominant mode of translating this useful knowledge not only into all the material riches but also into the convenient services that are the hallmarks of modern societies.
Manufacturing’s importance cannot be judged merely according to its share of value added to a nation’s GDP; the sector remains the principal source of technical innovation and hence a key driver of economic growth.
2 The Ascent 1865–1940
By 1897 US manufacturing had surpassed the British output to make the US the global leader, and cheaper American products began their rapid penetration of foreign markets.
In 1929, the country’s non-farm unemployment rate was fairly low, at 5.3%; the very next year it had nearly tripled to 14.2%, in 1931 it surpassed 25%, and it peaked in 1933 at nearly 38% (far + non-farm is 24.9%). The rate declined gradually to 21.3% by 1937, but the following year it rose to 28%, and by 1940 it was still above 21%;
3 Dominance 1941–1973
Without an unprecedented manufacturing surge the US would not win the first global way, and a steadily expanding manufacturing was also a key to the country’s domination of the post-WWII world.
Wartime mobilization was helped by the fact that during the preceding decade, the federal government had increased its involvement in economic and social matters, largely in response to the devastation of the Great Depression, and was more ready to exercise a dominant role than it might have been during the late 1920.
During the quarter century of postwar economic expansion between 1938 and 1973, America’s manufacturing progress made it possible to create, for better or for worse, the world’s first true mass consumption society, to reach new peaks of industrial production, and to start diffusing the powers of electronic computing.
One shift that helped keep the unemployment rate down was the large-scale withdrawal of women, as well as very young and older workers, from the workspace. About 2.2 M women left, many involuntarily. Greater female participation in manufacturing was just one of several important legacies of WWII.
Census figures show that between 1940 and 1950, America’s urban population increased by about 22 M people, compared to an increase of just 5.5 M during the 1930s.
In Flink’s (1985, 158) judgement, these American vehicles were “overpowered, undertired, and underbraked.” Nader — they were unsafe at almost any speed.
4 The Retreat, 1974 —
Bill Gates, 2011 — The US has had a lot of advantages — learning from defense, importing the smartest people from around the globe, having its domestic market be the largest and the most demanding and having great universities with research funding that managed to have some relationship with the private sector… OVER TIME I think manufacturing moved away because of some mixture of regulations (not all bad), high cost labor (unions), higher cost of capital (complex) and a focus on other things (comparative advantage, or misdirected cultural signal?).
In 1975, US crude oil output,, the world’s largest since the early years of the twentieth century, was surpassed by the Soviet production, and by 1977 Saudi Arabia had also begun to extract more oil.
The first significant milestone in the retreat of the US auto industry from its commanding post WWII position was reached in 1968 when imported cars, mostly inexpensive German Volkswagens, accounted for the first time for more than 10% of annual US motor vehicle retail sales. Still, nobody envisaged that Honda or Toyota cars would be the bestselling models just a decade after their entry into the US market.
American carmakers turned into resigned bystanders.. was a result of 4 independent but symbolic trends:
- The lack of appropriate innovation and inertial development of American car designs.
- Relatively high prices of American cars, attributably mainly to the combination of high wages and generous benefits that the United Auto Workers (the union representing all workers in Detroit’s factories) secured through strikes and bargaining since the 1950s. In 1979, hourly wages in the US auto were 2x the Japanese average.
- A combination of good value, rapidly improving quality, and the relatively high fuel efficiency of imported Japanese cars.
- Two sudden OPEC-driven increases in oil prices. 1973–1974, and 1979–1981.
CAFE (corporate average fuel economy) rules mandated a minimum performance for new vehicles of 20 mpg for passenger cars in 1980 and 27.5 in 1985.
By 2009, only 1 of the 16 new plants under construction was in the US, compared to 6 in China and 5 in Taiwan (SIA 2011). The shift can be largely attributed to the capital grants and tax benefits offered by Asian competitors; these advantages make it 10% — 15% cheaper to locate outside the US, for an absolute difference of close to $1B (Wilson 2011).
I will briefly recount the most common Chinese manufacturing and trade practices and offenses, as well as the incomprehensible US failures that have made this quarter-trillion-dollar imbalance possible. The two items that must be at the top of any such list are China’s manipulation of its currency’s exchange rate and a large variety of open and hidden subsidies. The third great advantage is the pitiful wage paid the country’s workers as repressed labor rights have kept wages at a fraction of their fair level (AFL-CIO 2006).
Apple’s quest to maximize profits, Apple prefer China so much for the society responsibility of that much-admired e-company… while it is true that a large share (30% — 60%) of well-paid engineering and professional jobs involved in the design and upgrading of e-gadgets have remained in the US, this quality-for-quantity shift works well only for those Americans who have high-tech qualifications; it has reduced the country’s pool of potential lower-paying manufacturing jobs by hundreds of thousands. But it has been a boon to Apple and its shareholders.
5 The Past and the Future
The affluent world large manufactured inputs continue to be needed not because of any massive increase in personal consumption but because of the increasing need to maintain and upgrade an aging and poorly functioning infrastructure.
Those growing aggregate numbers (GDP) are only a part of the story because they ignore the realities of offshoring, outsourcing, the loss of entire manufacturing sectors, and the huge labor shifts that left behind many unemployable workers, boosted income inequality, and depopulated cities and towns, which were left to decay and be reclaimed by grass and trees.
A combination of the same three factors contributed to the decline of both the automobile and the steel industries: unionized labor repeatedly striking for higher wages, even though the auto and steel workers were already the highest paid in the world; management ignoring the long-term quest for a profitable business and willing to buy short-term labor peace by granting these increases while unwilling to take the radical modernization steps needed to remain competitive with foreign producers; and the federal government extending its support, whether through tariffs or loan guarantees, to struggling producers, who used it only to delay instituting the necessary changes.
Because manufacturing is such a critical part of any modern economy, much more important than its share of GDP would suggest, and because it has so many links and feedbacks to its every component, its fortunes are critically affected by a number of factors that shape the country’s overall political, economical, legal, educational, social, and health care situation.
The decades of manufacturing job losses have had on the country’s rising income inequality.
The combination of declining employment in the manufacturing sector and rising inequality has led to talks about the hollowing of the middle — because the trend towards employment polarization has been disproportionately affecting middle-skilled white- and blue-collar jobs, with destruction of jobs in between — and to concerns about the future of the middle class.
Some commonly acknowledged general German socioeconomic advantages include a high domestic saving rate, a strong preference for balanced fiscal books, worldwide respect for the country’s high-quality products, and the benefits accruing from being the largest economy in an economic union of half a billion people. Perhaps the most important specific advantages are the widespread family ownership of Mittelstand manufacturing plants (which can operate free of the burden of quarterly profit reports), effective training of a skilled labor force, and the dedicated pursuit of manufacturing exports.
US labor and overhead add up to 45% of the total cost, compared to just 7% in China, and even after higher transportation costs are included Chinese wooden furniture is easily 30% cheaper.
In 2011 China publicly acknowledged that for the first time ever the budgeted spending on its internal security would surpass the spending on China’s military (Buckley 2011).
Andrew Grove, Intel’s founding chairman, offers what I think to be the best counterargument: “I disagree. Not only did we lose un untold number of jobs, we broke the chain of experience that is so important in technological evolution… abandoning today’s commodity manufacturing can lock you out of tomorrow’s emerging industry.” (Grove 2010)
The list of items, presented in no discernible order, includes a taxation regimen that does not put US producers at a disadvantage in the global marketplace; the preservation of a dynamic labor market and investment opportunities through limiting further expansion of federal mandates and regulations; legal reforms to eliminate costs arising from excessive litigation; stimulation of R&D activities through appropriate tax credits and to encourage continuing federal participation in this work; a push for internal safeguards for US intellectual property; means to attract a talented labor force from abroad; promotion of fair trade practices the modernization of outdated export controls and assistance programs for small and medium-sized producers; less dependence on imported energies; promotion of environmental protection; investment in infrastructure and in improved education at all levels; and support for cost-reducing health care reform.
The German model offers the greatest contrast, with most pupils (about 70%) never attending Gymnasium (up to grade 13) but, after Hauptschule or Realschule (ninth or tenth grade), entering a Berufsschule for a wide variety of vocational training in apprentice programs (Clark and Winch 2007). Germany has a long tradition of this training, and a law passed in 1969 defines the shared responsibilities of the state, labor unions and associations, and private companies in carrying on with this rewarding practice. These programs produce highly skilled workers familiar with the latest manufacturing processes.
One of the most common complaints of both American employers and foreign managers eager to locate their new factories in the US is the lack of a qualified labor force: even with a high unemployment rate it is often difficult to find qualified workers.
The only reason the US has been able to sustain such a long period of high trade deficits is because it holds the world’s reserve currency and can finance the deficits by continuous sales of US bonds to foreigners.
… as a result, by 2010, 82% of US semiconductor sales were abroad, making them (in terms of value) the country’s second largest export, following aircraft, aero engines, and parts.
The US is now the only affluent country without a nationwide consumption tax (an equivalent of the goods and services tax in Canada, or the value-added tax in EU countries) while having the highest corporate income tax, there is a logical appeal to enacting the first tax and lowering the second one.
The US has to start the rebalancing at home, as one of the principal causes of this disruptive phenomenon is the country’s excessive consumption.
6 Chances of Success
Jeffrey Immelt, CEO of GE “outsourcing based only on labor costs is yesterday’s model” (Immelt 2012, 46).
Grove (2010) — belief in the superior job creating capacity of startups is very mistaken because the ideas developed by such firms need considerable scaling up to be transformed into commercial successful products whose manufacturing will generate many new jobs.
## References
- https://hbr.org/2021/12/a-new-approach-to-rebalancing-the-u-s-china-trade-deficit