Hollow Industrial Base
During
the last decade, a hot topic in Japan and America has been the
"hollowing out" of their industrial bases. The share of Japanese-owned
productive capacity located abroad has grown from 8% in 1994 to 40%
today. The United States currently has just over 50% of its
manufacturing base located offshore. For both Japan and America, the
large outflows of direct investment, especially to China, have caused an
uneasy feeling that both countries had bleak futures as manufacturing
centers.
Surprisingly, in Japan the pendulum is now moving back as
large Japanese multinationals are busy investing in manufacturing
plants at home. Here are just a few examples of this trend. Canon is
building a large digital camera facility and plans to spend 80% of its
$7.2 billion capital budget in Japan over the next three years. This is a
reversal from the past ten years when 80% of its capital budget was
spent overseas.
Toshiba is building a $2 billion semiconductor
facility. Sharp, Matsushita and Nippon Steel are also building major
plants in Japan. Overall, spending on plants and equipment in Japan is
rising at a 10% clip.
It's not that China is not important to
Japan's economic growth. China has passed America to become Japan's
largest export market. In addition, it needs a strong presence in China
to tap its rapidly growing consumer market as well as a low cost base to
manufacture lower tech products. For certain products like cars it is
also likely to keep large manufacturing bases in countries like America.
For example, Toyota produces more than 1 million cars annually at eight
manufacturing plants in America and has two plants under construction
in Texas and Tennessee.
But for the more advanced
capital-intensive products, the investment is clearly coming home. How
can we account for this surprising turnaround and what are the lessons
for America?
Lose Now, Lose Big Later
First, Japanese
firms have learned the drawbacks of outsourcing. Supply bottlenecks,
poor infrastructure, power shortages, uneven quality, difficult
inventory management and high employee turnover are just some of the
problems. Secondly, even though China's wages are about 5% of Japan's,
its increasingly sophisticated factory automation has lessened the
importance of labor costs. For advanced high tech products it accounts
for only 10-15% of total costs. Having manufacturing closer to home also
shortens new product lead times and increases cooperation between
R&D and production teams leading to a crucial edge in staying ahead
of its nimble competitors. Supply lines of 2,000 miles can be
problematic.
Finally, and perhaps most importantly, there is the
critical issue of protecting intellectual capital. Having research,
development and production closer to headquarters better protects
proprietary technologies. Unfortunately, here in America the outsourcing
trend does not appear to be reversing even in capital-intensive
products. Many of the new high tech jobs are for managers to manage the
outsourcing process. Microsoft, Intel, IBM and Motorola all have large
and growing R&D centers in China to take advantage of Beijing's
cheaper pool of talent. Given China's disregard for intellectual
property rights, perhaps American executives should pause and reconsider
the long-term costs of growing outsourcing programs.
Their
offshore R&D staff may very well walk off with proprietary knowledge
and the company's future. Many Americans believe the loss of
manufacturing jobs is just about lower wage rates in other countries but
this is not always the case. One example is Whirlpool which makes its
high-end front loading washing machines in Germany ($32/hour labor) and
ships them to US ($23/hour labor). The reason given by Whirlpool:
trained German workforce, available capacity, and necessary technology.
Whirlpool could have produced these washing machines at their Ohio plant
and saved the $50 per unit shipping costs while creating high wage
American jobs.
Leverage Our Strengths
Then there is
America's growing annual trade deficit that exceeds $600 billion a year
with $200 billion attributable to our trade gap with China. You have to
admit that it is harder to make a strong case against Chinese trading
practices when 40% or more of American imports from China come from
American multinationals with China-based manufacturing plants. Why not
sell more of the stuff we make in China to China's 1.3 billion
consumers? If these markets are not open to American companies, let's
use the leverage of access to America's vast consumer market to bust
them open.
There are some economists and policymakers who claim a
strong manufacturing base is not important. I beg to disagree. History
shows that manufacturing is the foundation of all wealth and that
research and development follows manufacturing rather than the other way
around. There are now more American workers in state and local
government then in the manufacturing sector, and manufacturing as a
percentage of GDP has fallen from 20% in 1980 to less than 10% today.
This is not a call for isolationism or rolling back globalization, just a
reminder that outsourcing has its downside. How about a little common
sense and balancing short-term cost savings against long-term strategic
risks?
Stop Accepting the Risk for Short Term Benefits
Instead
of just taking the comparatively easy step of lowering labor costs by
outsourcing, let's roll up our sleeves like the Japanese, improve
manufacturing techniques and reap the benefits of keeping more
production and technology closer to home.
