Want a Manufacturing Renaissance? Here's How   (October 7, 2010)

The keys to launching a renaissance in manufacturing and industry in the U.S. are not just financial.

Given the widespread angst over the dwindling role of manufacture and industry in the U.S. economy, you'd think commentators and pundits might actually know something about manufacturing. Remarkably, they don't.

I see precious little evidence that anyone on either side of the issue--those bemoaning the loss of industry, and those who brush aside the whithering as a positive consequence of globalization, wage arbitrage and free capital flows--has ever worked in a factory or even toured factories in various countries to see for themselves.

The standard-issue pundit/academic may well have glanced through the viewing window at some high-tech factory with robots and workers in clean jumpsuits, and this one slice of manufacturing colored their scanty experience: this must represent all factories nowadays.

Only it isn't so.

Others (again, with no direct experience with manufacturing) are quick to point out the huge wage differential between Chinese workers (who have received substantial raises in previous years) and U.S. workers and pronounce the eventual death of all U.S.-based manufacturing just on the basis of wage arbitrage.

It isn't that simple. And what exactly is that wage differential? Few note that the dorms and food services provided to workers at large-scale factories in China are subsidized and thus constitute an additional "wage."

Today we look at issues which rarely if ever see the light of day in the mainstream media.

I happened to see two video clips filmed inside Japanese and German factories on TV recently, on the Japanese English-language channel NHK and on the German English-language channel DW.

As we all know, Japan and Germany are the world's powerhouse exporters of advanced machine tools and other high-technology equipment and goods.

In the Japanese plastics factory in Nagano Prefecture, neatly uniformed workers were shown cleaning plastic parts by hand.

In the German packaging factory, neatly uniformed workers were shown guiding cardboard boxes onto a conveyor by hand.

To the observer who knows something about either nation, both personally and as a mercantilist culture/economy, there is a wealth of information in these two short videos.

1. A staggering amount of "manufacturing" in advanced mercantilist economies still involves human labor.

2. Factory work is respected and not denigrated culturally.

Factory work in the U.S. is widely viewed as a dead-end job for losers, something you take grudgingly after all other avenues of livelihood have vanished. The American culture only admires the corporate raider who buys the factory to close it and send the production overseas, thereby reaping millions of dollars. The people making things are seen as pathetic dregs of humanity, the flotsam of a dynamic American economy based on transactional churn, speculation, global capital arbitrage abroad and and embezzlement/crony capitalism at home.

This is not the case in Germany and Japan. Employment in manufacturing and factories is still respected as a worthy profession. This is a broad-brush assessment, of course, but it is one our many German and Japanese friends would not contest.

Americans tend not to know much about the intersection of cultural values and manufacturing elsewhere, and thus they lack the context to understand the devolution of values in the U.S. Their politics of experience is shaped by the corporate media rather than by direct experience or study of other cultures and complex issues.

Why would Japanese workers be cleaning plastic injection-molded parts by hand? Is it some peculiarly Japanese attention to detail? The answer might be much more universal: it makes financial sense to do so.

Those influenced by images of high-tech factories populated by robots--yes, these kinds of factories make sense for semiconductors and vehicles, but not for everything--will be unable to absorb this possibility.

Global wage arbitrage means any handwork must be shipped overseas, right?

Not necessarily. You need to understand the nature of supply chains before issuing blanket judgments on manufacturing. This Japanese factory has many customers. It is part of a complex web of suppliers to a variety of industries. Some customers might need only a few new parts, but they need them tomorrow. The cost of the part, being a tiny sliver of the cost of the finished good, is not that important.

That's one reason (of many potential reasons) to have human beings on the factory floor in Japan rather than in China. The quality-control required to have the parts made in China and then air-freighted to Japan (oops, the parts don't fit, there was some mix-up, etc.) is uncertain and prohibitive.

If you need one million parts in six months, and you've invested in rigorous quality-control measures in a factory you own in China or Vietnam, then overseas production "works" financially. But much of manufacture doesn't need one million parts in six months.

Robots are wonderful investments if you're going to make one million silicon chips, or 100,000 vehicles of the same make and model. Yes, you can program robots to perform various tasks, but this programming isn't free. And designing a robot to clean specialized plastic parts may not be worth the substantial investment.

The tidy uniforms in German and Japanese factories speak of cultures which do not look down on factory work. The national identity is still based on producing quality goods for the world.

In both nations, CEOs of global companies earn salaries and bonuses in the high six figures ($800,000, and so on). In the U.S. CEOs routinely make $30 million "packages" and even more if they fail and must be ushered out the door.

That says a lot about the cultures and economies of the three nations.

Japan and Germany actively promote and preserve manufacturing and industry. The U.S. actively drives manufacturing abroad with high taxes and oppressive regulatory bureaucracy. If you doubt this, please accompany company officials as they gather permits to expand a factory in Japan, Germany or China, and then do so in California.

The U.S. culture is enamoured with "clean" "industries" like the FIRE sectors: finance, insurance and real estate. Americans love having a clean business park filled with workers performing transactional churn which produces nothing but magically makes money. The houses being sold aren't improved or modified in any way, the mortgage churn, the policy churn, the CDO churn and the stock, bond and derivative "portfolio hedging" churn all generate nice clean money which flows into the clean fast-food chain restaurants and strip malls which arise around the business parks.

All that "clean" transactional churn is the root cause of the American economy's devolution and impending implosion. America is also enamoured with film-making (clean!) and the music "industry" (clean!). Unfortunately, all these "clean" "industries" are precisely the ones being irrevocably gutted and dismembered by that other "clean" "industry", the Internet.

Few commentators, it seems, really look at the supply chain and labor costs before pronouncing manufacturing DOA in the U.S. Consider a manufactured item whose finished value is $100.

Since most of the costs are in materials, parts made elsewhere, transport and energy, the the labor component might be 5% of the finished cost. So let's say that labor in China ($400 monthly wage) is $5 of the finished cost.

Were the item assembled in the U.S., the labor cost would be roughly five times higher ($2,000 monthly wage). So the item costs $20 more when made in the U.S. (labor costs rise from $5 per item to $25 per item).

The wage differential is thus $20.

But this isn't the entire cost chain. You have to transport the item across the Pacific, so add $5 to the Chinese item. China's manufacturing base is considerably less energy-efficient than those in the U.S. or other advanced economies, so add $5 for inefficient energy use.

The wage differential is now down to $10.

Since U.S. corporate profits have zoomed from $200 billion to $1.2 trillion as production has moved overseas, then let's assume the corporate chain (manufacturer, wholesaler and retailer) could collectively sacrifice $5 of profit.

The differential created by the supposedly irresistable wage arbitrage is down to $5, or 5% of the finished cost. Since the item will have a huge markup by the time it's on the shelves, then that differential might be as low as 2.5% of the retail price.

Please recall that companies like Apple routinely skim gross profit margins in the 40%-60% range. There is plenty of fat marbling the end retail price.

In other words, the "story" underpinning the devolution of manufacturing and industry in the U.S. is absurdly incomplete. Under analysis, it becomes more of an excuse than an explanation.

You want to create a Renaissance of manufacturing and industry? Here's how to do so:

1. Cut the corporate tax on manufacturing and "real" industry to 5%. Keep the 35% tax rate on all FIRE economy sectors. Not only that, levy a 5% flat tax on all financial-churn corporations, whether they "make money" or not. Consider it an "entrance fee" to the speculative house of transactional churn. If companies don't want to pay the 5% entrance fee, then they can always exit the business of skimming and churn.

Many readers write me to insist corporations paid more 50 years ago and they should pay more now. I disagree based on these points:

A. The U.S. dominated global industry and trade 50 years ago; there was no global wage and capital arbitrage on the scale we have today.

B. The key tenet of capitalism is that capital will flow to the highest return and flee low returns. By trying to nail U.S. manufacturing corporations, we have driven capital to higher returns elsewhere.

C. If you want to raise taxes on wealth, then tax the wealthy individuals who reap the vast majority of the financial gains of corporations.

Please examine this chart again:

Taxing the wealth of the owners of capital is more direct and removes the incentives to base production overseas.

2. Change the culture of consumption to one of production. Daniel Bell wrote a seminal book in the 1980s titled The Cultural Contradictions Of Capitalism which explained the fundamental cultural yin-yang dynamic of American Capitalism: the core "Protestant Ethic" of thrift, capital accumulation and productivity versus the ceaseless promotion of luxury, consumption and excess.

Cultural trends (such as alcohol consumption and hemlines) tend to cycle, and on a long time-scale then we can anticipate just such a turn away from conspicuous consumption and a renewed appreciation for thrift and production.

This kind of cultural change manifests in many ways. It might be a chic actress bragging that she never shops retail and buys all her clothing at thrift stores. It is unpredictable and difficult to quantify, yet we will all recognize it when it occurs.

3. Double the price of oil to $150 a barrel. This will effectively raise the cost of shipping to the point that the wage differential is substantially reduced.

4. Raise the tax on financial-churn profits to 65% and reduce it on capital gains earned from productive assets. We have created incentives for financial speculation and churn, and created disincentives for industry and manufacture. Reversing these incentives will work a magic few seem to understand: capital flows to high returns and flees low returns.

5. Reverse the cultural trends of entitlement (getting something for nothing) and the rewarding of speculation/churn. Again, this cultural change of values is slow and uneven. It cannot be forced, or stopped once underway.

Will discouraging financial churn, speculation, leverage and embezzlement and encouraging production of real goods provide a panacea for all the nation's ills? No--but it is a step in the right direction.

Will industrial jobs return to America from overseas? Probably not--too many American corporations earn 75%+ of their revenues and profits from overseas for that to make sense. U.S. companies will leave production overseas to serve their overseas markets.

But it will certainly encourage start-ups and those planning manufacturing expansions to do so in the U.S.--especially if oil doubles and transport costs begin outweighing labor differentials.

Will adding a few manufacturing/industrial jobs reverse the erosion of jobs? Perhaps not, but once again it is a step in right direction. For every job in a factory--even one that is mostly robots with a few human attendents--there are dozens of other "invisible" jobs down the supply chain.

The politics of experience limits our understanding of the past--even the recent past. Thus it is difficult for most Americans to imagine an America which did not worship excess, "entertainment" and an addiction to shopping/consumption.

If we understand cultural values as a yin-yang dynamic which ebb and flow over generations, we can catch a glimmer of a much different America on the horizon.

Life has put on a full-court press, and while I read every email I am unable to respond to all correspondence. Hopefully Life reverts to a half-court press soon. (Please excuse the basketball analogy.)

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