America's Job-Creation Machinery Is Hollowed Out   (December 27, 2010)

Hollowing out small business and lower value-added enterprises has hollowed out America's job-creation machinery.

The conventional wisdom is that boosting consumer borrowing and spending (same old, same old) will magically create millions of new jobs. As usual, the conventional wisdom is dead-wrong: America's job-creation machinery is hollowed out.

Questioning the quasi-religion of "free trade" always brings down the wrath of true believers, but I don't see rigid ideologies as shedding much light on the complex interlocking crises we find ourselves tangled in.

I have long held that a mono-maniacal obsession with "low prices" is one factor which has hollowed out the U.S. economy: The Wal-Mart Model of Self-Destruction: Lowest Prices, Always (January 24, 2010)

In sum: the corporate globalization model of maximizing profits, efficiencies and long supply chains saves "consumers" $300 a year on goods that have declined in quality as well as price, while hollowing out the industries that once offered "citizens" $30,000 a year jobs.

The "free market" ideology holds that there is an either-or choice: either you pursue the corporate globalization model ("free trade") which supposedly benefits all while maximizing corporate political power and profits, or you choose by default "bad" "trade restrictions," which supposedly hurt everybody by making domestic "consumers" subsidize horribly inefficient domestic manufacturers.

Meanwhile, in the real world, both Germany and Japan have pursued a middle path for decades. As correspondent Dr. David D. has often noted, despite its well-publicized financial/fiscal woes, Japan remains a remarkably stable, wealthy society in which the domestic economy is 89% of GDP--yes, exports/imports are a mere 11% of Japan's GDP.

Japan has restricted "free trade" for decades, and has pursued a "low unemployment" policy that has little to do with restricting imports and everything to do with policies which enable hiring marginal workers. The "social contract" between citizens/consumers and the government is different than in the U.S. Is it "better" or "worse"? That sort of judgment cannot be made, as the criteria are cultural and social.

The same can be said of Germany, where workers shift to part-time when business is slow, as opposed to the American model in which workers are fired and more work is piled on the survivors--again, to maximize those all-important corporate profits.

In other words, the "free trade" ideologists claim it's all dollars and cents, but "soft" cultural values play a critical role in the "social contract" which controls the role of trade and imports in an economy.

America is in thrall to a specific cultural and financial ideology which claims that all good things flow from corporate profits, and the maximization of those profits is the foundation of a "growing economy" (if debt is rising faster than GDP, is it still "growth"?) and more jobs.

Too bad there is no evidence to support this narrow faith. Rather, maximizing profits requires that the Federal government and the private sector both borrow trillions to prop up fading "consumer spending" because corporate profits don't require jobs, they only require consumption. If it's funded by debt rather than producing wealth, no problem.

The unholy alliance of global corporate interests and the Central State has pursued a specific strategy which emphasizes borrowing and consumption over production and savings, and the massive expansion of debt in all sectors of the economy is the consequence of this policy.

Corporate interests can play both sides of the "free trade" game. When it suyits their purposes to move production overseas, then they are hearty proponents of "free trade," But if their profits are being pinched by other global interests, then suddenly a defense of "free trade" requires restricting imports.

The net result is that the high end of the value-adding chain remains in the U.S. but the bulk of the chain is now global. Free trade apologists claim that the "solution" for the U.S. is to compete globally for the high-end value-adding chain: the design, marketing, research and development, etc.

There is certainly some truth to the idea that global products demand global competition, but this idealized view of the economy overlooks the inconvenient fact that the vast majority of mere mortals do not have the brainpower or drive to become research scientists, top-level designers, etc. So by shipping everything below the top level of R&D, design and marketing overseas, then you've also shipped most of the employment in the lower value-added chain.

Even if the U.S. were to pump out 10 million PhD-level researchers, there wouldn't be 10 million new jobs waiting for them. The ugly truth is the number of positions available for high-end researchers, designers, etc. is intrinsically small. Post-doctorate researchers from the top research universities in the world still have to fight to secure a job.

In other words, there are very few $50 to $100 an hour jobs in the value chain, and many $10 an hour jobs. While it may well be possible to tax the $100/hour workers enough to pay for food stamps and other welfare so 100 million people can sit at home watching TV, borrowing trillions of dollars to prop up the current status quo is simply a criminal theft from future taxpayers to fund our current consumption.

In While Washington pursues CEOs, they snub U.S., Robert Reich notes that much of the value chain in Apple products goes elsewhere. In the simplistic view, that's wonderful as long as Apple pumps out fat profits.

But the social contract is larger than corporate profits--though that is obscured by the "solution" America has chosen: borrow trillions from future taxpayers and global players to fund current consumption and a growing army of unemployed with few prospects.

America's job-creation machinery has been hollowed out by the "globalization-debt-consumption" model. There are no simple, ideological pure "solutions" to the complexities of globalization, fostering entrepreneurship and small business and the often-unexamined "social contract" between citizens and their Central State.

I am reprinting a post by author Chris Sullins which illustrates how the hollowing out has occurred over the past few decades. Real life does not lend itself to simplistic ideological straitjackets; the "solutions" cannot be purely financial or ideologically driven. Any "solution" has to balance the needs of the citizenry against corporate interests and a cultural and governmental obsession with propping up consumption.

Here is Chris's entry:

The Lesser Evil is Still Evil:

There was a sequence of events that I observed over the last 25 years culminating in the destruction of one private business. This was a small corporation owned by an American family who had started off using local talent to make a quality product and took great pride in the “Made in USA” label.

Early to Mid 1980s: Company is born, grows, and does well. Moves from a mom and pop shop to hiring non-family members. A lot of hard work and growth during this time pays off. To help facilitate growth, investment, etc., company takes on partners with expertise in specialized areas.

* Late 1980s: Company continues to do well, but growth plateaus. Original owner does not want to do a public offering of the business. Internal triangulation and disagreements on how to proceed leads to moves by newer partners to break-up/sell the business. Original owner/family takes out loan to buy their company back from the newer partners. This takes a significant amount of money out of reinvestment in the business and improving health/retirement plans for all workers (including the owners).

Early 1990s: Owners continue to use American parts and labor as other companies begin to outsource some production of parts to Mexico. The company survives the regional recession of the early 90s and the owners are able to make their payments to the bank for the buyout and are also able to do a large expansion.

Mid 1990s: Due to increased domestic competition due in large part to changes under NAFTA, owner begins to buy some of their parts from Mexico, but the majority of products are still made in the USA and assembled by American workers –local people who have lived in the area for generations. At this time, similar completed products begin arriving from China. Owner expands production facility again and contracts out labor for some parts and completed products to other American-owned businesses.

Under the traditional business model in a fair and uncorrupted market, this expansion should lower costs over the long-term while still providing a quality product to customers. The plan looks good to the bank, too.

Mid to Late 1990s: The cost of parts from Mexico begins to rise and the completed products are now no less in retail price than similar products from China. Despite production in a low-tax, low-wage state (as in not much above the minimum wage!), both the company and subcontractors have difficulty making any kind of profit against the rising tide of Chinese imports. By the late 1990s, they can’t figure out how the Chinese products can sell at a retail price which is still less than the combined wholesale prices of many of their parts. There are also times when the raw materials alone cost very close to the wholesale price of the Chinese goods.

Retail outlets sell both the Chinese and American goods and the difference in price is apparent on the shelf. Although the loan to former partners has been paid off, the owner begins to struggle financially at times to meet the loan for the expansion as sales drop. The owner has to get some short-term loans to cover operational costs.

At this point in time, he has no idea how GATT, WTO, and MFN are impacting his business and changing the playing field. In fact, the American company owner thinks tariffs are still on the books and enforceable, that his elected representatives will protect the local community, that the Constitution still means something outside of the town he lives in, and that multinational corporations haven’t been bribing…sorry, I digress…

Late 1990s to Early 2000s: Continued importation of Chinese goods which cost less than American raw materials pushes company owner to focus on a niche market by offering “Made in USA” products to consumers who have higher standards, i.e., quality over price. Catering to this high-end consumer seems to work for a while, but the company takes a major hit when one of their biggest wholesale customers (a retailer in that high-end niche market) declares bankruptcy. The timing is “unfortunate” since it happens right after the company had delivered one of its biggest orders ever to the retailer before the Christmas shopping season.

The bankrupt retail chain is a big player and has many creditors and suppliers. The company finds itself to be one of many small fish in a big ocean inhabited by larger fish, whales, and sharks. Nevertheless, the company demands their unpaid products be returned. The big retailer responds: Those goods have all been sold and there’s nothing to return to inventory.

A couple years later a federal judge from another district orders: All small companies to be awarded new stock cut by the big retailer. The stock “paid” to the company is literally worth pennies on the dollar against the products originally delivered, but never paid for, by the retail chain. Big retailer never changes the name on their storefronts, re-organizes on paper (board members play musical chairs), has a record year and is still in business to this day. (BTW, during the entire history I’m describing today the top value ever reached by this stock was 1/10th of the sum originally owed to the company for the products that the retailer ripped off…er, supposedly unable to pay for).

During this same time period, the bank which loaned the company money for the expansion demands larger monthly payments. Owner/family members sometimes defer their own pay, but the company is at least able to pay the bank and not go into a forced sale. Upon a review with the bank months later, the banks representative makes a comment to the effect of “I can’t believe you guys were able to make your payments” before raising the monthly payments even more. Negotiations for readjusting payments, rates, frank talk on how the company won’t be able to survive and local workers will be thrown into the unemployment line quickly go nowhere with the bank.

Owner has to go to another bank to get short-term loans to cover payroll for non-family workers as owner/family members go without compensation for health, retirement, etc. At least the workers understand the company is going through a rough time and do NOT demand raises or other increases in benefits. Many years of life in the community together, shared hardships and reciprocated loyalty still mean something at this point.

Mid 2000s: Owner can’t meet bank terms and is on the brink of losing personal/non-business property. They haven’t been able to put aside any money for retirement (I need to interject here that owner lived modestly and frugally as well). Open and honest discussions with workers about future of the company and tough changes ahead. Owner sells company, all contents, and product line and only retains ownership of the building.

New owner is able to get a better deal from another bank to buy the same company that the old owner couldn’t get a loan to maintain. New owner believes he can continue to focus on the well-heeled consumers in the niche market. New owner soon learns that Americans of all shoes would rather save a buck than buy “Made in USA” products. Production is curtailed and majority of workers are laid off. Repackaging of imported goods with very few finishing touches by American hands becomes the new norm just to survive.

The company’s base of buyers shrinks –they’ve either turned to suppliers representing the Chinese or have gone out of business themselves. Old customers aren’t happy about the change in leadership at the company and soon notice the lower quality of goods and services they receive. More customers begin dealing directly with importers/distributors rather than the company which appears more and more like an unnecessary middleman.

No one looks at labels to see where products are made or even asks about quality anymore –the bottom line is cost. The new owner sells to yet another person. This transaction still includes leasing the facility from the original business owner.

Mid to Late 2000s: The third and soon to be last owner quickly shrinks to a mom and pop operation. The company becomes a part-time operation in only a small portion of the original facility. The company’s products are no longer offered in retail catalogs. The last owner stops making payments on the building and the original owner has to get a short-term loan to cover the building (a debt leftover from the last expansion). A year later production stops altogether and the company closes. The building goes into disrepair and is put on the real estate market, but it’s already past the bubble and there are no buyers.

In the meantime, the original owner and last owner end up in court over the breached agreement on the building. Rather than cutting some stock for a company which no longer has any sales or apparent residual worth (nor was ever publicly offered), the last owner has to pay some real cash to the original owner. A settlement is reached for far less than what was owed.

Late 2010: Everyone involved with ownership of the company at some point in its history has debt. They’re all working for someone else now. But, at least they’re working. Unofficial unemployment is 20% in their area.

It’s easy to blame China for what happened, but it was only possible with the willing connivance of people who sit in D.C.

Thank you, Chris. If I had to summarize the point being made here, I would say that small business has been hollowed out by specific policies which just so happen to favor corporate profits and thus corporate political power above all other considerations in the social contract.

The Central State has papered over this hollowing out of small business by borrowing and spending trillions of dollars to prop up consumption. That "solution" has consequences which few are willing to face--yet.

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