The Holes in Globalization’s Fabric

Stephen DeAngelis

August 26, 2011

Overall globalization has been a good thing for the world. Millions (if not billions) of people have emerged from poverty’s grasp as globalization washed over the shores of the better part of the world during the last several decades. Admittedly, globalization’s effects have varied by region and state. Along with winners globalization has created some losers. As a result, globalization’s fabric has become threadbare in spots. Jeffrey Sachs, a well-known advocate for the underprivileged and director of The Earth Institute at Columbia University, points out, for example, that unskilled labor in developed countries like the United States has been hit hard by the consequences of globalization. [“Tripped up by globalisation,” Financial Times, 18 August 2011] Sachs insists, “The path to recovery now lies … in upgraded skills, increased exports and public investments in infrastructure and low-carbon energy.”

For the most part, I agree with that prescription. The problem, of course, is that the remedy obviously requires government support and, if you hadn’t noticed, Washington isn’t in a mood to support much of anything. When the U.S emerged from the heartache, suffering, and unemployment of past depressions and recessions, it found that it had new infrastructure on which to build a stronger economy. The roads, bridges, and other infrastructure projects built during the Great Depression helped support the war economy and post-war transition. The freeway system built following the Second World War laid the foundation for greatly increased interstate commerce. The Internet that was strengthened during the era left the country in a better position to emerge from the bust. There is no such legacy emerging from the Great Recession. Republicans and Democrats alike have failed to demonstrate leadership when it comes to creating jobs or building infrastructure upon which a sound recovery can be based. As Sachs notes, “the US and Europe have veered between dead-end, consumption-oriented stimulus packages and austerity without a vision for investment.”

Although I agree with Sachs on the basic thrust of what is required to bring real recovery to the U.S. economy, we differ in some particulars. Sachs, for one thing, believes corporations should be taxed more heavily. I fear that would only make matters worse since corporations would likely send more of their money to tax havens overseas. Clearly, tax revenues need to increase and government spending needs to be reeled in if basic government needs and essential social services are going to be provided; but the best way to increase tax revenues is to put people back to work. Corporations that create jobs should be rewarded for their efforts rather than be penalized. I’ve argued since the beginning of the recession that more needed to be done to encourage entrepreneurs to start businesses and hire employees. Unfortunately, it looks like politicians are more interested in pointing fingers of blame at each other than they are about trying to work together to stimulate job creation. Getting off the soapbox, let me return to the subject of globalization.

Sachs also asserts, “Export-led growth is the other under-explored channel of recovery.” I’m not sure that it is an under-explored topic. During his State of the Union address, President Barack Obama stated, “To help businesses sell more products abroad, we set a goal of doubling our exports by 2014 -– because the more we export, the more jobs we create here at home.” To learn more about efforts to increase exports, read my post entitled Small Businesses and Globalization. To some extent those efforts have been working. Harold L. Sirkin, a Chicago-based senior partner of The Boston Consulting Group, reports, “U.S. exports increased more than 20 percent, according to the Census Bureau, and some 85 percent of those exports were manufactured goods.” [“Made in the USA—and China,” Bloomberg BusinessWeek, 5 August 2011] He muses, “If I had told you in the summer of 2009 that America’s long-suffering manufacturing industries would lead the lackluster recovery from the Great Recession, you probably would have wondered what I was reading — or smoking. I would have been correct, however.”

There are mixed views about whether U.S. manufacturing can really make a rebound. But there is a lot more optimism today than there has been in a long time. If manufacturing does return in any significant way to the U.S., the jobs created will be much different than those that were lost to globalization. Perry Sainati, founder and president, Belden Inc., writes, “I take a backseat to no one when it comes to appreciating the role that manufacturing plays in this country’s economy. But then again, anyone who believes that a pronounced uptick in this country’s manufacturing output will immediately translate into a full-scale spike in job growth just doesn’t understand the fundamentals of manufacturing.” [“Your Grandfather’s Manufacturing Jobs ‘Ain’t Comin’ Back’,” Industry Week, 7 July 2011] He explains:

“U.S. manufacturing these days is in the midst of a remarkable three-year recovery because for three years running manufacturing has not been about job growth. It’s been about automation. It’s been about process improvement. It’s been about productivity. And it’s been about quality. In fact, it’s been about reinventing the very process by which durable and disposable goods get manufactured. What’s more, it’s been about streamlining our factories to the point that they’re now among the most efficient in the world. That’s why America’s manufacturing sector has achieved such a dramatic turnaround, and that’s why our economy is slowly but surely working its way down the long road to recovery.”

Sainati apparently agrees with Sachs that yesterday’s factory workers must be retrained to meet the demands of today’s job market. He concludes:

“[The types of manufacturing jobs that once defined the American workforce] are gone. What’s more, as Bruce Springsteen once sang, ‘they ain’t comin’ back.’ That’s not to say, of course, that manufacturing growth will not continue to translate into meaningful job growth — and meaningful careers — in this country. Because it will. It’s just that it won’t translate into the massive quantities of jobs people still want to believe are possible. Nor will it translate into the kind of low-skilled jobs that once defined the assembly line dynamic. In this day and age, companies like mine simply cannot afford to pay top dollar for workers whose skill sets do not extend beyond the ability to spot weld a piece of metal or maybe torque down a bolt or two. Today’s lean manufacturing companies are looking for skilled workers who think like engineers and who bring to the job each day a broad knowledge of product design and product development. Today, small, independent businessmen like myself are not so much looking for manufacturing cogs as we are manufacturing assets; people whose skills are essential to the process of designing, prototyping and manufacturing products for market. America’s economic future will remain forever linked to our ability to manufacture quality goods. But the minute we start focusing more on this country’s ability to manufacture jobs than we do our ability to manufacture things is the minute we step out onto what promises to be a very slippery slope.”

Sainati is correct. Germany has weathered the recession pretty well because it continues to manufacture goods that others want. As result, Germany’s unemployment rate has been relatively low. To read more on that subject, see my post entitled Entrepreneurs, Medium-Sized Companies, and the Global Supply Chain. Sirkin points out in his article that manufacturing — once seen as a zero-sum game — is no longer perceived as an us versus them scenario. He writes, “The good news about U.S. manufacturing is no fluke. For [numerous] reasons, … the manufacturing renaissance should continue for years to come.” Sirkin, however, warns that his optimism “does not mean it will be smooth sailing.” Sirkin, like most analysts, sees rising labor costs in China and understands that the advantage of manufacturing overseas quickly dissipates once wages converge. He writes:

“With the value of the yuan continuing to increase, the total cost advantage will drop to single digits after businesses factor in inventory and shipping costs—with productivity-adjusted labor costs effectively converging by 2015 or so. This will make states such as Alabama, Louisiana, Mississippi, North Carolina, South Carolina, Tennessee, and Texas—with their competitive wages and flexible work rules—increasingly attractive as low-priced manufacturing hubs for the North American market. In fact, these states are becoming some of the cheapest locations in the developed world for manufacturing. That’s why European companies such as Volkswagen are building plants there. For some companies, the economics already have reached the tipping point. … The bottom line is clear. With rapidly rising wages in China, critical shortages of skilled workers in many of China’s lower-cost regions, and the higher productivity of U.S. workers, many companies are finding that it makes sense to manufacture goods for America in America.”

Sirkin isn’t trying to make a case for manufacturing either in China or in the U.S. Depending on circumstances, he insists that companies may want to consider doing both. He offers three rules of thumb to use when making the decision about where to manufacture your goods:

“First, don’t write off China as a highly desirable manufacturing location. While more goods sold in the U.S. will be ‘Made in the USA,’ China—as the largest and fastest-growing developing economy in the world, with a rapidly growing middle class and a population more than four times America’s—will remain a top overseas market and a key manufacturing location. Although other low-cost countries, such as Vietnam, Thailand, Cambodia, and Indonesia, will attract some manufacturing from companies seeking wage rates lower than China’s, these countries lack the supply base, infrastructure, and labor skills to absorb much of China’s manufacturing. So don’t even consider abandoning China. The new paradigm will be to manufacture in China and the U.S., not either/or. It’s all about where to put the next plant. China-based plants will be busy serving China and other export markets. The U.S. may prove the best place for the next plant to serve the North American market.”

Over the past several years, I’ve argued that we would start to see more regionalization within the larger context of globalization. Analysts like Sirkin only serve to convince me that the trend will emerge sooner rather than later. He continues with his second rule of thumb:

“Second, differentiate between product lines. Executives also need to understand that many products intended for the U.S. market should still be sourced from China. Products that require less labor and are created in modest volume—especially heavy expensive-to-shop products, such as household appliances and construction equipment—become strong candidates to shift to U.S. production. Labor-intensive products made in high volume, such as textiles and apparel, remain strong candidates for manufacturing overseas.”

In other words, Sirkin agrees with Sainati that the old “labor-intensive” jobs that require unskilled labor aren’t coming home. It’s time to rev up those re-training programs. Sirkin’s final rule of thumb discusses total costs. He writes:

“Third, consider total cost. Some executives make the mistake of comparing ‘average’ labor costs for Chinese production workers with those in the U.S. But averages can deceive. Although wages remain much lower in China, they don’t reflect the full cost of doing business or range of decisions that companies have to make. Executives planning a new factory in China to make products for sale in the U.S. need to look at all the expenses. They are likely to find that, for many goods, China’s cost advantage will shrink too much to bother with—and that’s before taking into account the added expense, time, and complexity of long-distance management, logistics, and quality control.”

Sirkin concludes, “Those who have been writing U.S. manufacturing’s obituary need to recall Mark Twain’s famous ‘last’ words: ‘The report of my death was an exaggeration.'” Supply chain analyst Bob Ferrari adds a nice side note to the discussion of manufacturing and jobs creation. He writes:

“[If] modern manufacturing process is all about doing more with less — less time, [material] and labor — … readers may ask — where, if anywhere does job growth come from? According to [General Electric CEO Jeff] Immelt, it comes from the supporting supply chain. Large manufacturers such as GE have placed ever more dependency on networks of suppliers. GE’s Greenville South Carolina plant relies on 16 Tier One suppliers, Immelt’s ratio is that for every employee at the factory, there are 8 jobs in the supply chain, because smaller suppliers lack the scale and resources to invest at the same level as global manufacturing OEM’s.” [“More Debates and Discussion on U.S. Manufacturing Competitiveness,” Supply Chain Matters, 29 July 2011]

That is a pretty significant (and, I’m betting, often overlooked) statistic. The bottom line is that every manufacturing job we can create in America is a big plus for the economy.

There’s one last argument I’d like to explore before leaving the subject of business and globalization. A recent report claims, “Strong multinationals seem less healthy than successful companies that stick closer to home.” [“Understanding your ‘globalization penalty’,” by Martin Dewhurst, Jonathan Harris, and Suzanne Heywood, McKinsey Quarterly, July 2011] Dewhurst and his colleagues write:

“Global reach seems to threaten the underlying health of far-flung organizations, even highly successful ones. In particular, we have found that high-performing global companies consistently score lower than more locally focused ones on several critical dimensions of organizational health—direction setting, coordination and control, innovation, and external orientation—that we have been studying at hundreds of companies over the past decade. Understanding this threat, and its causes, is a first step toward diminishing its impact.”

One way of interpreting the McKinsey analysts’ findings is that companies are better off manufacturing at home and exporting abroad. If, however, maintaining extended supply chains and overseas manufacturing plants are imperatives, you might want to rethink how businesses can be more regionalized to reduce the “globalization penalty.” Dewhurst and company conclude, “Since even leading multinationals appear to suffer this globalization penalty, the importance of addressing it will only grow larger in the years ahead. For more and more companies, the globalization imperative is intensifying, and that could present additional organizational and leadership challenges that are not yet fully understood.” The bottom line is that I’m still a big supporter of globalization; but, where holes are beginning to appear in its fabric, we need to start thinking about how to mend them.