Sunday, June 12, 2011

Destruction of U.S. Manufacturing: The Unusual Suspects (Guest Post)

By Andrew Butter

If you want to know the real “culprits”, have a look at this chart:


The blue line is US Employment in Manufacturing (from the St Louis Fed), the purple line is the cumulative amount of money that Americans (mainly US Corporations) invested in projects outside of USA, instead of inside USA; (from the BEA time series on International Transactions Line 51).

Do I need to draw a picture?

That line is probably an under-estimate of the value that was sucked out of USA and sent elsewhere.

Because when you set up a factory in a Special Economic Zone in Guangdong Province or somewhere, to manufacture something that you know you can sell, particularly in USA; because you own the patents and the distribution and the brand. You also have the luxury of “transferring” intellectual capital, outside of the beady eyes of US tax-inspectors reading up the statutes on “Transfer Pricing”; so a lot of what get’s transferred is “intangible” (as in the tax-man can’t get his sticky fingers on it).

Here is a statistic, 80% of China’s exports have “value-added”, added, in what they call “Special Economic Zones” (and what I call Free Zones). That’s huge.

Here’s another one, 50% of the earnings of S&P 500 corporations (that’s the “E” in “P/E”) are generated outside of America.

My part in all that:

In June 1990 I drove with my business partner at the time, to meet with His Excellency Mr. Sultan bin Sulayem, who was then the Chairman of the Jebel Ali Free Zone.

The meeting had been set up because Sulayem had been invited to speak at the Confederation of British Industry in UK about how British companies might like to invest in the Zone. The head of the Dubai Promotion Board had figured it might be nice if someone wrote his speech and perhaps coached him a little on his delivery technique. We were a boutique consultancy doing work for the Board, so we were asked to “lend a hand”.

Anyway, we put together a 20-Slide presentation, and wrote a script to go with the slides. Sulayem did his homework like he was told, and submitted to a practice session, and off he went. The trip was a success, he kept to his 20-minute time-slot (one minute per slide); and at the end, everyone clapped; mission accomplished.

From then on for about five years, we wrote all of Sulayem’s speeches, and not just for him, for other Excellencies too; after the word got around that people tended to clap when you delivered one of our presentations, rather than going to sleep and having to be woken-up at the end.

During that time, we managed to sell the idea that if the Zone was to be successful, then it might be a good idea to devote some very modest resources, as in put money into our pockets – (since the “speech” thing was a complete loss-leader for the time we spent), to find out (a) who were the potential customers, and (b) what they might want, that the Zone could offer? That was a pretty radical idea at the time.

So we got hired to do research, we pulled together information on all the Free Zones in the world, we did cross-section analysis, and we interviewed everyone who had expressed an interest the zone (mainly on the telephone). Based on that we kind of eased the marketing strategy away from “this is what we got, take it or leave it”, into “this is how we can meet your needs and exceed your expectations”.

Whether we had any effect is impossible to know, but from flat-lining for the ten previous years, the numbers of new arrivals and also the exports from the Zone went up by 40% a year (compounded) for four years.

And whether what we learned applies directly to America’s story, I don’t know, most of the “customers” were European, or from the region.

The point of that story is that we found out a lot about why corporations, Europeans, in particular, some Americans, were moving out of the “safety” behind the wall that keeps the “Great Unwashed” separated from the “Great Washed”, into the “danger zone”.

Seeing as that was twenty years ago (or so); and when we started off there were only 300 companies registered in the Zone; now there are over 6,000, so I don’t think I’m breaking any client confidentiality by “sharing”.

It’s nothing to do with Labor Costs

There is a popular idea that cheap labor is why America lost its manufacturing jobs, perhaps that might play a part in something (although if it did, why didn’t Germany and Japan lose more?), but there is nothing I ever saw to support that notion.

One thing we found out pretty-quick; was that the ability of the new-arrivals to hire cheap labor and suck blood out of their veins before throwing them on the scrap heap; was not an important reason why they were coming. In point of fact, the labor was relatively expensive because there was a minimum wage, there were laws on how many hours people worked, you had to provide decent accommodation (luxury accommodation by Third-World Standards), there were strict Health, Safety and Environmental rules that were enforced, and the employers had to pay for medical care.

In short, compared to the indignities that some illegals in USA and the kids who strap themselves under trains to get into fortress Europe, have to endure, it was Paradise.

Sure, you can find other less salubrious Free Zones elsewhere, but right from the start the Unique Selling Proposition of the Jebel Ali Free Zone, was never as a place where you could squeeze the last drop of blood out of cheap labor and make a profit out of doing that.

Regardless, if the applicants’ business model was to do that, and there were plenty, they got told to go elsewhere; none of the decent companies were interested in that business model. The stuff you read about exploiting labor; is done by sub-contractors, on the fringe of what the whole Free Zone idea is about, and often outside; sure you can make money, good money, doing that, but that’s not core to what Free Zones are about.

Infrastructure

Things had to work; planes & ships had to arrive on time, and go places on time, plus telephones, electricity, water and waste needed to work, all the time. Sheikh Rashid bin Sultan, once said to someone I knew, “I will build the infrastructure and the rest will follow”. How right he was, but you go to USA or UK, and the infrastructure is lousy, the money that gets paid by corporations in tax, does not end up servicing their needs.

Security

A lot of people have this thing about other people stealing what they got; and whether the crooks are government “gate-keepers” hustling kick-backs, clever tort lawyers, or the mafia, it makes no difference. And violence is a real turn-off; you would be surprised how important having proper laws and decent-honest policemen are for people making 10-Year or so investment decisions. You think America is a “safe” place to do business? Well sorry to have to break the news, compared to a lot of places, it isn’t, and I got “genuine customer feedback”, to prove it.

Tax

Of course, and sure, infrastructure and security have got to be in place first, that’s what marketing guru’s call an “absence of gross-negatives”, but tax is huge.

A while back in America, they had this idea about “no taxation without representation”; that got changed to “shake-down the dirty capitalists so we can live off their ill-begotten riches”.

Corporate taxation in USA is 38%; it’s 37% in UK. The interesting thing is that not a big part of the total tax-revenue comes from that source (in UK it’s about 7%, I didn’t find what it is in USA, perhaps I didn’t look hard enough, but I don’t imagine it’s much different). The reason it isn’t much is

(a) the cost of the process of making sure you pay less tax, is tax-deductable, so a huge amount of “GDP” is devoted to employing legions of accountants and lawyers so as to pay less tax,
(b) since the early 1990’s there has been an alternative, as in Free Zones outside USA (and Europe).

And the point is that when you pay that 38%, you often don’t get much if anything in return. Think of it; you set up a factory or a business process, you employ people, but you have to pay out of your nose to support all the people in the area where you set up your business, who don’t work for you! That might sound logical to some people, but the reality is that faced with that “incentive”, a lot of people, quietly…leave.

That’s called “Killing the Golden Goose”.

Free-Labor Markets

In Jebel Ali, you want to employ a one-eyed cross-dressing transvestite from Bangladesh; well you just submit an application with a copy of his passport, three photographs, and $1,000. Two-days later you got a three-year-work visa. Nobody is going to ask you why, or tell you that the quota for those has been filled, so come back next year.

A friend of mine went to USA last month to check out a 2nd Hand 500-ton crane he was buying. The guy he was buying it from told him that he had a real problem finding anyone who could maintain or operate it, that’s why he was selling. Well, I could find him ten decent and competent people who could do both of those things, tomorrow, but he wouldn’t be able to get them a visa, particularly since three of the ten come from Peshawar, and the best one has got a huge beard and wears a short skirt; he prays five times a day without fail (as in he got religion with a capital “R”), and he’s one of the most honest and decent people I ever met – but don’t piss him off!!

Sure the labor is cheap, but that’s just what it costs. No one is forced to come to leave their village in Pakistan or Philippines to travel half-way around the world to work, except that they want to leave behind the corruption and chaos. The point is, you work out the cost, and do your calculations, in Germany or Japan, which both seem to manage OK, you have high labor costs, so you automate more, that’s just an input; but if you can’t buy the skills, when you want them, you are nowhere.

Immigration doesn’t steal jobs, unreasonably preventing it, does.

Paperwork

The United States Federal Tax code, is 70,000 pages, in 1940 it was 400 Pages.

When Sheikh Rashid set up the Jebel Ali Free Zone, he told the lawyers who drafted the pro-forma agreement that potential customers would sign, to keep it short. Legend has it they came back with 30 pages, and he threw it back at them, and again, and again, until they managed to say everything that needed to be said, in two pages. “Surprisingly”, the Free Zone has “survived”.

Trickle-down

A good businessman always makes sure that the person he sells something to, can, if he wants, sell it on and make a decent margin. Whenever you do business, you need to think, not just “what I can get out”, you need to think “what am I bringing, that’s special”, because if you don’t keep an eye on that, one day someone is going to kick you out of your little niche.

Free Zones add value to the inefficient and corrupt places where they are located, over the other side of the fence. That’s what happened in China, and it happened in the Jebel Ali Free Zone, the success of the zone which attracts in business, creativity, opportunities and money, which would have never come in 1,000 miles of those countries, had there not been the “protection” of the zone, which sustains and adds value to the host country.

Persuading US Corporations to invest in USA and not Guangdong Province

Follow the trend-line on the chart from after the War to 1979, and extrapolate, if the investment had not piled out of America, there would perhaps be 24 Million people employed in manufacturing in USA today, as opposed to just under 12 Million.

Meanwhile as one bunch of economists after another pontificates about how it is possible to “create jobs and Make America Great Again”, by tinkering with the base-rate, playing tricks with the money-supply, and lambasting China for over-valuing their currency, the thing that once made Americans swagger, so sure in their invincibility, is gone.

Personally, I liked that, sure Americans used to be really “in-your-face”, but they were great, I liked their optimism, their “can-do”, and their generosity, and I learned a lot from them, old and young, fat and thin, when I was young…but from what I see, that’s gone; replaced by fear and insecurity.

None of the economic horse manure that counts as policy in USA, goes anywhere close to solving the real “gross negatives”, that cause US corporations to think twice, or more, about where to locate their latest business process, and certainly, I know a lot of people who do manufacturing, none of them are even contemplating setting up in USA.

And like I said, it’s not the cost of labour; it’s the cost of government, and dealing with government.

There is a town in California, with a population (at night) of zero people, it sustains a lot of people, but the people around and about can’t put their hands in the pockets of the businesses that operate there; there is talk of closing it down.

Perhaps, if there is anyone in America who wants “Change”, then once the clever monetary and economic policies are seen to fail (again), some thought might be directed at creating more towns like that, which can escape whatever it was that paralysed American Manufacturing?

The point of Free-Zones is to create an environment where free-enterprise, and free-markets can thrive; and when all the rest is so corrupted by silly laws, regulations, and special interests, sometimes you just need to start over.

And don’t talk about the 38% corporate tax which would be “lost”, you can only lose something you got, and there are plenty of ways to make that up taxing rich people, and people with jobs.

Source: http://www.businessinsider.com

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