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Too much offshoring endangers future innovation [ClearOnMoney]
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Too much offshoring endangers future innovation

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Commentary

Too much offshoring endangers future innovation

6 Jul 2010 by Jim Fickett.

The offshoring of high-tech manufacturing has been extreme – resulting in about 10 foreign employees per US employee. This implies both (1) long-term structural problems in the US employment situation and (2) a possible loss of competitiveness as the web of relationships among those with technological know-how is increasingly outside the country.

Bloomberg Businessweek has published an important article by Andy Grove, former CEO and chairman of Intel, entitled How America can create jobs.

Grove's first point is that the offshoring of jobs in the computing industry has been massive.

Startups are a wonderful thing, but they cannot by themselves increase tech employment. Equally important is what comes after that mythical moment of creation in the garage, as technology goes from prototype to mass production. This is the phase where companies scale up. They work out design details, figure out how to make things affordably, build factories, and hire people by the thousands. Scaling is hard work but necessary to make innovation matter.

The scaling process is no longer happening in the U.S. …

Today, manufacturing employment in the U.S. computer industry is about 166,000, lower than it was before the first PC, the MITS Altair 2800, was assembled in 1975. Meanwhile, a very effective computer manufacturing industry has emerged in Asia, employing about 1.5 million workers—factory employees, engineers, and managers. The largest of these companies is Hon Hai Precision Industry, also known as Foxconn. The company has grown at an astounding rate, first in Taiwan and later in China. Its revenues last year were $62 billion, larger than Apple (AAPL), Microsoft (MSFT), Dell (DELL), or Intel. Foxconn employs over 800,000 people, more than the combined worldwide head count of Apple, Dell, Microsoft, Hewlett-Packard (HPQ), Intel, and Sony. …

Some 250,000 Foxconn employees in southern China produce Apple's products. Apple, meanwhile, has about 25,000 employees in the U.S. That means for every Apple worker in the U.S. there are 10 people in China working on iMacs, iPods, and iPhones. The same roughly 10-to-1 relationship holds for Dell, disk-drive maker Seagate Technology (STX), and other U.S. tech companies.

Grove is worried about the jobs.

You could say, as many do, that shipping jobs overseas is no big deal because the high-value work—and much of the profits—remain in the U.S. That may well be so. But what kind of a society are we going to have if it consists of highly paid people doing high-value-added work—and masses of unemployed?

But he is even more worried about losing a place in the web of high technology know-how and relationships.

There's more at stake than exported jobs. With some technologies, both scaling and innovation take place overseas.

Such is the case with advanced batteries. It has taken years and many false starts, but finally we are about to witness mass-produced electric cars and trucks. They all rely on lithium-ion batteries. What microprocessors are to computing, batteries are to electric vehicles. Unlike with microprocessors, the U.S. share of lithium-ion battery production is tiny.

That's a problem. A new industry needs an effective ecosystem in which technology knowhow accumulates, experience builds on experience, and close relationships develop between supplier and customer. The U.S. lost its lead in batteries 30 years ago when it stopped making consumer electronics devices. Whoever made batteries then gained the exposure and relationships needed to learn to supply batteries for the more demanding laptop PC market, and after that, for the even more demanding automobile market. U.S. companies did not participate in the first phase and consequently were not in the running for all that followed. I doubt they will ever catch up.

The second problem, of long-term damage to capacity for innovation, is hard to quantify but certainly real, especially as China strengthens research and moves up the value chain.

One might wonder whether Grove is exaggerating with talk of “a society … of highly paid people doing high-value-added work—and masses of unemployed”. But one of the most worrisome long-term features of the US employment situation is that the number of prime-age men 'Not employed' (including those not looking for work) has oscillated around a rising 40 year trendline from about 8% in 1968 to about 13% in 2008 (US not employed rate).

I do not find Grove's proposed solution – protectionism – sufficient. Could US high-tech companies really compete globally if forced to use US labor, currently at many times the cost of labor in China? I doubt it. Perhaps tariffs are part of the answer. But labor cost may have to adjust. Unless globalization is fundamentally reversed, many of the less educated in the US may have to give up the middle-class lifestyle they gained during the golden age of US automobile manufacturing.