14614_apple and american economy

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Supply chains

Apple and the American economyJan 23rd 2012, 13:46 by R.A. | LONDON

THE macroeconomic discussions that Apple's success prompts tend to be very curiousthings. Here we have a company that's been phenomenally successful, making productspeople love and directly creating nearly 50,000 American jobs in doing so, criticised fornot locating its manufacturing operations in America, even as Americans complain toApple about the working conditions of those doing the manufacture abroad: life indormitories, 12-hour shifts 6 days a week, and low pay. It isn't enough for Apple to havechanged the world with its innovative consumer electronics. It must also rebuildAmerican manufacturing, and not just any manufacturing: the manufacturing of decadesago when reasonable hours and high wages were the norm.

The utility of Apple, however, is that it does provide a framework within which we can

discuss the significant changes that have occurred across the global economy in recentdecades. Contributing to that effort is a very nice and much talked about piece from theNew York Times, which asks simply why it is that Apple's manufacturing is located inAsia.

You should read that piece for yourselves, but the story, in a nutshell, is this. Apple'sproducts are assembed in massive factory complexes in China, run by Foxxconn, whichalso handles the production of consumer electronics for many other large players in theindustry:

The facility has 230,000 employees, many working six days a week, often spending up to

12 hours a day at the plant. Over a quarter of Foxconn's work force lives in companybarracks and many workers earn less than $17 a day. When one Apple executive arrivedduring a shift change, his car was stuck in a river of employees streaming past. The scaleis unimaginable, he said.Foxconn employs nearly 300 guards to direct foot traffic soworkers are not crushed in doorway bottlenecks. The facility's central kitchen cooks anaverage of three tons of pork and 13 tons of rice a day. While factories are spotless, theair inside nearby teahouses is hazy with the smoke and stench of cigarettes.FoxconnTechnology has dozens of facilities in Asia and Eastern Europe, and in Mexico andBrazil, and it assembles an estimated 40 percent of the world's consumer electronics forcustomers like Amazon, Dell, Hewlett-Packard, Motorola, Nintendo, Nokia, Samsungand Sony.They could hire 3,000 people overnight, said Jennifer Rigoni, who wasApple's worldwide supply demand manager until 2010, but declined to discuss specificsof her work. What U.S. plant can find 3,000 people overnight and convince them to livein dorms?The components that go into the phone are quite often assembled in China, or elsewherein Asia, as well:

Manufacturing glass for the iPhone revived a Corning factory in Kentucky, and today,much of the glass in iPhones is still made there. After the iPhone became a success,


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Corning received a flood of orders from other companies hoping to imitate Apple'sdesigns. Its strengthened glass sales have grown to more than $700 million a year, and ithas hired or continued employing about 1,000 Americans to support the emergingmarket.But as that market has expanded, the bulk of Corning's strengthened glassmanufacturing has occurred at plants in Japan and Taiwan.Our customers are in Taiwan,

Korea, Japan and China, said James B. Flaws, Corning's vice chairman and chieffinancial officer. We could make the glass here, and then ship it by boat, but that takes35 days. Or, we could ship it by air, but that's 10 times as expensive. So we build ourglass factories next door to assembly factories, and those are overseas.All told, the physical production of Apple's products accounts for hundreds of thousandsof manufacturing jobs. America, which finds itself several million jobs short of where itwould like to be, and particularly short of the middle-skill manufacturing positions thatonce powered growth in the middle class, seems to want some of those back. Is that areasonable desire?

How did we get here? A new paper by Richard Baldwin helps lay out some of the story.

We can summarise it briefly by noting that specialisation is limited by the extent of themarket. When transport costs are very high, the accessible market is quite small, perhapsno more than a village, which will then make nearly everything it needs for itself. Astransport costs decline, economic activities may begin to unbundle. As overseas shippingcosts fell during the industrial revolution, it became possible for massive industrial citiesto specialise in large-scale production and ship their goods to customers all over theworld. The concentration of industry in cities, however, was still largely a product of thefact that it was costly to move goods over land. In a port city, you could bring in inputs,process them into outputs, and ship them back out. If it had been necessary to moveintermediate goods well inland for manufacture at any point, costs would have soared,making profitable production impossible.

But transport costs continued falling. Shipping became much cheaper and more efficient.Air freight became an economic possibility. And improvements in trucking and freightrail led to stunning drops in the cost of moving goods over land. And so where onceproducers had crowded on top of each other in cities to take advantage of specialisationwithout blowing their budget on transport costs, they now began to spread out: first intothe suburbs, then into cheaper regions of the same economy, and then, finally, into vastlycheaper economies abroad. This process facilitated the rapid industrialisation of Asiangiants like Japan and Korea, while also speeding along the process of deindustrialisationin expensive markets in America and Europe.

At this point, many seemed to conclude that distance was if not dead then dying, and thatcontinued fracturing of supply chains was likely to continue. What actually seems to haveoccurred is a bit more interesting. Supply chains have indeed continued fracturing, butdistance has reasserted itself in two important ways. First, in the advanced world,agglomerations of the talented individuals who design these products have becomeincreasingly important. And secondly, information technology, which allows for bettercoordination of production processes, has once again made proximity a relevant concernin manufacturing. It's possible to coordinate a supply chain that's draped across an


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archipelago of Asian economies. To maximise the return to this chain, however, it's stillnecessary to keep plants reasonably close together. A plant located in America is toodistant from Asia to make much economic sense; transit time to the rest of the supplychain in Asia is sufficiently long, in most cases, as to erode the gains to just-in-timeproduction, or unexpected changes in designs or orders. Changing transportation and

communication technologies facilitated a shift in manufacturing to Asia, then reinforcedits presence there.

It's not necessary to talk about this as an entirely organic process. Unquestionably, Asiangovernments aggressively pursued manufacturing and subsidised it heavily, both directlyand through advantageous exchange rates. As the story points out, Asia has capitalised onother advantages, as well. Cheap labour is one. More flexible land-use, labour, andenvironmental rules are another; China can erect a massive operation in no time at all,staffed with compliant labour and with little concern about the impact of the factory onwatersheds, air quality, and traffic. Skill supply seems to matter as well. China ischurning out engineers with basic technical competence (but less, it appears, than a

bachelor's degree) by the hundreds of thousands. It would be incorrect to point to any oneof these characteristics as the driving force behind the global shift. Rather, these are self-reinforcing factors within a global economy that has multiple stable equilibria. Aftersome level of Asian development and integration, it became more attractive formanufacturers to locate there as more manufacturers located there.

What does this mean for the American economy? The Times piece quotes Steve Jobs astelling President Obama that those jobs aren't coming back, and they probably aren't.Attracting firms back to America wouldn't simply be a matter of helping reduceproduction costs in America. You'd have to replicate the convenience of the entire supplychain, which would likely be an enormously costly enterprise. Given the quality of thejobs characteristic of these production chains, one should ask whether it might not be abetter idea to invest that money elsewhere.

Apple, it's worth pointing out, continues to capture most of the value added in itsproducts. The most valuable aspects of an iPhone, for instance, are its initial design andengineering, which are done in America. Now, one problem with this dynamic is that asone scales up production of Apple products, there are vastly different employment needsacross the supply chain. So, it doesn't take lots more designers and programmers to sell50m iPhones than it does to sell 10m. You have roughly the same number of brainsinvolved, and much more profit per brain. On the manufacturing side, by contrast,employment soars as scale grows. So as the iPhone becomes more popular, you get hugereturns to the ideas produced in Cupertino, and small returns but hundreds of thousandsof jobs in China.

This discrepancy manifests itself in America as rising income inequality, which makesApple's choices somewhat politically fraught. At the same time, it's worth asking how theAmerican government might alter its policies so as to make life better for middle- andlow-skill workers in America at reasonable cost. Offering heavy subsidies to Apple to getit to relocate production would reduce inequality in America; you'd increase the tax


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burden which would mostly affect richer households and you'd create low-wage jobs,which would mostly benefit underemployed, low-skill workers. Now, perhaps after weadd up everything Americans will decide that this kind of massive intervention in theeconomy and associated efficiency cost is worth it, in order to provide the dignity ofemployment, such as it is, to millions of workers. It's worth asking, however, whether

there might not be a different and better way forward.

For one thing, it's far from obvious that the embrace of this system by Asian economies isa good thing for them over the long run. In the short term, as Mr Baldwin points out inhis paper, industrialisation via biting off bits of global supply chains is in many ways amore superficial form of development than was achieved in earlier periods by Europe,America, Japan, and Korea, all of which developed an entire production capacity fromthe ground up. There is far less technology transfer in the newer, supply-chain model, forinstance, and so it is less clear that Chinese manufacturing centres will develop theinnovative hubs and headquarters that did emerge in America and Japan. Furthermore,technology can change quite rapidly. It is stunning how quickly the present system

emerged. It might well go away just as quickly, either through mass automation orchanges in input costs or shifts in the cost of moving goods and ideas. Who knows, rapidimprovements in 3-d printing could take the world economy back to the days ofhyperlocalisation in manufacturing.

America has also done very well in the past by looking forward toward the unseenopportunities ahead rather than the obvious opportunities currently being exploited.Think for a moment about the world Apple has created: one in which a very large shareof the population is connected to each other and to all sorts of data resources viaremarkable and powerful little hand-held computers. The potential to develop newbusiness models for the production and delivery of goods and services is almostunimaginable, and it's safe to say we've only begun to scratch the surface. One can't sayin advance what the impact of such businesses will be on employment and earnings, but itmight well change the demand for skills within America in unexpected ways. To theextent that China's government is encouraging resources to flow toward manufacturingand assembly, it is reducing its ability to experiment with and develop these newtechnologies and businesses.

Jobs matter. They certainly matter to the well-being, material and psychological, of thosewho struggle to find one. Whether they matter enoughand specifically whether theselow-skill manufacturing jobs matter enoughto undertake major and costly governmentinterventions in the economy, in the process potentially harming the effectiveness ofAmerica's innovative businesses, is the question with which American workers andleaders are now wrestling. The answer seems clear enough to me, though my perspectiveis obviously different from those elsewhere in the economy. Until there is a meaningfulimprovement in American labour markets, however, especially for those without acollege degree, recapturing those assembly jobs from China will continue to linger as apolicy temptation.

14614_apple and american economy

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