Will we bring back manufacturing or outsource innovation too?
Saturday, January 2, 2010 at 02:48PM Innovation must be located near manufacturing because so much of innovation is learning from and improving manufacturing, according to GE CEO Jeffrey Immelt on this CNBC forum, The Future of "Made in the USA." Others who understand the innovation process have made the same point. I think I first heard it about 30 years ago from Donald Firth after he left the UK's National Engineering Laboratory in Glasgow. This directly contradicts the naïve view that the US can be the global center of high-skill, high-pay "innovation" jobs and that it makes economic sense for low-skill routine manufacturing jobs to go to Asia. In reality, China can do everything the US can do to assemble the best and brightest in innovation centers, but increasingly only the Chinese can locate them near manufacturing centers.
During and after WWII, the US government provided numerous substantial financial incentives for innovation (favorable tax treatment, government contracts, grants to higher education, etc.), and the many resulting innovations created whole new industries and millions of jobs in the US. However, Government subsidies for innovation make much less sense now—and perhaps make no economic sense at all—because now the odds are that most of the jobs resulting from future US innovations will be created in Asia instead of here. This means that nations like China can get much more bang for their innovation subsidy bucks than can the US because a much higher proportion of the benefits will be in China.
Bad as that is, we're helping our competitor nations by educating more of their students and fewer of our own in America's best universities, and not many of them plan to stay here. Those who still believe the world sees the US as the land of opportunity should recalibrate. A survey of 1,224 foreign nationals from India, China, and Western Europe studying at U.S. universities and colleges - or who had graduated by the end of the 2008 academic year - primarily in engineering, business and economics, computer science and biological sciences, funded by the Ewing Marion Kaufman Foundation and reported here, found:
Just 7 percent of Chinese students and 25 percent of Indian students surveyed said the best days for the United States economy lie ahead.
Approximately 74 percent of Chinese students and 86 percent of Indian students said their home countries' economies will grow faster in the future than they have in the past decade.
Most foreign students said innovation will occur faster over the next 25 years in India and China than in the United States.
Some 76 percent of Chinese students and almost 84 percent of Indian students said it would be difficult to find a job in their field in the United States.
While 58 percent of Indian, 54 percent of Chinese and 40 percent of European students want to stay in the United States for a few years after graduation, only 6 percent of Indian students, 10 percent of Chinese students and 15 percent of European students said they wanted to remain permanently.
Circling back to Jeffrey Immelt, under his leadership GE has located its clean coal technology global innovation center in China. My advice to American teenagers who want to achieve big things in science or engineering: Become fluent in Mandarin and accept the idea of being part of privileged technocratic class in a politically oppressively and highly-polluted nation.
Skeptic
From this op ed by a distinguished chemistry professor at Brandeis University:
At many top schools, including my own, international students constitute from 30% to 70% of the doctoral candidates in math, physics and chemistry.
The situation might be tolerable, if embarrassing, were it not for recent changes in world economies and attitudes toward science and education. As a result of dramatically increased investment by other countries in science, the brain drain is not just slowing, it appears to be changing direction.
International students and post-docs are returning to their home countries in much greater numbers after reaping the benefits of an American education, and many who have worked for years at U.S. companies and universities are being lured home by offers of new labs, easy access to research funding and the comforts of their native culture.
UPDATE 1/5/10: As relative incomes, wealth, tax bases, and preparatory education systems in the US decline versus China, India, etc., financial pressures on US universities, especially state-supported universities, will lead to admission of an even higher proportion of foreign students. Current events at Berkeley:
The chancellor also decided to gradually increase Berkeley's out-of-state inrollment from 9.5 to twenty percent. Out-of-state students pay more than triple the in-state fees, and the admissions measure would eventually generate an extra sixty million dollars for the campus--while, of course, reducing access for Californians.
UPDATE 7/15/10: The Los Angeles Times reports that Berkeley actually increased out-of-state enrollment to 22.6% and UCLA to 14.9% in this fall's entering classes, all very deliberately to offset decining State government subsidies. The less prestigious UC campuses have lower percentages of out-of-state and foreign students.
Skeptic
Tyler Cowen exults that China, India, Indonesia, and Brazil have enjoyed a decade of very robust growth “while it’s questionable whether the decade as a whole has been good for Americans, economically speaking. Median wages have not risen much, if at all, and the costs of the financial crisis and irresponsible fiscal policies have become increasingly obvious.” But that’s OK, he says, because the wealth and innovation of other nations will be good for America too, "if only for the longer run,” which he does not define.
It might be pleasant to boast that America is — or should be — a world leader in every area, but the practical reality is that if some other country solves the problem of green energy, so much the better for us.
The subtler point is that a wealthier China, India, Brazil and Indonesia will lead to more customers for new innovations, thereby producing greater rewards for successful entrepreneurs, no matter where they live. There are so many improvements in cellphones these days because there are so many cellphone customers in so many countries.
To put it bluntly, if the United States takes one step back and the rest of the world takes two steps forward, even in purely selfish terms we should consider accepting the trade-off, if only for the longer run. Most of us gain from the wealth and creativity of other countries, even if we can’t always feel like the top dog.
Cowen implies that the benefits of innovation get distributed equally among trading partners and that, therefore, it doesn’t matter where innovations occur and that we can be a free rider on the investments of other nations. I’m pretty sure that’s not how those other nations intend to divide up the benefits. If America does not write for its future a script that does not depend for success on mere slogans like “education” and “innovation,” our future will be written for us by the Chinese. Here’s a preview of what that could be like.
Skeptic
The new Google smart phone may have been innovated in Silicon Valley, but it will be entirely manufactured in and shipped from Taiwan, completely eliminating the American distribution/retail system, according to this LAT report:
In an ambitious bid to expand its reach even to consumers on the go, Google Inc. on Tuesday unveiled the widely anticipated Nexus One smart phone as it launched a bold new business model that could shake up the mobile phone industry.
The Internet giant began selling the phone -- manufactured to its specifications by a Taiwanese firm -- directly to consumers through its website rather than through retail outlets and service providers.
Skeptic
This NYT story illustrates another way in which manufacturing is connected to innovation—venture capital. Asian manufacturers are desperate to get in on the ground floor of innovations because stagnation would endanger their core manufacturing business. (Once everybody in the world owns one of your gizmos, your business is finished unless you can replace all the gizmos with the next new thing.) Therefore, they will outbid US venture capitalists for control of Silicon Valley innovators—i.e., they will take bigger risks and accept the potential of lower returns than the VCs.
The investment arms of large Taiwanese and Chinese manufacturers have created an investment network in Silicon Valley operating under the radar that pumps money into a variety of chip, software and services companies to gain the latest technology. As a result, some Asian manufacturers have proved more willing than entrenched Silicon Valley venture capitalists to back some risky endeavors.
“In the past, the manufacturers would sneak around and get inside information on technology by investing in these companies,” said K. Bobby Chao, the managing partner at DFJ DragonFund China, a business that invests in technology companies in China and the United States. “Now, they’re more involved, more visible and charging after more complex maneuvers.”
. . . .
Asian investments in Silicon Valley present some risks for America’s top technology companies, which could lose their connection to top innovations.
Asian manufacturers like Foxconn or Quanta, as a result, could wrestle away the edge in research and design.
“The manufacturers have gotten more competitive as it relates to innovation, and in some instances they’re already competing directly with their customers,” said Patrick Moorhead, a vice president at Advance Micro Devices, a major PC chip maker.
. . . .
Some former manufacturers have already made the transition and are gaining global brand recognition. Acer and Asustek are Taiwan’s most prominent computer brands, but both companies were contract fabricators for major American companies. Some of their executives steeped in this manufacturing tradition now run the investment arms of the companies.
. . . .
The Asian companies often back projects that Silicon Valley’s financial heavyweights pass on because pay offs are too low and take too long. The Asian companies are “thinking that they didn’t get their fair share of the technology pie in the past,” Mr. Chao said. “Now they have money and will take the risks needed to build up new levels of expertise.”
And this statement from the same article presages Asian companies bringing the innovation effort to Asia, either altogether or at an earlier stage in the development process than Americans would hope.
With $115 million at its disposal, Innovation Works, based in Beijing, has pledged to “build dream teams to collect, analyze, prioritize and execute on the most promising ideas” in the Internet and mobile computing markets.
Skeptic
More anecdotes about top Chinese scientists going home and China's determination to outspend the US on innovation, in this NYTimes piece today:
China’s leaders . . . . are [d]etermined to reverse the drain of top talent that accompanied its opening to the outside world over the past three decades, they are using their now ample financial resources — and a dollop of national pride — to entice scientists and scholars home.
The West, and the United States in particular, remain more attractive places for many Chinese scholars to study and do research. But the return of Dr. Shi and some other high-profile scientists is a sign that China is succeeding more quickly than many experts expected at narrowing the gap that separates it from technologically advanced nations.
China’s spending on research and development has steadily increased for a decade and now amounts to 1.5 percent of gross domestic product. The United States devotes 2.7 percent of its G.D.P. to research and development, but China’s share is far higher than that of most other developing countries.
Chinese scientists are also under more pressure to compete with those abroad, and in the past decade they quadrupled the number of scientific papers they published a year. Their 2007 total was second only to that of the United States. About 5,000 Chinese scientists are engaged in the emerging field of nanotechnology alone, according to a recent book, “China’s Emerging Technological Edge,” by Denis Fred Simon and Cong Cao, two United States-based experts on China.
A 2008 study by the Georgia Institute of Technology concluded that within the next decade or two, China would pass the United States in its ability to transform its research and development into products and services that can be marketed to the world.
“As China becomes more proficient at innovation processes linking its burgeoning R.&D. to commercial enterprises, watch out,” the study concluded.
Skeptic
Here's another example of almost all of the job-creation benefits of US innovation being realized in China. ESolar, a part of well-known technology incubator IdeaLab, is transferring its solar thermal power generation technology to China where all of the manufacturing will be done.
ESolar already manufactures its heliostat arrays in China, and under the terms of the agreement with Penglai it will also build its power plant receivers there. Gross said that ESolar would retain control of the intellectual property behind the technology's design and operation.
Nathaniel Bullard, a solar energy analyst with consulting firm Bloomberg New Energy Finance, said the ESolar deal indicated China was moving aggressively to pinpoint technologies around the world that could help it meet its ambitious renewable energy goals.
"If you're identified by China as a leading technology developer, the technology will be imported with the implication that your technology will over time become local," he said. "You effectively have one stakeholder, the government, which makes development much easier."
Emphasis added. No doubt ESolar will receive a royalty for the use of its technology, probably in the neighborhood of 5%. That means for every $100 of economic activity generated in the manufacture, $95 will enter the Chinese economy through payments to its suppliers, workers, taxes, and payouts to capital, and $5 will enter the US economy through payments to ESolar. As far as I know, other than investment tax credits, there was no US public money invested in ESolar, nor should there be public money invested in similar technology development ventures (or even tax benefits) when the benefits fall so disproportionately abroad.
Skeptic
Here’s an example of how many jobs can be created by successful innovation compared to the small number of jobs involved in the actual innovation:
The Obama administration will announce on Monday funding for nine projects designed to significantly increase fuel efficiency in heavy trucks and passenger vehicles, with more than half the money coming from the $787 billion stimulus package.
. . . .
According to the administration, the nine recipients are expected to create more than 500 research, engineering and management jobs, with 6,000 more positions anticipated when the technologies go into production and assembly.
This investment by USG could be a good deal for America if those 6,000 production jobs were going to be long-term jobs for Americans, but if those 92% of the total jobs created are going to be in China, “American” companies should apply to the Chinese government for the R&D funding.
Skeptic
Here's another example, reported by Tom Friedman, of how innovation centers get collocated with manufacturing. Applied Materials in Silicon Valley makes the machines that make computer chips and photovoltaic solar panels. It has equipped 14 PV plants around the world, generating $1.3 billion in the last year. How many of those PV plants are in the US? None. Five are in Germany (a high wage nation), four are in China, one is in Spain, one is in India, one is in Italy, one is in Taiwan, and one in Abu Dhabi.
Joe Romm, whose post today brought this to my attention, and Friedman also make another good point, that a big reason why PV plants are being built where they are is that national governments have arranged in various ways to make sure there are big and growing domestic markets for PV power generation. (I wonder to what extent those "arrangements" favor domestic manufacture.) China has recently made a big and credible commitment to green power. The US has not. Friedman:
In October [2009], Applied will be opening the world’s largest solar research center — in Xian, China. Gotta go where the customers are.
If America wants to keep the high-paying innovation jobs, it also needs to keep the manufacturing jobs to which they are related, and there also need to be big domestic markets for the manufactured goods. The industrial force can't function with all the generals and colonels here and all of the privates and sergeants an ocean away.
Skeptic
A recent report by Silicon Valley researchers, reported here in NYT, looks beyond the deep recession and high unemployment rates there and sees this (emphasis added):
Even when the trauma of the financial crisis subsides, Silicon Valley will still be at risk because of deeper, long-term challenges, the report said.
Sixty percent of the region’s scientists and engineers are foreign-born, but foreign immigration to the region dropped 34 percent over the last year. The home countries of foreigners are increasingly luring them back, while the United States government’s policies have made it harder for them to stay, the report said.
To combat the brain drain, California must do a better job educating local students, said Stephen Levy, director and senior economist of the Center for Continuing Study of the California Economy, who also serves as an adviser to the annual study. “We’re not going to be able to live on global talent forever,” Mr. Levy said.
However, 5 percent fewer high school graduates are meeting requirements for entrance to state universities, the number of science and engineering degrees has leveled off and state general fund spending on higher education dropped 17 percent last year, according to the report.
Skeptic
Harvard Business School Professor Willy Shih has a pending paper titled The US Can't Manufacture the Kindle, and That's a Problem. Although key parts of the device, including the "ink" were innovated by US companies they outsourced the bulk of the manufacturing value added to Asia. According to Shih, further innovation in these components is now likely to occur where the manufacturing is done. It gets worse. The Cambridge, MA "ink" innovator, E Ink, is trying to sell itself to its Asian manufacturer, which seems to be making more profit on the screen than E Ink is. Mark Muro reported this here in The New Republic. Thanks to Christine for the link.
Skeptic
Boeing's most advanced wing technology--composite constructions--developed in part with US government financing is being offshored to reduce manufacturing costs, according to Charles A. Hamilton in the Seattle Times:
The global alignment of economic power and technology leadership is changing. Boeing has given composite wing technology to its Japanese business partners and outsourced much of its manufacturing to others in the interest of "shareholder value" and the harvesting of its product line. One wonders, in the end, whether Boeing may have set the stage for the destruction of its strategic value to the United States.
Skeptic
Bye, bye, Mark Pinto. The chief technology officer of Applied Materials and the firm's technology center have both moved from Silicon Valley to China.
In addition to moving Mr. Pinto and his family to Beijing in January, Applied Materials, whose headquarters are in Santa Clara, Calif., has just built its newest and largest research labs here. Last week, it even held its annual shareholders’ meeting in Xi’an.
Skeptic
Chinese wind turbine companies are squeezing out Western companies like GE and Vestas, who have superior technology, with buy local policies. Although Western companies are getting royalities on the older technology they have licensed to Chinese companies, a royalty is smaller than a manufacturing profit, and it creates no US jobs. From this Bloomberg report:
Chinese companies have kept costs down by licensing older technology from overseas rivals, including Vestas, Japan’s Mitsubishi and others that sell their own turbines in China.
While the Chinese pay royalties to the foreign firms, those payments don’t come close to making up for the business the foreign companies are losing in China, according to Emerging Energy Research’s Hays.
China’s so-called “buy local” policy steers most state- financed energy contracts to domestic players, said Magued Eldaief, a GE Energy executive who formerly oversaw the Fairfield, Connecticut, company’s Asia Pacific unit.
“There’s no question preference is given to Chinese companies,” Eldaief said. “It’s a reality you have to live with.”
Skeptic
The US is continuing to shift to Asia better and better high tech jobs, according to this NYT report:
[C]omputer scientists, systems analysts and computer programmers all had unemployment rates of around 6 percent in the second quarter of this year, [which is] significantly higher than the unemployment rates in other white-collar professions.
If and when there is a cyclical uptick in US high tech employment, it will probably continue to be overwhelmed by the structural downward trend for this work to be done offshore.
The disappointing hiring trend raises questions about whether the tech industry can help power a recovery and sustain American job growth in the next decade and beyond. Its tentativeness has prompted economists to ask “If high tech isn’t hiring, who will?”
“We are talking about people with very particular, advanced skills out there who are at this point just not needed anymore,” says Bart van Ark, chief economist at the Conference Board, a business and economic research organization. “Even in this sector, there is tremendous insecurity.”
Skeptic
When Immelt said innovation and manufacturing must be co-located it was no slip of the tongue or off-hand remark. He hammers this theme every chance he gets, in this December 2010 CNBC clip, for example.
Skeptic
The domestic printed circuit board industry has departed for Asia, leaving only enough at home to supply the US military. But that can last only as long as the US military doesn't need the latest technology because PCB innovation has moved where the manufacturing is. An interview with Doug Bartlett on his decision to liquidate the oldest PCB manufacturing operation in America is here.
Skeptic
Chinese venture capitalists are becoming big players in high tech and clean tech, and their funding is easier to get than in the US. Climate Progress has the story here. This is a further indication that the notion that America can let go of manufacturing but keep innovation isn't working and can't work.
Skeptic
Dave Johnson's lede today in National Science Board Report: US Losing R&D Jobs To Asia:
The United States is losing ever more jobs and becoming ever less competitive as our universities are cut back and companies move R&D jobs to Asia. We lost 687,000 high-tech manufacturing jobs lost since 2000. Universities cut back 20% on public research. 85% of growth in R&D employment by American companies occurred abroad.
Skeptic
Apple is moving more R&D to China for just the reasons explained above. From the Los Angeles Times:
Apple Inc. plans to open its second research and development center in China, a move that could help bolster the tech giant’s presence in a lucrative market.
The Cupertino, Calif., company said Wednesday it would open a facility next year in the manufacturing hub of Shenzhen.
In a statement, Apple said the center would allow the company’s engineering team to “work even more closely and collaboratively” with its manufacturing partners.
“The Shenzhen center, along with the Beijing center, is also aimed at strengthening relationships with local partners and universities as we work to support talent development across the country,” Apple said.
Reader Comments (4)
Interesting points, however if the US really wants to stimulate innovation it needs policies that encourage innovation. Unfortunately, since 2000 we have passed a number of laws and regulations that are killing innovation in the US. The incredible innovation of the 90s was based on technology start-up companies built on intellectual capital, financial capital, and human capital. All three of the pillars have been under attack since 2000. Our patent laws have been weakened reducing the value of intellectual capital. Sarbanes Oxley has made it impossible to go public reducing financial capital for start-ups and the FASB rules on stock options have made it harder to attract human capital to start-ups. The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovation http://www.amazon.com/Decline-Fall-American-Entrepreneur-Regulations/dp/1439261369/ref=sr_1_1?ie=UTF8&s=books&qid=1262124667&sr=8-1, explains these problems in more detail.
My friend Charlie sent the following comment by email:
I find the GE clean coal program an example of globalization at its best, including the potential benefits for American workers. It’s pretty typical of the advantages of technical globalization which brings together wide-spread expertise into a single product. Yes, the research center is in China but that's substantially because GE sees this as the largest and earliest market for its clean coal technology and is doing it there in part for political reasons; and because it already has a big China presence through roughly 25 commercial installations of its gasifier technology (Ex Texaco), mostly used on pet coke at refineries. My understanding is that the China center is mainly to integrate technology development being done elsewhere, primarily for purposes of the Chinese market. Note that GE recently entered a similar agreement with the University of Wyoming for joint clean coal R,D and D, including a US commercial demonstration.
GE’s clean coal R&D, and the eventual manufacture, is/will be substantially US-based:
*The main reason GE is in clean coal is to sell its turbines. (The main components of its IGCC clean coal setup are the gasifier, essentially a pressure vessel, and a combined generation cycle with both gas and steam turbines.) The turbines, by far the largest value added and labor intensive component, as with all GE turbines will be manufactured in the US.
*Much of the R&D is being done in the US. Gasifier work, including the ex-Stamet feeder technology acquired by GE two years ago, is mostly in Irvine, CA. Additional work, including control systems is in Schenectady and North Carolina. Turbines are in South Carolina Some R&D is being done in GE’s India center.
*Emission control work, including carbon capture and sequestration, I understand is also being done mostly in the US
*All of this is managed by GE’s clean coal group in Houston, which now employs several hundred people.
No doubt some of the manufacturing will be done in China or elsewhere in Asia, but this will be mostly the grunt stuff with low IP and value content, like the pressure vessels. My guess is that other components which have high value and substantial IP (like the Stamet feeder), yet can easily be knocked-off, will be made in the US or else in a way where final assembly can be tightly controlled.
GE is looking to hire more US engineers for this and other energy programs. Unfortunately, we’re not producing the talent.
Charlie seems to agree with my main point that the national strategy espoused by many of basing the US economy on a supposed “comparative advantage” of innovation is just plain unworkable under any suite of US policies remotely like the current ones.
I agree with him that there are many reasons other than collocation with manufacturing why this is so: Put innovation activity in the earliest and largest markets to learn from and influence the customers, yield to the strategic demands of governmental customers, accept local subsidies, tap local talent pools, reduce the cost of innovators, operate in a more relaxed regulatory environment, etc. Whereas my original post implied that revivifying manufacturing in America would enable us to reestablish dominance in innovation, it isn’t nearly that easy. The US government would have to become as strategic and tough as China and other mercantilist regimes, and even then innovation could not be contained.
On the other hand, Charlie seems to agree with Tyler Cowen, with whom I heartily disagreed above, that where innovation occurs doesn’t matter. Whether the “potential benefits for American workers” mentioned by Charlie are realized will depend in large part on the outcome of negotiations between GE and organs of the Peoples Republic of China. If history is any guide, GE will reluctantly agree to do more manufacturing in China than it would like for these “political” reasons, and the US government will not intervene on behalf of American suppliers and workers or to ameliorate the trade deficit. Ultimately, GE will be willing to manufacture turbines in China, just as Boeing reluctantly agreed to manufacture significant portions of its 737s and 787s there.
As these trends continue, America will continue to have high unemployment and declining real wages—and no apology from GE, whose CEO Jeff Immelt says this about US labor costs:
Also, our crippling trade deficits will continue. Every year but one since 1981, the US has run a current account deficit up to 6% of GDP and averaging 3%. Link. This is a transfer of American wealth, economic power, global leadership, and talent to foreign powers, especially China. What GE and the other multinationals are doing with the assistance of the US government is the cause of these problems—not the solution.
Western companies in China are figuring out that they've been suckered.
They are being bled dry and robbed blind by predator Chinese 'partners' mandated by the govt.
Serves them right!