Why does Andy Grove want a trade war with China?

In How to Make an American Job Before It's Too Late, Andy Grove explains that America cannot be an innovation powerhouse if it does not do manufacturing at home and says US policies need to change. Grove was Intel's chief executive officer or chairman from 1987 until 2005 and is now a senior advisor.

He starts by pointing out that "the great Silicon Valley innovation machine hasn't been creating many jobs of late -- unless you are counting Asia, where American technology companies have been adding jobs like mad for years." He says it matters critically where the hard and expensive work of scaling up an innovation to commercial size is done.

The underlying problem isn't simply lower Asian costs [for manufacturing and engineering]. It's our own misplaced faith in the power of startups to create U.S. jobs.

. . . .

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. And as long as that's the case, plowing capital into young companies that build their factories elsewhere will continue to yield a bad return in terms of American jobs.

American tech companies have largely completed the transition to doing the scaling and manufacturing work in Asia, with the result that there are roughly 10 Asian jobs for every American job created for each new product.

Until a recent spate of suicides at Foxconn's giant factory complex in Shenzhen, China, few Americans had heard of the company. But most know the products it makes: computers for Dell and HP, Nokia Oyj cell phones, Microsoft Xbox 360 consoles, Intel motherboards, and countless other familiar gadgets. 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, and other U.S. tech companies.

Since the early days of Silicon Valley, the money invested in companies has increased dramatically, only to produce fewer jobs. Simply put, the U.S. has become wildly inefficient at creating American tech jobs. . . .

Already the decline has been marked. It may be measured by way of a simple calculation: an estimate of the employment cost-effectiveness of a company. First, take the initial investment plus the investment during a company's IPO. Then divide that by the number of employees working in that company 10 years later. For Intel, this worked out to be about $650 per job -- $3,600 adjusted for inflation. National Semiconductor Corp., another chip company, was even more efficient at $2,000 per job.

Making the same calculations for a number of Silicon Valley companies shows that the cost of creating U.S. jobs grew from a few thousand dollars per position in the early years to $100,000 today. The obvious reason: Companies simply hire fewer employees as more work is done by outside contractors, usually in Asia.

Grove calls it a "tragic mistake" to think we can have "highly paid people doing high-value-added work -- and masses of unemployed." Then he explains why that isn't even possible—without manufacturing, we will lose our edge in innovation and the high-value jobs too, an extremely important point others have made and I have reported here and here.

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 didn't participate in the first phase and consequently weren't in the running for all that followed. I doubt they will ever catch up.

. . . .

Not only did we lose an untold number of jobs, we broke the chain of experience that is so important in technological evolution. As happened with batteries, abandoning today's "commodity" manufacturing can lock you out of tomorrow's emerging industry.

Why are we doing this? Because for operating companies and financiers short-term profitability of individual companies trumps every other consideration.

However, our pursuit of our individual businesses, which often involves transferring manufacturing and a great deal of engineering out of the country, has hindered our ability to bring innovations to scale at home. Without scaling, we don't just lose jobs -- we lose our hold on new technologies. Losing the ability to scale will ultimately damage our capacity to innovate.

. . . .

We got to our current state as a consequence of many of us taking actions focused on our own companies' next milestones. An example: Five years ago, a friend joined a large VC firm as a partner. His responsibility was to make sure that all the startups they funded had a "China strategy," meaning a plan to move what jobs they could to China. . . . [Instead,] VCs should have a partner in charge of every startup's "U.S. strategy."

To counteract these market-driven impulses, American needs a different industrial policy, says Grove.

[J]ob creation must be the No. 1 objective of state economic policy. The government plays a strategic role in setting the priorities and arraying the forces and organization necessary to achieve this goal.

. . . .

Long term, we need a job-centric economic theory -- and job-centric political leadership -- to guide our plans and actions.

. . . .

The first task is to rebuild our industrial commons. We should develop a system of financial incentives: Levy an extra tax on the product of offshored labor. (If the result is a trade war, treat it like other wars -- fight to win.) Keep that money separate. Deposit it in the coffers of what we might call the Scaling Bank of the U.S. and make these sums available to companies that will scale their American operations. Such a system would be a daily reminder that while pursuing our company goals, all of us in business have a responsibility to maintain the industrial base on which we depend and the society whose adaptability -- and stability -- we may have taken for granted.

Hat tip to Yves Smith.

Update on Monday, July 5, 2010 at 10:28PM by Skeptic

Economist Tim Duy considers Grove's piece, presents other data about the decline of US manufacturing, and says he's become a heretic:

Bottom Line:  Something more than cyclical forces is weighing on the American jobs machine.  Here I have tried to extend the Grove/Smith/Sethi discourse with additional focus on absolute declines in manufacturing jobs and distressing declines in capacity growth rates.  These trends may be critically important in understanding the dismal performance of US labor markets. If they are in fact critical, they raise serious questions about US trade policy - questions that few in Washington want to address.  Given the extent to which manufacturing capacity has already been offshored, those questions go far beyond the recently announced tiny shift in Chinese currency policy.  Simply put, accepting the importance of manufacturing capacity and the possibility that offshoring has had a much more deleterious impact on the US economy than commonly accepted would requrie a significant paradigm shift in the thinking of US policymakers. If you scream "protectionist fool" in response, then you need to have a viable policy alternative that goes beyond the empty rhetoric of "we need to teach better creative thinking skills in schools."  That answer is simply too little too late. 

Welcome aboard, fellow heretic.

Update on Tuesday, July 6, 2010 at 07:09AM by Skeptic

The Grove piece has provoked many good comments elsewhere, including this one by Arne on Economist's View explaining how this looks at ground level:

Ten years ago I was a manufacturing engineer. I designed machines and processes that were used to make stuff for consumers. During the 90's our customers became the whole world and we went from one manufacturing plant in the US to 4 plants worldwide. We transferred our manufacturing technology to those other three countries because that maximized profits.

There was a bubble and so when it popped, we ended up with excess capacity. Which of the four manufacturing sites do you think closed first?

We kept the design in the US, but now that the parts are not made in the US, we are also losing our competetive advantage in designing the machines and processes, too. I am no longer a manufacturing engineer. Soon there will not be Research and Development engineers either.

Globalization is going to cause technology transfer. Technology is always going to leak out without the receivers paying for it. But the dot-com boom/bust created a flood that has had long-lasting consequences.

Update on Tuesday, July 13, 2010 at 02:47PM by Skeptic

Grove's piece as it appeared in the print edition of Business Week with some graphics is here.

Update on Wednesday, September 1, 2010 at 09:00AM by Skeptic

It looks like this HP deal with Hynix will result in the scale-up work on the next big new computer technology, memristors, being done in South Korea.

Update on Sunday, May 29, 2011 at 01:26PM by Skeptic

McKinsey Global Institute says America is not just losing its technological edge, as Andy Grove says, but also our economic leadership in innovation. The MGI report assesses the problem and proposes a responsive public policy agenda.