December 17, 2012
Have you heard of the newest trend sweeping through corporate America? After nearly three decades of worshipping at the altar of “outsourcing” – moving production out of the United States attracted by lower wages and lower taxes in the foreign companies – American managers are now switching to “insourcing”.
A few years ago, I worked with Jack Welch, the legendary CEO of GE, then America’s largest corporation. Jack was at the vanguard of the outsourcing movement. Together with the mantra: “shareholder value”, it dominated boardroom thinking in manufacturing America. This March, Welch’s successor Jeff Immelt, writing in the bible of corporate America The Harvard Business Review stated: “outsourcing is quickly becoming outdated as a business model for GE Appliances”.
There is a fascinating article on this global trend in this month’s Atlantic magazine featuring China-based, Irish entrepreneur Liam Casey; but the bones of the argument are pretty straightforward and the implication for also Ireland quite clear.
Increasingly, outsourcing is costing American corporations because the initial massive cost savings in hourly wages is now not so appealing and the losses in terms of production productivity and the expense of setting up operations in foreign countries are beginning to make huge manufacturers like GE bring their production back home.
The big changes in the global economy of the past five years are changing the long-term view of outsourcing’s efficiency. We have seen a huge increase in the price of oil, obviously making the cost of shipping goods halfway around the world very expensive. Second, the collapse in the price of gas – due to the discoveries of the shale gas potential of the US – makes energy-intensive production in the States much cheaper. Natural gas is now four times cheaper in the USA than Asia.
Third, Chinese wages are rising rapidly as their economy booms and labour shortages emerge. Their wages are now five times the 2002 level and for the past two years alone have been increasing at close to 20% per annum. In the US, the fall in manufacturing jobs over the past few years has caused trade unions to change work practices so thoroughly that those movements, once seen by management as an impediment to investment, are now seen as willing allies.
Finally, as labour productivity in the US has improved – due to a combination of more intensive technology and cheaper and more efficient energy practices – the overall cost of making things in the US has fallen, while the amount of stuff the average American worker makes per hour is now on the rise.
This final point means that advantages such as low wages or their fiscal equivalent low taxes aren’t as attractive anymore.
Also, many American corporations have had the gradual realization that when you take the production part of your operation and put it in a foreign country, other skills leave too. Lots of industrial innovation stems from people being together, collaborating and talking to each other about how to best change this or that method. When you separate workers from other parts of the business, this communication stops and the ‘learning by doing’ aspect of innovation tends to stop with it.
This debasement of the manual part of production is the type of thing that MBA business books are full of, as though producing the actual stuff can be divorced from the marketing and selling of it without any repercussions.
Manufacturing by textbook is a bit like reading a good sex guidebook; studying it and learning all the different positions, but without actually having sex. And we all know that’s not the way forward!
Speaking of glorious human urges and human nature, the central human weakness for going with the herd – or as it has become known in Ireland – “group-think”, comes into play too. Managers tend to behave in the same way as Irish house buyers did in the boom. The “if everyone else is doing it, it must be right” approach to management tended to see them all looking to outsource first and think later.
The effects of this constant outsourcing on the American industrial working class have been traumatic. This was particularly evident in the period 2000-2010, coincident with the rush to China.
Now, however, if the huge in-sourcing drive we are seeing in the likes of GE (which has just invested close to $1 billion in developing an old relic of the 1970s called Applications Park), we will see a change to all that.
It is still very early days but trends are beginning to become evident. The notion that the US will export jobs, in the process hollowing out its industrial working class indefinitely, simply makes no sense. All the huge changes in the energy and labour costs at home and abroad, making America much less expensive than it previously was vis Ã¡ vis foreign countries, changes the game. The fact that the CEO of its biggest industrial conglomerate is talking about bringing the jobs back home suggests the mantra of Apple, “designed in California” but made elsewhere might not be the slogan of the future.
What are the implications of this shift for us? Well, taken together with the backlash against tax avoidance from the likes of Starbucks in the UK last week, it suggests that we have to be vigilant. In the era of outsourcing we cut taxes, allowing us to garner good pay rates and conditions in the multinational sector. This was paid for by higher indirect (and direct other) taxes, but the local low-tax strategy played directly into the global outsourcing narrative.
If the global narrative is going to change, what should we do?
It means we probably have a few years to change, not much more. We should run tests about how the overall profitability of US multinationals would be at 20% or 30% tax rates if that were to be imposed by the EU. We could also use the next few years to try to create stronger links between the multinationals and suppliers at home, which might make the insourcing decision more difficult. We could also try to divert — through incentives — as much of the multinational budgets now as possible to local R&D and other activities which might make the multinationals think twice about leaving.
This all takes a bit of vision in government to see what is coming around the corner and a whole-hearted from Irish entrepreneurs to act swiftly. That’s not beyond the realms of possibility, is it?
David Mc Williams new book The Good Room is out now.