Trouble Down Below

As a junior naval officer in the US Navy Reserve, I was stationed on a destroyer during the Korean War.  I came back home with a number of memories of my tour of duty, but none more vivid than an experience in the port of Oran, Algeria.  We were nested alongside a dock with two other destroyers when a mistral struck unexpectedly sending cascades of water over the breakwater along with powerful gusts of wind and rain hitting the side of the ships.  Rocking violently, the three destroyers banged into one another-the anchor flukes on one ship tearing into the side of its neighbor, gun mounts above deck crashing into one another, and the bumpers strung between the ships smashed beyond recognition.  Rising above the roar of the storm, the clanging of metal against metal was deafening.

The pandemonium at our dock was obviously being repeated elsewhere in the port where the rest of the fleet had tied up, for, within a few minutes, orders came down from the fleet commander to cast off and sail out into the safety of the open sea.  Our ship could obey the first part of the order readily enough.  Indeed we had no choice.  As the middle ship in the nest, we had to move to let the innermost ship out.  So the moment the outermost ship slipped away, we  released our lines and unsnapped our connections with dock’s electrical supply.  That done, we slowly drifted away from the dock and what had been our two neighbors.

Following the second half of the commander’s order was another story.  We could not sail out of the port or anywhere else for that matter.  We had no propulsion.  More specifically, we had no steam to drive the propeller shafts because the generators had been shut down when docked.

The next several minutes were memorable.  Down below the engineers were desperately trying to build up pressure while, on the bridge, I was grimly tracking our route across the chart from bearings shouted at me by sailors taking sights, port and starboard.  Every few moments, Captain Maddox looked over my shoulder and, it was clear, he did not like what he saw.  Neither did I, for that matter.  The wind was pushing us toward shore.

Then, almost miraculously it seemed, the ship shuddered and I heard the irregular stutter of sleepy propellers trying to wake up.  Simultaneously, the track on my chart came to a standstill and the captain turned his none-too-gentle attentions to the quartermaster at the wheel.  Anxious moments later came the thrashing sound of the propellers turning in earnest and we had headway on a course out of the harbor.  A few hours later we were on our way to the shipyard in Piraeus, Greece to repair the damage done to our hull by the storm.

That happened over fifty years ago, but to this day, there have been occasions when the sound of the captain’s thunderous screams down to the engine room for a head of steam echo in my brain.  To be sure, those occasions had been rare until the last year or so when they have resurfaced with some regularity whenever I listen to the nightly news.  More specifically, every time I hear an administration official bemoan the lack of jobs.

The difference between our ship’s successful escape from Oran harbor and today’s unsuccessful plea for higher employment is that Captain Maddox could call upon willing able seamen and trustworthy equipment whereas the administration can call upon neither.  Allow me to elaborate.

UNWILLING SEAMAN

President Obama has surrounded himself with academics, attorneys, and other types removed from the crass world of commerce.  As I understand it, none of the President’s cabinet members or close advisors has had the kind of business background that would have acquainted them with all the difficulties involved in keeping a commercial enterprise afloat.  And certainly nothing in the President’s personal resume suggests any familiarity with the conduct of business other than, perhaps, fundraising.

This abysmal lack of experience, for an administration leading a supposedly capitalistic country, is, I believe, the only way one can account for the decision-making that has come out of the White House during the first two years of the Obama’s term.  It seems to have misled policy makers into accepting the Hollywood image of corporations as indestructible structures of steel and concrete insensible to whatever governmental vicissitudes are thrown their way.
And, as often as not, this misperception has produced a class warfare mentality that causes officials into thinking of businesses as bastions of an enemy whose single-minded pursuit of profits puts it irredeemably at odds with the working men and women they have pledged to defend.  Whatever their motivations, the administration’s actions have, in any case, damaged the economy and increased unemployment.

The key to job creation in the US is a component of the GDP (gross domestic product) economists call “investment in goods bought and sold” or more succinctly as “I.”  However arcane this statistic might sound, its value is essential to the economic health of the country because it reflects the production decisions of employers throughout all sectors: manufacturing, hospitality, construction, technology, whatever.  A rising value of “I” is an indication that business decision makers are optimistic enough to expand their operations including, of course, adding to their workforce.  A falling value of “I” obviously means just the opposite.

The grim fact is that “I” has not only fallen during the recession of the last few years, it has fallen at three times the rate of consumption spending.  Put another way, behind the news reports of such conspicuous signs as the slowdown in retail sales and the slump in housing, is the little-commented-upon, but far more ominous, retreat from investment.  If Betty Smith postpones the purchase of a new dress, her decision colors our perception of the present; if XYZ Corporation postpones the construction of a new plant, its unobserved decision cripples our hopes for a prosperous future.

Based on the above, one would think the administration would be doing everything possible to bolster the weakest area of the economy-that is to say the lagging “I” figures.  Unhappily, it has not.  Instead the government, along with an obliging media, has focused on seeing to it that Betty gets her dress-her husband’s unemployment notwithstanding.  Hundreds of billions have gone into stimulating consumer spending with predictable results-the economy picks up until the money runs out when it again falters.  As several commentators  have observed, the government is pushing against a string.

In accord with its anti-business stance, the administration has not only ignored the investment area, it has perversely done much to impede it.  Consider a partial list of the imponderables this administration has loaded onto the business community:

  •       The fluctuating value of the dollar including the possibility of ruinous inflation
  •       The added burden of healthcare costs and associated record keeping
  •       The uncertainty of future energy costs
  •       The weakened state of contracts and property rights
  •       The exposure to punishing class action and product liability litigation
  •       The favoritism shown to one company over another by the government in the form of tax advantages, etc.
  •       The trade restrictions on sales to foreign countries
  •       The piling on of more and more regulations

The impact of these decisions upon business leaders is what one would expect: according to the Dallas Fed President, Richard W. Fisher, “the politicians and officials who craft and enforce the rules are doing so in a capricious manner that makes long-term planning difficult, if not impossible.  They are increasingly distressed by the lack of consistent direction coming from Washington…so they are calling time-outs and heading for the sidelines while they wait for the referees to settle the rules of the game.”

Or, as Peggy Noonan put it in the Wall Street Journal,  “Government not only can change the national character, it can bizarrely channel national energy…the government increasingly forces  us to become a nation of accountants….you are likely to be overwhelmed by forms, by a blizzard of regulations, rules, new laws.”

In an article in Barron’s, Jim McTague writes “Tom Donohue…the president of the U.S. Chamber of Commerce…has been reciting a litany of complaints from the nation’s CEOs about the current tax and regulatory climate in the U.S.  The bottom line, he claims, is that Democratic policies have set off a paralyzing uncertainty among America’s business leaders that restrains investment  and results in net job losses….Donohue says his CEO’s are unable to plan for the future because they are  unsure how the wave of new rules and regulations will impact their bottom lines…All these guys are saying  to me, ‘Tom, what they are doing is crazy.’ ”

Sometimes letters to the editor from the trenches are the most explicit.  For example, George Koeninger of Kingwood, TX wrote to Business Week, “Think about the cost of OSHA compliance, workers’ compensation, liability insurance, medical insurance, minimum wage, paid vacation, paid holidays, paid maternity leave, payroll taxes, taxes on inventories, and taxes on buildings and land.”

In short, trying to stimulate consumption is akin to treating the symptoms instead of the disease.  Until we restore a healthy investment climate, high unemployment-17% counting the partially employed-is going to stay with us.  Mr. President, that is not doing the working people any favors.

 UNTRUSTWORTHY EQUIPMENT

THE IMPORTANCE OF MANUFACTURING

Our destroyer’s successful escape from Oran’s harbor required not only competent willing hands but reliable engine-room equipment.  By the same token, a strong economy requires both motivated entrepreneurs and a vibrant manufacturing sector.  The reader will not be surprised to learn that here in the U.S., we can no more take for granted the viability of the latter as we could of the former.

Smaller economies might prosper on tourism or the mastery of some craft, but, if we have any hope of offering 308 million Americans a decent living, we have to do more than just fill hotel rooms and produce popular movies.  A comparison of the financial status of Germany and, let us say, Spain makes the point.  Thanks to its manufacturing prowess,  Germany enjoys a positive trade balance and a strong financial position.  Spain, on the other hand, confined the bulk of its investment to condominiums and now faces austerity measures, a crippled credit standing, and street demonstrations.

It’s not hard to understand why manufacturing is so important to the economic health of a large country such as ours.  First, it has a high multiplier effect in areas such as transport, raw materials, supplier networks, and so on.  Second, manufacturing and innovation are closely intertwined.  It takes a strong manufacturing sector to afford the research and development needed to survive in a competitive world.  And, third, the supply of manufactured goods to meet the world’s needs is an important factor in maintaining a positive trade balance in trade.

Obviously, services play an important role in today’s world, but it is hard to imagine that they could entirely replace manufacturing as the core of our economy.  Services require fewer workers, do not have the same multiplier effect, and can be more readily duplicated by foreign competitors.

AMERICAN MANUFACTURING IN DECLINE

Despite the critical importance of manufacturing to our economic well being, we have flagrantly neglected it in favor of stimulating consumerism -a policy that provides some temporary quickening of activity but has no lasting benefit after the money runs out.  The result of this neglect has been, as might be expected, a deterioration in our production capacity.  The data to support this decline is all too easy to find.

Start with this 2007 snapshot of manufacturing as a percentage of GDP.  In China it is 34%; in Germany, 23%, in the United States, 12%.

One might hope that, despite our neglect of manufacturing, we could continue to stumble along as before thanks to our preeminence as the world’s largest manufacturer.  Unfortunately, the hope that we can retain our number one position is not realistic.  Citing a report from the National Association of Manufacturers,  “In 2008 the U.S. still had surpluses in … aerospace, biotechnology, electronics, flexible manufacturing and weapons. In addition, the U.S. had only a small deficit in advanced materials and may see almost balanced trade in that sector in 2009…However, even in the areas where the U.S. has trade surpluses, it has lost world market share since 2000. The U.S. share of semiconductor exports has fallen from 20 percent to 12 percent as it has shifted to a more global business model in that industry.  In machinery and transport equipment, the U.S.’ share has fallen from 16 percent of world exports of those products in 2000 to 10 percent in 2008.”

At the risk of straining the reader’s tolerance for statistics, let me add Business Week’s take on the same overall situation.  Under a headline reading “America’s waning industrial base,” the magazine produced a chart comparing changes in manufacturing capacity for two time periods, 1994-1999 and 2001-2007.  In the first instance, companies boosted manufacturing by a full 44% compared to an overall economic growth of 26%.  Not so in the second instance.  Manufacturing grew a scant 5% while the economy grew by 17%.  To which the NAM report adds this sobering note, “Furthermore, the decline in manufacturing production since the start of the recession in December 2007 wiped out all the gains made during the most recent expansion. The lowest point [was] in June 2009, when manufacturing output was down 16.7 percent from December 2007.”  No doubt there has been some pickup since June of 09, but I doubt that it changes the overall picture.

The export picture tells the same story.  Once the world’s preeminent exporter of manufactured goods, the US has fallen to third place behind Germany and China.  And the decline has been precipitous.  In 2000 the  U.S. share of world manufactured exports was almost 14 percent; by 2008 it had fallen to only 9.2 percent.

For basic industries in the U.S., the situation has been especially bleak.  In 2009 the production of motor vehicles and chemicals shrank 4.4% And 1.7% respectively, the largest such drops since 1949.  Overall, our industrial capacity shrank by 1%, more than in any time in history.  That year, just to cite one example, Dow Chemical closed, or announced plans to close, six plants producing ethylene-related chemicals.  Peter Huntsman, the CEO of a major chemical plant, has recently stated flatly, “The chemical industry is leaving the United States and it won’t be back.”

Huntsman’s pessimism was echoed more broadly by a survey conducted by Deloitte Research and the Manufacturing Institute, in which 60% of North American manufacturing executives believed that U.S. competitiveness will decline further by 2012.

Hopefully the point has been made.  U.S. manufacturing is in trouble.

AMERICAN INNOVATION IS ALSO IN DECLINE

From the intimate relationship between manufacturing and R & D, one would expect the decline in the first would negatively impact the second, and such, unfortunately has been the case.

The NAM report describes our present leadership in innovation as “precarious. The industries that fund the largest amount of U.S. R&D -pharmaceuticals, software publishing, semiconductors, motor vehicles, computer system design, and aerospace -have been severely hurt during the recession. Output in these sectors has been hit hard by the recession.  Even pharmaceuticals, usually a recession-proof industry, saw some declines in its output.

The Information Technology and Innovation Foundation conducted a broad-based survey that raises longer-term concerns about R & D in this country.  It found “the U.S. scored at the bottom of the list when ranking how much the U.S. has done to improve its position in these areas over the last decade; China and Singapore ranked 1st and 2nd. This analysis is not manufacturing specific, but reinforces [the conclusion] that the U.S. cannot take its role as global R&D leader for granted, the rest of the world is constantly gaining ground.”

One unfortunate consequence of our losses in manufacturing and R & D is that the two can create a negative feedback cycle that takes its toll on employment.  For example, even after U.S. private companies and taxpayers spent billions funding the development of high tech devices, those expenditures did not create the thousands of high paying jobs here that might have been expected.  Instead those jobs drifted off to Asia, not so much on account of its lower labor costs, but largely because those countries had made the investment in highly automated production lines that we did not and, overall, provided a friendlier climate to industry.

CHINESE MANUFACTURING IN ASCENDANCY

In addition to the usual competition from the countries of East Asia, Japan, Europe, and Latin America that we have more or less adjusted to, a new threat has arisen from the east that unalterably changes the game.  China has already overtaken Germany and Japan in global manufacturing and seems certain to overtake us in the next few years.  If present trends continue, her output will be double ours in the not too distant future.

Niall Ferguson writes in the November 18, 2010 issue of the Wall Street Journal, “China has been the biggest and fastest of all the industrialization revolutions.  In the space of 26 years, China’s GDP grew by a factor of ten.  It took the U.K. 70 years after 1830 to grow by a factor of four.  According to the International Monetary Fund, China’s share of global GDP (measured in current prices) will pass the 10% mark in 2013.  Goldman Sachs continues to forecast that China will overtake the U.S. in terms of GDP in 2027, just as it recently overtook Japan.”

CHINESE INNOVATION ALSO IN ASCENDANCY

A few years past, the refrain one heard was that China’s thrust was limited to basic industries and assembly.  The high tech stuff would remain comfortably sequestered in Silicon Valley.  The US could afford to lose labor intensive manufacturing to China where low wages gave it a clear advantage.  Meanwhile, we would continue to dominate in technology with its well-paid jobs.  As it turned out, however much this neat division in economic activity may have suited us, it did not suit our competitor.

China has made no secret that it is resolved to overcome the west’s technological advantage and, in time surpass it.  Among the steps China has taken to pursue this ambition, it has stepped up its student enrollment in engineering and science studies; done its best to entice U.S. technologically-trained Chinese students and academics to return home; made English a required subject in its public schools so as to enable it to better take advantage of the Internet, technical papers, training manuals, etc.; and devoted more of GDP to research and development.

Perhaps no Chinese initiative to gain technological supremacy has been as successful as its collaboration with western multinationals.  No two deals were alike, but they have all had this tradeoff in common -to wit, in exchange for the opportunity to capitalize from China’s huge marketplace, the participating corporation divulge its “trade secrets” to its host.  A few  examples should serve to convey something of the scope of these partnerships:

  • Japanese and German manufacturers eagerly cooperated with China in building its original high-speed train lines. If the companies were concerned about sharing their hard-won, advanced technology with their Chinese partners, they could, at least, take consolation in a side agreement in which China promised not to market its newly acquired railroad savvy outside the country. Surprise. Among the bidding countries eager to help the U.S. acquire its own high-speed transit is China -now a formidable worldwide competitor of its erstwhile partners. The rationale it offers, for the circumvention of its pledge, is that it has reengineered its trains so that they no longer rely on foreign input.
  •  General Electric is just one of the corporations helping China move ahead. As part of this effort it has trained some 200 Chinese executives in its famed management techniques. In another endeavor, it is supplying jet engines for new Chinese airliners intended to eventually compete with Boeing and Airbus. All told, its businesses in China generated 6 billion in sales -not an easily overlooked incentive.
  • In a recent announcement of its new research center in China, IBM Director of Research, John E. Kelly III, stated the “establishment of IBM Research in Shanghai reflects both the rich pool of science and engineering talent in China, as well as our continued commitment to expand our collaboration with Chinese enterprises and academic institutions.”
  •  As part of a deal to sell the Chinese four nuclear plants, Westinghouse Electric has turned over 75,000 related technical documents
  •  Microsoft and Motorola have likewise set up research facilities in China and are helping train scientists, engineers, and managers
  •  Denis Fred Simon, a professor of international affairs at Penn State University and an expert on Chinese technology policy, identifies an increase of 1160 R&D centers established by multinationals in China over those that existed in 1999. [An example of this trend is] Intel, which is building a $2.5 billion chip fab in Dalian, China.”
  •  Examples like these could fill a book, but let me conclude with a dispatch from the front line, as it were. A July 9, 2010 article by a Mr. Lechleiter in the Wall Street Journal proposed ways to stimulate innovation in this country. In response, Thomas D. Smith, Ph.D. of Oak Harbor, Washington, wrote a letter to the editor that appeared on the fifteenth of that month. “I am afraid, he [Lechleiter] is way too late. I see scientific journals with not a single contribution from the U.S. All are from China, Taiwan, India, and Japan and, by the way, written in impeccable English. The American education system is a train wreck. As a British scientist immigrant who prospered in this wonderful country in the 20th century, I am sad to say that the 21st century will not be the ‘second American century’ as far as innovation is concerned.”

If these scattered examples have not served to fully convince the reader of China’s determination to become dominant in advanced technology, her officially proclaimed policy should do so.  In 2006, she announced the “National Medium and Long Term Plan for the Development of Science and Technology” which calls for doubling the share of her GDP devoted to research and development.  Along the same lines, Mr. Min Zhu, a special advisor to the IMF in Washington, projects that China’s current share of global high-tech manufacturing will increase from 8% today to over 30% in the coming decade.

OUR LOSS, CHINA’S GAIN

Offshoring, is, of course, one of the major reasons for the decline in U.S. manufacturing.  A Bureau of Labor Statistics study concluded that “almost every computer and mathematical science occupation has some degree of susceptibility to offshoring.”  These factors suggest basic industrial research could follow applied R&D offshore. That is in contrast to a decade ago when relatively lower tech development activities were outsourced. The conduct of drug trials and computer program testing are major development areas  accomplished abroad, largely for cost reasons. The remainder is sensitive to the availability of scientific talent, the shortage of which apparently is a worldwide problem.

Whereas there is not a one-to-one ratio between China’s gain and our loss, her ascension is bound to further weaken our manufacturing sector and, consequently, depress our standard of living.  Industry after industry have already closed their US operations and moved to China taking along with them many of their suppliers and subcontractors.  If there is any question as to the breath of this relocation, an inspection of the goods on sale at any Walmart store should erase all doubts.  Likewise a trip to a Foxconn’s facility in Shenzhen, China should erase all doubts as to the scale of these changes.  The 1.16 square mile industrial complex employs 250,000 workers in the manufacture of computers for Dell, iPads for Apple, and countless other items making it the world’s largest electronic contract manufacturer.

In brief, China’s rise as an industrial juggernaut is transformational.  I’ll give the last word to the economist, Larry Summers, who, in departing from the White House included in his remarks the statement, China is the “central challenge facing the world.”

CONCLUSION

In the opening paragraphs of this piece I analogized our country’s economic position to that of my experience aboard a destroyer in the harbor of Oran, Algeria.  Allow me to return to it briefly.  As I picture it, the President can call down to the engine room for jobs until he is blue in the face, but it is questionable how many down there will spring to their feet shouting “aye, aye, sir.”  Instead, I’m afraid, many more will sink back in their seats muttering “There’s no I, I, sir.”  And those who do rush to the boilers will find many of them gone and the rest too rusted to develop a full head of steam.  I fear it is inevitable then that, condemned by too few hands and too little equipment, our helpless ship of state will be pushed relentlessly toward shore by the cruel winds of international commerce.  The only question that remains is whether it will be shipwrecked on the rocks or foundered on a sandy beach.  Some good seamanship is called for.

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Comments

2 Responses to “Trouble Down Below”
  1. Bing D says:

    What great analogies! “Trouble Down Below” reminded me of some dear uncles (God rest their souls) who were also officers in the service at the time — one of them an artillery man in the Korean War, another in the Philippine Navy — and the fascinating stories they shared with me as a young man. More importantly, your article reflects so well our own experience as a small business weathering this economic storm, and how the administration could really use more business acumen and a seaworthy infrastructure to help the country sail safely into port.

  2. Irene Pence says:

    Hi Dan

    Lots of good research in your article. In Sept., I was in Japan, China, Vietnam and Singapore. Hard working, dedicated people there–it’s scary. No obesity, no tattos, no body piercings, and no graffiti. Vietnam is the only exception–they have the aforementioned, but they don’t have the business success because they have a communist government and are going nowhere. People have very little while govt. officials ride around in Mercedes.

    I think we all would love to see Obama be forced to start a business and make a profit under his rules. He wouldn’t be spending Christmas in Hawaii.

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