China Trade Policy and the Fallacy of 'Idea-Land'

It is becoming painfully obvious that our China trade policy is deindustrializing America.  Even our latest "green technology" firms like Massachusetts' Evergreen Solar have packed up their manufacturing bags and fled to Wuhan in search of huge subsidies, the freedom to pollute, and a union-free work force held down by jackbooted cops.  So how does a "free trade at any cost" pundit slap a happy face on the reality of 10% unemployment?

Well, many a cockeyed optimist has been quick to assert that America will triumph as the "land of ideas!"  In Idea-Land we will design and market fantastic products and not worry about what goes on in Chinese factories.  Fareed Zakaria, the patron saint of globalization, recently posted this on CNN's GPS blog:

In America's case, we have all the ingredients to succeed in the 21st Century. We have the most innovative companies in the world such as Facebook, Apple and Google.

He goes on to conclude that America's problems are consequently the fault of our own dysfunctional domestic political system (no argument), not the fault of unfair Chinese competition.  Mr. Zakaria's three exemplars of American innovation offer the perfect opportunity to analyze Idea-Land.

Facebook is a classic example of China's non-tariff trade barriers at work.  The Social Network is illegal in China, and its website is blocked as part of China's social repression system.  Yet, Beijing actively supports the growth of its Chinese competitor Renren, which just had a successful IPO on the NYSE.  While Facebook's idea has no access to the Chinese market, American capital pours into a firm that stole it!

Apple Computer has become the poster child for China trade.  Research by Greg Linden, Kenneth Kraemer, and Jason Dedrick (from my own institution) suggests that the majority of profits from the iPod and other insanely great Apple stuff accrue in the U.S. because most of the value is generated by Apple's innovation rather than in production.  While confirming that labor rates are not a big part of product cost -- the work could be done by Americans with little impact on the retail price -- it overlooks the effect of currency manipulation, massive subsidies (entire factories provided by the government for free), and the plethora of other Chinese trade cheats that make the both the production inputs and the final product cheaper. 

Additionally, Steve Jobs is smarter than your average CEO; Apple was not forced into a minority partnership like most U.S. firms.  Companies like GM find their profits skimmed, their operational control restricted, and their technology forcibly transferred to a "partner" that often evolves into a brutal competitor.

By using Taiwan-based, mainland-savvy Foxconn group as a contract assembler, Apple keeps its profits and technology.  Tying their operating systems to their hardware avoids Microsoft's fate in China -- most Windows copies there are bootlegs.  Not that fake iPods, iPads, and even entire faux Apple stores can't easily be found.

Finally, my experience with production engineering and a recent visit to Foxconn City -- a complex with 350,000+ workers -- convinces me that Foxconn makes a greater contribution to the design value than is visible from the data.  As a product moves from prototype to production, a lot of re-engineering takes place.  Done well, this results in a feedback process that yields manufacturing efficiency and product enhancements.  Worryingly, this process works best with the design team closer to the production environment.  As America's manufacturing moves to China, much of our corporate R&D is following, and Chinese policy actively encourages that.  Let's hope it we don't find an Apple R&D center in Beijing next to GE's new X-Ray division HQ.

Anyway, Foxconn isn't going to be making cars, airplanes, or nuclear reactors anytime soon.  Apple is a rare exception, not the standard for analysis.  Joint partnership hell and rampant idea theft remain the norm for American firms behind the Great Wall.

Google tried to play China's game but was burned.  Beijing directed it to censor offensive search results like "Chinese democracy."  Though originally compliant, the California firm was continually disadvantaged by induced disruptions to its Chinese network, a blatant public preference for its Chinese competitor, and hassles over its internet "license."  In order to avoid the trap Beijing laid for Yahoo -- demanding dissidents' emails and info -- Google disabled services such as gmail.  Its YouTube service was completely blocked.  China eventually requested that Google also censor "objectionable" Chinese material from its U.S.-based site.  In 2009 Google discovered that Chinese agents had hacked their systems -- along with more than 200 other U.S. firms -- and swiped their cherished source code.  So much for the advantage of ideas.

Remember that these are the experiences of three of the smartest firms in America.  For almost every other company, from Hollywood movie studios and online video game developers to aircraft and auto manufacturing, it has been far worse.  It is simply impossible to base our nation's future on ideas, when ideas are systematically repressed and methodically stolen by a powerful and immoral tyranny masquerading as our trading partner. 

Finally, Idea-Land itself is a "bifurcation trap."  Linden, Kraemer, and Dedrick state:

As long as the U.S. market remains dynamic, with innovative firms and risk-taking entrepreneurs, global innovation should continue to create value for American investors and well paid jobs for knowledge workers.

That's great for the Stanford engineering grads designing the next iPhone and the Wharton MBAs who will market it.  However, the career for the rest of us -- sub-120 IQ America -- will be a pair of 30-hour-a-week (no benefits) retail jobs selling Chinese-made products to the new knowledge-worker nobility. 

Americans need manufacturing because we have varying skillsets, and it offers the highest value-add career for people who are not product-innovators.  And it isn't just assembly jobs; it's the aforementioned production engineers, as well as the safety officers, HR staff, plant services, janitorial crew, and cafeteria cooks.  As we abandon manufacturing, we are being forced to embrace either a highly stratified social order or enact a massive and inefficient wealth redistribution scheme.  Both are already happening as the jobs that our stimulus "created" pay far less than the ones we packed off to China and we extend unemployment to those completely displaced.  In Idea-Land, America's future looks a lot like Latin America's past.

Greg Autry is the co-author of Death by China.  He teaches macroeconomics at the Merage School of Business, UC Irvine.  He writes and speaks on China, space, economics, investing, and business strategy.  For more information, please visit http://www.deathbychina.com and follow the author on Facebook and Twitter.

It is becoming painfully obvious that our China trade policy is deindustrializing America.  Even our latest "green technology" firms like Massachusetts' Evergreen Solar have packed up their manufacturing bags and fled to Wuhan in search of huge subsidies, the freedom to pollute, and a union-free work force held down by jackbooted cops.  So how does a "free trade at any cost" pundit slap a happy face on the reality of 10% unemployment?

Well, many a cockeyed optimist has been quick to assert that America will triumph as the "land of ideas!"  In Idea-Land we will design and market fantastic products and not worry about what goes on in Chinese factories.  Fareed Zakaria, the patron saint of globalization, recently posted this on CNN's GPS blog:

In America's case, we have all the ingredients to succeed in the 21st Century. We have the most innovative companies in the world such as Facebook, Apple and Google.

He goes on to conclude that America's problems are consequently the fault of our own dysfunctional domestic political system (no argument), not the fault of unfair Chinese competition.  Mr. Zakaria's three exemplars of American innovation offer the perfect opportunity to analyze Idea-Land.

Facebook is a classic example of China's non-tariff trade barriers at work.  The Social Network is illegal in China, and its website is blocked as part of China's social repression system.  Yet, Beijing actively supports the growth of its Chinese competitor Renren, which just had a successful IPO on the NYSE.  While Facebook's idea has no access to the Chinese market, American capital pours into a firm that stole it!

Apple Computer has become the poster child for China trade.  Research by Greg Linden, Kenneth Kraemer, and Jason Dedrick (from my own institution) suggests that the majority of profits from the iPod and other insanely great Apple stuff accrue in the U.S. because most of the value is generated by Apple's innovation rather than in production.  While confirming that labor rates are not a big part of product cost -- the work could be done by Americans with little impact on the retail price -- it overlooks the effect of currency manipulation, massive subsidies (entire factories provided by the government for free), and the plethora of other Chinese trade cheats that make the both the production inputs and the final product cheaper. 

Additionally, Steve Jobs is smarter than your average CEO; Apple was not forced into a minority partnership like most U.S. firms.  Companies like GM find their profits skimmed, their operational control restricted, and their technology forcibly transferred to a "partner" that often evolves into a brutal competitor.

By using Taiwan-based, mainland-savvy Foxconn group as a contract assembler, Apple keeps its profits and technology.  Tying their operating systems to their hardware avoids Microsoft's fate in China -- most Windows copies there are bootlegs.  Not that fake iPods, iPads, and even entire faux Apple stores can't easily be found.

Finally, my experience with production engineering and a recent visit to Foxconn City -- a complex with 350,000+ workers -- convinces me that Foxconn makes a greater contribution to the design value than is visible from the data.  As a product moves from prototype to production, a lot of re-engineering takes place.  Done well, this results in a feedback process that yields manufacturing efficiency and product enhancements.  Worryingly, this process works best with the design team closer to the production environment.  As America's manufacturing moves to China, much of our corporate R&D is following, and Chinese policy actively encourages that.  Let's hope it we don't find an Apple R&D center in Beijing next to GE's new X-Ray division HQ.

Anyway, Foxconn isn't going to be making cars, airplanes, or nuclear reactors anytime soon.  Apple is a rare exception, not the standard for analysis.  Joint partnership hell and rampant idea theft remain the norm for American firms behind the Great Wall.

Google tried to play China's game but was burned.  Beijing directed it to censor offensive search results like "Chinese democracy."  Though originally compliant, the California firm was continually disadvantaged by induced disruptions to its Chinese network, a blatant public preference for its Chinese competitor, and hassles over its internet "license."  In order to avoid the trap Beijing laid for Yahoo -- demanding dissidents' emails and info -- Google disabled services such as gmail.  Its YouTube service was completely blocked.  China eventually requested that Google also censor "objectionable" Chinese material from its U.S.-based site.  In 2009 Google discovered that Chinese agents had hacked their systems -- along with more than 200 other U.S. firms -- and swiped their cherished source code.  So much for the advantage of ideas.

Remember that these are the experiences of three of the smartest firms in America.  For almost every other company, from Hollywood movie studios and online video game developers to aircraft and auto manufacturing, it has been far worse.  It is simply impossible to base our nation's future on ideas, when ideas are systematically repressed and methodically stolen by a powerful and immoral tyranny masquerading as our trading partner. 

Finally, Idea-Land itself is a "bifurcation trap."  Linden, Kraemer, and Dedrick state:

As long as the U.S. market remains dynamic, with innovative firms and risk-taking entrepreneurs, global innovation should continue to create value for American investors and well paid jobs for knowledge workers.

That's great for the Stanford engineering grads designing the next iPhone and the Wharton MBAs who will market it.  However, the career for the rest of us -- sub-120 IQ America -- will be a pair of 30-hour-a-week (no benefits) retail jobs selling Chinese-made products to the new knowledge-worker nobility. 

Americans need manufacturing because we have varying skillsets, and it offers the highest value-add career for people who are not product-innovators.  And it isn't just assembly jobs; it's the aforementioned production engineers, as well as the safety officers, HR staff, plant services, janitorial crew, and cafeteria cooks.  As we abandon manufacturing, we are being forced to embrace either a highly stratified social order or enact a massive and inefficient wealth redistribution scheme.  Both are already happening as the jobs that our stimulus "created" pay far less than the ones we packed off to China and we extend unemployment to those completely displaced.  In Idea-Land, America's future looks a lot like Latin America's past.

Greg Autry is the co-author of Death by China.  He teaches macroeconomics at the Merage School of Business, UC Irvine.  He writes and speaks on China, space, economics, investing, and business strategy.  For more information, please visit http://www.deathbychina.com and follow the author on Facebook and Twitter.