Lights Out for China?

Oh, the ad nauseam predictions of China's imminent economic collapse!  Yet the juggernaut keeps rolling.  Soothsayers cite China's high debt burden, wasteful infrastructure spending, and collapsing demographics as portents of the deluge.  While these are severe problems, none has stopped China's march toward manufacturing dominance.

There's unlikely to be a silver bullet that ends China's stellar economic growth and manufacturing muscle.  Instead, a combination of forces will lead to a day of reckoning.  Advances in manufacturing technology, which created the Chinese Miracle, may trigger the end of China's moment in the sun.

Lights-out manufacturing, 3-D printing, A.I., and a myriad of new buzzwords ceaselessly spew from the heads of youthful commentators.  Emerging technologies suggest that all, or nearly all, manufacturing will become completely automated.  In the near future, the factory floor will need lighting only when humans replace or repair the robots or other machines.  Hence the term "lights-out manufacturing."  3-D printing enables the home production of goods, which eliminates the need for stores as well as factories.  A.I., or artificial intelligence, provides the ghost in the machine that keeps everything running like clockwork.  Some suggest that the result is The End of Workers and the dystopian doom this entails.

As with other fanciful visions, the purpose of this nightmare is to illustrate how The New Generation and its problems are completely different from those before and require new and bold solutions.  Never mind that every previous generation had its youthful Jeremiahs, and they grayed in a world less dire than prophesized.  Perhaps this hand-wringing will come to naught as well.  Fortunately, old-fashioned spatial economics can shed light on the winners and losers of this apocalyptic post-factory, post-worker world.

Spatial economics has been around since Johann Heinrich von Thünen's The Isolated State (1826).  Developed to explain the location of economic activity, such as cities and factories, spatial economics is used by a multitude of disciplines, from urban planners determining efficient bus routes to military planners designing supply routes.  Like most specialized fields, spatial economics contains confusing jargon.  However, its basic idea is quite simple: transportation costs matter.

Transportation costs, or shipping costs, are the costs associated with moving raw materials and finished goods.  Minimizing these costs often determines where businesses locate factories, warehouses, and stores.  Other costs matter, such as labor and capital costs, but transportation costs play a critical role.  In spatial economics, assuming that all other costs are equal, the rules of thumb are that (1) a manufacturing plant locates near the raw materials if shipping costs of raw materials are higher than the shipping costs of the finished product and (2) a manufacturing plant locates near the customers of the finished product if shipping costs of raw material are less than the costs to ship the finished product.

Finished lumber provides an example of transportation costs affecting the location of manufacturing under the first rule of thumb.  The costs of shipping logs and finished lumber are nearly the same.  Since cutting logs involves waste, like sawdust, overall transportation costs for finished lumber are lowered by locating sawmills near forests, the location of a sawmill's raw materials, rather than urban areas, the location of most users of lumber.  By locating near forests, sawmills save money by not shipping the portion of raw timber that will eventually become sawdust or other waste.

Restaurants are an example of the second rule of thumb.  If only labor, capital, and raw material costs were considered, most restaurants would locate in agricultural areas; however, they do not.  Transporting freshly prepared meals in a timely manner is prohibitively expensive.  To mitigate the costs of transporting meals, a restaurant's finished product, restaurants generally locate where their expected customers live, work, or shop.  Unlike sawmills, restaurants are typically far away from the location of their raw materials.

As automation continues to lessen labor costs, transportation will become a relatively increasing share of the total costs faced by firms and, as a result, relatively more important in determining the manufacturing location.  In general, manufactured goods have higher transportation costs than raw material because manufactured goods require more care, since they may break during shipping.  This will have a significant effect on the future of manufacturing in the U.S., as well as other countries like China.  As most of a firm's manufacturing becomes increasingly automated or "lights-out," there will be a growing incentive to locate production near the firm's customers to lower costs.  This suggests that firms will move factories from low labor cost countries, like China, to countries that contain their primary customers, such as the U.S., European nations, and Japan.

This incentive exists regardless of a country's trade strategy.  Whatever the Trump administration or China or the E.U. does is largely irrelevant.  The fix is in.

Low labor cost countries, like China, will suffer most from the move to automation and lights-out manufacturing.  As plants automate, they will relocate and take the remaining jobs with them to the U.S., Europe, or Japan.  This loss of manufacturing base will exacerbate many internal political problems faced by most low labor cost countries and could result in political instability and crisis.  The adjustment will be tricky.

Of course, a return of manufacturing to the U.S. will not bring back the jobs that left.  Many of those jobs will be replaced by automation.  Instead, most jobs will be for technicians who maintain the robots and other parts of the automated production system.  Low-skilled labor will typically involve warehouse, janitorial, and shipping work.  Obviously, this will disappoint many and not solve the problems faced by unemployed, non-college-educated workers, who once earned a living on the factory floor.

The point is that increased automation, particularly the move to lights-out manufacturing, will have destabilizing effects worldwide.  This will occur regardless of the wishes of governments.  The chase for the lowest labor cost may be coming to an end and, with it, the Chinese Miracle.  The winners will be semi-skilled and skilled labor in countries with a large base of affluent consumers.  As usual, low-skilled workers in developed and developing countries will be out of luck. 

Will this be lights out for China?  Well, countries generally find a way to muddle through.  However, it will be a continuing and increasing problem for China's policymakers to manage.  The same policymakers already have severe impediments to overcome.  At a minimum, the brave new world of automated manufacturing will take the shine off the Chinese Miracle.

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