Does the U.S. need factories to be an economic power?

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I recently had a fascinating conversation with Hartmut Jenner, CEO of a German firm named Kärcher, which produces very high-quality cleaning equipment. Kärcher is a prime example of those mid-sized, extremely competitive manufacturers that are the backbone of Germany’s export sector, the part of the economy that drives the nation’s growth. Companies like Kärcher have done an excellent job of keeping their edge over rising competitors in low-wage, industrializing countries like China, and have managed to keep a good chunk of their factory production at home in high-cost Germany. Jenner has some strong feelings about the U.S. economy. Companies in America, he believes, have moved so much production offshore to China and other low-cost countries that the U.S. is losing its ability to manufacture. Here’s what he told me:

I have some fear that (Americans) are losing their capability for mechanical manufacturing. I’m very scared. The physical skills are missing to manufacture. This is not a joke. That’s not good for a country. The U.S. needs a mechanical base again.

Passionate stuff. His thoughts echo those of many in the U.S. who worry about the potential damage done to America’s future by the loss of factories to a rising Asia. But is Jenner correct? Are factories a necessary requirement for national prosperity in an advanced economy like the U.S.? Or is that an old-fashioned concept, out of step in this age of global production networks, instant communications and competition from emerging economies? I’m going to offer up a counterpoint: A nation today doesn’t need to have its own factories to be an economic power, even a manufacturing power. Here’s what I mean:

The notion that the outsourcing and offshoring of American manufacturing would come to destroy the U.S. economy is not a new concern. Akio Morita, the co-founder of Sony, made this same point back in the 1980s, when the U.S. was scuffling with a rising Japan. Americans, he warned, “make money by ‘handling’ money and shuffling it around instead of creating and producing goods with some actual value.” That problem may seem more true today than ever, as the meltdown on Wall Street raised serious questions about the viability of growth based on services, and especially financial innovation. (The collapse of Ireland offers even more evidence.) Perhaps Jenner and Morita are right. Americans have to get back on the assembly line, manufacturing cars and electronics and airplanes rather than financial instruments if the economy is going to thrive in the future.

Or perhaps not. The alternative argument is that the real value in manufacturing may not be in the production process anymore. Let’s look at Apple, for instance. Here’s a firm that is essentially a computer and consumer electronics maker – that doesn’t make very many of its own products. Apple owns one factory (in, of all places, Ireland), but outsources “substantially all” its manufacturing to other companies, as an Apple spokesperson wrote me. And what impact has that had on Apple? Not much, it seems. Apple is one of the most influential companies in the world, with a stock price that is currently around an all-time high. That’s because the real value in Apple’s products can be found in the design, technology and branding, not in the process of physically screwing them together in a factory.

That becomes even clearer when we look at the companies that actually make Apple products. Take, for example, Hon Hai Precision Industry, a Taiwan-based giant that manufactures computers, mobile phones and other gadgets for a who’s-who of international brands. Hon Hai runs a perfectly profitable, successful business, but it isn’t benefiting quite as much from making the iPad as Apple has from designing and marketing it. Hon Hai’s stock is well off its 52-week high, and its chairman recently said he had sliced the firm’s annual revenue growth target to 15% from 30%.

The problem with being a firm like Hon Hai – which focuses more on the manufacturing process rather than the branding and innovative aspects of the business of making products – is that it lacks pricing power. The no-name manufacturers of Asia are constantly seeing their profits squeezed by their customers, who can outsource production to any number of eager factory owners. A company like Hon Hai likely has more leverage than many others, since it is so exceptional at what it does. But companies that primarily manufacture are always more vulnerable than those which control the brands, technology and designs.

That’s why manufacturing companies across Asia are trying to follow the Apples, Sonys and H-Ps of the world, to expand out of making stuff into the more profitable realms of branding and design. South Korean electronics companies Samsung and LG have greatly enhanced their influence in the world economy since they developed powerful and well-known brands, and the well-designed products to match. Taiwan PC maker Acer used to manufacture computers for itself and other firms, but not anymore. Now Acer focuses on PC design and marketing. The company spun off its manufacturing over the years and now outsources 100% of its production. But that hasn’t hurt its fortunes. Acer has gorged on market share in recent years, racing up to become the No.2 brand in the world, even though it doesn’t produce one of its own computers.

From this perspective, the real value of manufacturing in today’s economy can’t be found on the assembly lines. Manufacturing has become somewhat of a commodity – lots of factories around the world can make a perfectly good mobile phone or PC. But not everyone can design an iPad or develop the applications for it. That innovative process at the heart of manufacturing hasn’t been commoditized, and can’t be. That’s where a high-cost but creative economy like the U.S. can maintain its advantage over the rising manufacturing powers of the emerging world.

That doesn’t mean the U.S. should close all of its factories tomorrow. There is still a ton of room to compete in manufacturing industries that require a great degree of skill and technology. (Germany’s manufacturing sector has excelled in that regard, but that’s the subject of another post.) What I do believe, however, is that the advanced economies place far too much importance on the role of factories in their future competitiveness and growth.

There are some serious implications of this thinking. The loss of manufacturing does mean the loss of certain employment opportunities, especially for semi-skilled workers. It also means that the U.S. has to devote much greater resources to education, to produce the kind of creative, skilled employees who can design the next iPad rather than manufacture one. Perhaps the U.S. would have been better off using the billions to bailout General Motors to bailout the nation’s struggling schools. Or instead of continuing tax breaks for the rich, who can afford to send their kids to elite boarding schools, we should divert more tax dollars to smart but needy children so they can excel and contribute to the national economy. The U.S. has to wake up to the reality that the classic industrial age is coming to an end for Americans, and they have to prepare better for the new age, in which creating stuff means a lot more than building it.

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