Innovation Key to Job Growth in America

After decades of globalization, manufacturing needs to return to U.S. shores
By Emel Akan, The Epoch Times
February 9, 2017 12:03 pm Last Updated: February 10, 2017 5:49 pm

Offshoring production from the United States to factories overseas has arguably done a lot of damage to the U.S. economy. Over the last three decades, the trade deficit ballooned and millions of American manufacturing jobs were lost. And with those jobs, according to analysts, America also lost some of its innovative edge.

Campaigning on a platform that clearly resonated with many voters, President Donald Trump vowed to bring jobs back to America.

Gary Pisano, professor of business administration at Harvard Business School, argues that while Trump is right to focus on jobs and manufacturing, the benefits of repatriating production extend beyond mere job creation.

“I don’t think manufacturing is going to be a job producer. Even if jobs come back to America, there’s tons of automation in manufacturing,” he said.

Willy C. Shih (L), Professor of Management Practice  and Gary P. Pisano, Professor of Business Administration at Harvard Business School in his office at Harvard University in Cambridge, Massachusetts, on Jan. 27, 2017. (Samira Bouaou/Epoch Times)
Willy C. Shih (L), Professor of Management Practice and Gary P. Pisano, Professor of Business Administration at Harvard Business School in his office at Harvard University in Cambridge, Massachusetts, on Jan. 27, 2017. (Samira Bouaou/Epoch Times)
Instead of job creation, we believe that the central objective of a national manufacturing strategy should be keeping America’s innovation capabilities healthy.
— Gary Pisano and Willy Shih, 'Producing Prosperity: Why America Needs a Manufacturing Renaissance'

Pisano and his colleague Willy Shih, professor of management practice at Harvard Business School, authored the book “Producing Prosperity: Why America Needs a Manufacturing Renaissance” in 2012.

Pisano and Shih argue that when a country loses the capability to manufacture, it loses the ability to innovate and compete as well.

“Instead of job creation, we believe that the central objective of a national manufacturing strategy should be keeping America’s innovation capabilities healthy, because innovation drives productivity and productivity drives wages,” the authors state. In other words, innovation boosts profits and thus expands the pie shared by companies and workers.

Short-Term Gain, Long-Term Pain

President Donald Trump (C), CEO of Johnson & Johnson Alex Gorsky (R), and CEO of Corning Wendell P. Weeks (L) at a breakfast meeting with business leaders at the White House on Jan. 23. Established in 1851, Corning continues to invest in innovation and manufacturing in the United States. (AP Photo/Pablo Martinez Monsivais)
President Donald Trump (C), CEO of Johnson & Johnson Alex Gorsky (R), and CEO of Corning Wendell P. Weeks (L) at a breakfast meeting with business leaders at the White House on Jan. 23. Established in 1851, Corning continues to invest in innovation and manufacturing in the United States. (AP Photo/Pablo Martinez Monsivais)

For decades, many large U.S. companies moved their manufacturing operations to low-cost countries, primarily China. Such moves were expected to bring cost benefits and competitive advantage.

But business leaders and politicians are now seeing the long-term consequences of these choices in some industries in which the United States has fallen behind in its ability to compete.

In solar power, for example, a significant amount of the required know-how and production infrastructure migrated to Asia.

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Although solar cells, also called photovoltaic (PV) cells, were first invented in the United States, today only 3 percent of PV production is based in the United States (and Canada); 81 percent is in Asia, with China and Taiwan leading the market, according to the National Renewable Energy Laboratory.

“Once you lose the capabilities, you can bring them back, but the level of investment, activation energy to bring back is higher,” said Pisano in an interview.

The case of solar PV is not an isolated example. Pisano and Shih’s book lists the “endangered species” of American industries, including semiconductors and rechargeable batteries.

With declining industrial innovation, America’s competitive position in the world is weakening. The increasing trade deficit is one of the symptoms.

“The huge trade deficit is the reason the United States went from being the world’s largest creditor nation in the 1970s to the largest debtor nation,” the book states.

Andrew Liveris, chairman and CEO of Dow Chemical Co., is sounding the alarm bells.

“Without a vibrant manufacturing sector, R&D (research & development) will be done not by the United States, but by its major competitors. Over time, that will leave America dependent on intellectual property that’s created by other countries; America’s ability to generate its own growth will atrophy,” Liveris stated in his 2011 book “Make It In America: The Case for Re-Inventing the Economy.”

Trump named Liveris to head the American Manufacturing Council, a private sector group that advises the U.S. secretary of commerce.

Deindustrialization in the United States

The United States was once the world’s leader in manufacturing. After World War II, the country invested in research and development and was significantly ahead of other countries in employing cutting-edge technologies. However, that picture changed in the 1980s.

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It all started with the globalization of supply chains. Companies thought they could move their manufacturing elsewhere and be cost competitive.
— Gary Pisano, professor of business administration, Harvard Business School

“It all started with the globalization of supply chains. Companies thought they could move their manufacturing elsewhere and be cost competitive. They could design here and manufacture there,” said Pisano.

This assumption fails to recognize the strong interaction between designing a product and producing it.

An IBM PC in August 1981. IBM once dominated the PC market but fell behind Compaq and Dell in the 1980s after those firms outsourced production to Taiwan. (AP Photo)
An IBM PC in August 1981. IBM once dominated the PC market but fell behind Compaq and Dell in the 1980s after those firms outsourced production to Taiwan. (AP Photo)

“When I was at IBM in the 1980s and early 1990s, my plant manager prided himself on having the engineering across the street from production. Especially in early product cycles, you do a lot of iteration; you do a lot of going back and forth in the commercialization process,” Shih said in an interview.

Before joining Harvard, Shih spent 28 years in product development and manufacturing at large U.S. corporations including IBM and Eastman Kodak.

“IBM invented the magnetic disk drive, and it was the pioneer in commercializing computers in the 1950s, 1960s, and 1970s. They introduced the IBM PC,” said Shih.

However, in the 1980s, IBM lost control of the PC market because it tried to do everything itself, while competitors like Compaq and Dell chose to outsource to specialist firms, said Shih.

The real revolution happened when Compaq decided to outsource to Taiwan. The company started a price war and became the market leader in PCs by leveraging offshore design and production.

IBM almost fell out of the PC business. After observing the IBM case, some economists started to argue that companies should focus on their core competencies and outsource everything else.

“That argument laid the groundwork for the labor arbitrage and outsourcing overseas,” explained Shih.

The World Is Not Flat

The book “The World Is Flat” (2005) by Thomas Friedman suggests globalization, free trade, technological changes, and the emergence of new markets made the world smaller and flatter.

Pisano and Shih argue that the world is not so flat and that distance still matters in certain industries.

For example, biotechnology and life sciences industries are mainly clustered in Boston, San Francisco, and San Diego. Semiconductor manufacturing is amassed in Taiwan, South Korea, Singapore, Shanghai, and Beijing. And high-end shoe producers are located south of Venice in Italy.

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When I got to Kodak—that was in 1997—the damage had already been done.”
— Willy C. Shih, Professor of Management Practice, Harvard Business School

Why? Because these industries form “industrial commons” that operate within an “ecosystem” and share know-how and capabilities. This know-how is used by the members of the ecosystem, including workers, companies, suppliers, and universities.

The decline of one industry will affect the whole ecosystem and lead to the erosion of the industrial commons in that region. It is very similar to nature:

“If the bee population declines, the flower population is affected. This may lead to less fruit production, which will then negatively affect species that rely on the fruit for food,” state Pisano and Shih in their book.

A roll of Kodak film from 2004. In the photographic film market, Kodak used to have a market share of over 80 percent in the United States and about 50 percent globally. The company ultimately filed for Chapter 11 bankruptcy protection in 2012. (Chris Furlong/Getty Images)
A roll of Kodak film from 2004. In the photographic film market, Kodak used to have a market share of over 80 percent in the United States and about 50 percent globally. The company ultimately filed for Chapter 11 bankruptcy protection in 2012. (Chris Furlong/Getty Images)

One example that confirms the importance of industrial commons is the Kodak case. The once-mighty U.S. company had nearly 50 percent market share in global photographic film. It also produced one of the first consumer digital cameras in 1994.

The company was initially buying components from Japanese suppliers and doing design and final assembly in the United States. Shih, a senior Kodak executive at the time, visited Japan and quickly discovered the problem with this strategy.

“When I got to Kodak—that was in 1997—the damage had already been done. Because of earlier decisions to outsource camera manufacturing and all consumer electronics assembly to Asia, the innovative capability no longer existed in the United States,” he said.

Japanese players like Nikon, Canon, and Olympus were all clustered in Japan. A product designer sitting in Rochester, New York, where there was no camera or consumer electronics industry around him, was at a major disadvantage.

The erosion of industrial commons led Kodak to shut down its highly automated assembly line for cameras in Rochester and relocate its design activities to Japan in 1998. After a long struggle, the company filed for Chapter 11 bankruptcy protection and ceased to produce digital cameras in 2012.

Tackling Chinese Protectionism

Protectionist and trade-distorting policies in China and other Asian nations also weakened the competitiveness of American companies.

There is stiff competition among countries to gain market share in high-wage and high value-added industries.

Ninety percent of the problems in the global trading system stem from China, said Robert Atkinson, president of the Information Technology and Innovation Foundation (ITIF), a U.S. think tank that focuses on innovation.

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China uses many unfair tactics, such as forcing companies that want access to the Chinese market to relocate their production, R&D, and data storage to the mainland, as well as hand over their intellectual property, according to a report by ITIF.

The U.S. government should take a tougher stance on China’s protectionist policies to ensure American companies can compete on a level playing field, Atkinson said.

A previous Epoch Times investigative report revealed how the Chinese regime is stealing intellectual property from American companies and universities, and selling the products made with the stolen innovations back to the United States at largely reduced prices. This practice costs U.S. firms trillions of dollars each year in economic value, according to estimates.

If the new administration is serious about restoring America’s competitiveness, it should impose rigorous measures, such as reducing Chinese access to the U.S. market or preventing China from buying U.S. assets, advises Atkinson.

*Asia Other consists of Malaysia, Philippines, Singapore, South Korea, Taiwan, and Thailand.
*Asia Other consists of Malaysia, Philippines, Singapore, South Korea, Taiwan, and Thailand.

Ironically, Pisano and Shih’s book is more popular in China than in the United States.

“Here’s a book for American companies and the American government to work more strategically about the role of manufacturing because of … the growing strength of China, and it’s a little bit ignored here,” said Pisano. By contrast, “it sells like hotcakes in China.”

Labor costs have been rising in China since 2006. So the cost advantage is going down, and hence the benefits of producing in China are diminishing, according to Shih.

“In fact, what the Chinese are really worried about is now losing that industrial base, that capability to lower-cost countries, like Vietnam, Indonesia, Southeast Asia, and India,” Shih said.

“I think the reason the book is so popular in China is because they understand … the value of having design close to production, and they don’t want to lose that production capability,” he said.

Exceptions

Intel is supporting the rapid development and the growing demands of Internet of Things systems (the internetworking of physical devices, vehicles, and other items). The company controls its manufacturing and has a proprietary process for making its products. (courtesy of Intel)
Intel is supporting the rapid development and the growing demands of Internet of Things systems (the internetworking of physical devices, vehicles, and other items). The company controls its manufacturing and has a proprietary process for making its products. (courtesy of Intel)

America lost its leadership and competitive advantage in many sectors, but there are some instructive exceptions.

Success stories show that a commitment to innovation and manufacturing is more important than cost cutting.

“In the aerospace industry, there are many good examples, like GE Aviation. They’ve kept their design, production, and assembly operations pretty much entirely within the United States,” Shih said.

A Boeing 737 aircraft during the manufacturing process at the Boeing factory in Renton, Wash., on May 19, 2015. The company is America's biggest manufacturing exporter. (SAUL LOEB/AFP/Getty Images)
A Boeing 737 aircraft during the manufacturing process at the Boeing factory in Renton, Wash., on May 19, 2015. The company is America’s biggest manufacturing exporter. (Saul Loeb/AFP/Getty Images)

“And if you look at companies like Boeing or Rockwell Collins, they have done a great job too.”

Corning developed the first glass encasement for Thomas Edison's lightbulb. The company manufactures glass, ceramics, and related materials primarily for industrial and scientific applications. (Courtesy of Corning)
Corning developed the first glass encasement for Thomas Edison’s lightbulb. The company manufactures glass, ceramics, and related materials primarily for industrial and scientific applications. (Courtesy of Corning)

Aside from aerospace and aviation companies, a few U.S. corporations like Intel and high-tech glassmaker Corning also stand out.

Many semiconductor companies no longer manufacture their own chip designs. However, Intel controls its manufacturing and has a proprietary process for making its chips. And that is how Intel maintains its leadership in the global chip market.

Corning sets a good example in valuing manufacturing and innovation. And it maintains market leadership in all its businesses, including Gorilla Glass, a very thin, damage-resistant glass display for mobile devices.

“We have an unwavering commitment to invest approximately 8 percent of our revenue each year into research, development, and engineering, as innovation is at the heart of our company,” Dan Collins, vice president of corporate communications at Corning, wrote via email.

 

Thinking Long-Term

The Tesla Model X is produced at the Tesla factory in Fremont, Calif. For years, Tesla has been working toward having the majority of its car parts made in America, primarily for logistics and access to the workforce. (Courtesy of Tesla)

Almost all advanced economies feel the pressure from emerging countries like China and India. But there are a few developed countries that do relatively better in controlling manufacturing and innovation.

One of them is Denmark. The country has many small firms that are world leaders in very narrow fields.

“The Nova Nordisk factory is a superb factory. It produces half of the world’s supply of insulin,” said Shih.

Denmark also holds a strong global position in food ingredients, such as enzymes, cultures, and proteins, supplying 14 percent of the global market.

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There’s a tradition of maintaining innovation, research, development, and manufacturing in Denmark. … That is why we have a lot of specialized companies that are global.
— Nicolai Broby Eckert, partner, PA Consulting

Most of these companies are public, but the majority of shares are still owned by Danish nonprofit or family foundations. They focus on longevity.

“Foundations have a purpose of reinvesting in Denmark because that’s what the families set out in the rules when they pass on the ownership to the foundations. And I think that’s one of the key reasons that these companies are so successful,” said Nicolai Broby Eckert, a partner at PA Consulting in Denmark.

By contrast, most public companies in the United States are obsessed with short-term performance.

According to Pisano and Shih, it is easier for business leaders to focus on next year’s earnings than to understand how technology will evolve in the long term.

“The short-termism has become a bit of an excuse. I think a lot of managers have a hard time managing for the long term, so they like to blame Wall Street,” Pisano said.

Germany has also done well in manufacturing. The country relies on a highly skilled workforce, dense supplier network, and local know-how.

Unlike the United States, Germany made significant investments in the apprenticeship system to have a job-trained workforce.

“A number of companies I come across say that one of their biggest challenges is finding skilled production workers. It’s baffling,” Pisano said.

The United States has a generational skills deficiency in many important technical areas. For example, the average age of skilled machinists, such as CNC machine operators who use computers to control machine tools, is roughly 59, he said.

So far, Trump has focused on bringing jobs back to America, which will yield results in the short term.

The air conditioning company Carrier reached a deal with Trump last November to keep nearly 800 jobs in Indiana. Foxconn, the world’s largest contract electronics-maker, said in January it would invest over $7 billion to set up a display plant in the United States. Ford canceled plans to build a car factory in Mexico and will instead invest $700 million to expand its Michigan factory and create 700 jobs.

Ford Mustangs go through assembly at the Ford Flat Rock Assembly Plant in Flat Rock, Mich., on Aug. 20, 2015. Ford canceled plans to build a car factory in Mexico and instead will expand its Michigan factory, creating 700 jobs. (Bill Pugliano/Getty Images)
Ford Mustangs go through assembly at the Ford Flat Rock Assembly Plant in Flat Rock, Mich., on Aug. 20, 2015. Ford canceled plans to build a car factory in Mexico and instead will expand its Michigan factory, creating 700 jobs. (Bill Pugliano/Getty Images)

According to Pisano and Shih, how much this will benefit the economy in the long run will depend on whether America can redevelop a highly skilled workforce. Making that key to any job creation strategy would be the first step toward creating a healthy industrial ecosystem and truly bringing innovation in manufacturing back to the United States.