The hidden flaw holding back full recovery in U.S.

LOS ANGELES —

Post-election America: it was a hard-fought campaign on both sides, but incumbent President Barack Obama won with his message of “let’s finish what we started.”

His next step domestically is tackling the “fiscal cliff” (with a compromise solution tied to a grand bargain… or not).

Moving ahead, new fiscal policies will be announced, and some cabinet changes made. Obama’s January inauguration will precede a measured economic recovery in 2013.

That’s the good news.

The bad news: this scenario might be as good as it gets for the American economy. The upcoming recovery won’t boost middle- and working-class households in a meaningful way. It won’t be a sustained, permanent fiscal recovery.

But this isn’t necessarily the Obama administration’s fault. Since the U.S.’s 2008 fiscal meltdown, government officials, policy experts and financial gurus of all stripes and credibility levels have rolled out any number of ideas aimed at solving our continuing financial crisis and revitalizing the economy.

Little has worked so far. The lack of significant job creation and its twin symptom of high unemployment, stagnant or dropping wages, stagnant or dropping worker productivity, decreased consumer spending and its twin symptom of increased household debt, and volatility in the housing market are all side effects of something much larger.

Policy makers are focused on the symptoms, not the problem. The real problem is far more fundamental and systemic than a few leading economic indicators.

And this fundamental problem is invisible to nearly everyone.

This unseen, and therefore unaddressed, problem means that an even bigger and longer-lasting crisis—a true economic tsunami—lies ahead for the world as a whole, not just the U.S. Industries around the globe will continue to shed valued (and valuable) jobs, in turn harming consumer-driven economies and creating a self-sustaining downturn.

This downturn will continue until the world economy either “breaks” permanently—or the fundamental problem is recognized and addressed. At its heart, the flaw is our mistaking efficient markets as being effective markets and failing to recognize the significant and profound difference.

The solution starts with acknowledging that domestic manufacturing needs to be the backbone of any significant economic recovery. The “experts” will say, of course, that America doesn’t “do” manufacturing anymore.  Our economy is all about service, finance, software, and entertainment.

That’s not strictly true, of course: the auto industry is still a major player. Just ask Ohio and Michigan.

The fact manufacturing isn’t considered a primary element of our economy is the big reveal of our fundamental problem. We can encourage entrepreneurs, innovators, and inventors in any number of ways, but if the basic conversation assumes that new manufacturing at any significantly higher level would simply shift overseas—we’ve been misled that job creation is and will be the primary direct benefit of American innovation and entrepreneurship.

But this is the case now, and it’s because over the last 20 to 30 years of the Information Age, we have shifted our “real market” process (basically, the physical supply chain process) to a more efficiency-oriented supply-side environment. This shift essentially created numerous domestic “job-killing machines,” as large firms focused on efficiency and profitability generated by information technology and advanced networking systems. This altered the whole economic environment, making the destruction of jobs a major result of this efficient, “intelligent” streamlined process.

Isn’t efficiency good for the economy? In a balance-sheet recession, no. Here’s why:

Think of the manufacturing and supply chain network – from product manufacturer to distributor to retailer and finally to the consumer – as a long stretch of highway, leading from the countryside, through the mountains via tunnel, over a bridge spanning a river, and into a city. The highway passes a variety of buildings, ultimately leading to a retail store. The companies in these buildings are members, whether they can afford it or not, of this highway “network.” The network is the connected supply chain.

The highway, tunnel, and bridge are all well designed and maintained. It’s an example we can see over and over in the U.S. and other nations. In this specific case, however, imagine that the highway, tunnel, and bridge are privately owned. The companies located along the highway are part of the same conglomerate. Moreover, the owners aren’t AT ALL interested in opening this transportation system to the public – not even to collect tolls. They simply want the highway-tunnel-bridge system for their own, private use because of its competitive advantage.

That’s a major problem, and unlikely to happen in any rationally run country. Right? Wrong. The same thing is happening throughout our economy, but in less obvious ways. 

Example: A Private Information-Based Supply Chain Network

Let’s look at just one example: Zara, the world’s largest clothing retailer, has developed a private IT-based supply chain network that vertically integrates its logistics and collaborative functions. The Arteixo, Spain-based firm’s network is so efficient it now needs just two weeks to develop a new product and get it onto its stores’ shelves—compared to a six-month industry average. This competitive advantage lets Zara launch around 10,000 new designs each year, far more than its competition. By one measure, Zara has been remarkably successful: Bloomberg Markets named Chairman Amancio Ortega the third richest person in the world this year.

What happened to other players in the industry? Most smaller designers, manufacturers, and retailers are far less competitive (or efficient) than Zara. A few lucky groups (including suppliers, designers and distributors) were brought into Zara’s system.
Because of the resources pulled into Zara’s closed network, combined with the chain’s cost efficiencies, the larger fashion retailing industry’s supply chain became seriously unstable. Most other companies lost their businesses. As a result, jobs for middle- and lower-income workers in this industry have continually and relentlessly decreased.

And Zara is in no way an isolated case. Due to the superior position of large companies with their own private, highly efficient supply chain networks (think Wal-Mart), small- and medium-size companies worldwide have likewise seen their businesses weakened and often destroyed. Jobs in those smaller companies also have been lost – and they haven’t been replaced in anything resembling equal numbers by the larger firms.

There are three primary reasons why jobs replacement isn’t happening. (1) the aggressive adoption of IT systems that can identify redundancies (eliminating similar positions within the domestic marketplace), (2) off-shoring and outsourcing manufacturing to lower labor-cost countries (shifting jobs out of the domestic market), and (3) broad adoption of robotic machines and automation processes (eliminating jobs from entire industries, period).

This is strongly correlated with the decline of the self-generation, or recovery/rebuilding, capability of the economy (and once again illustrating why Henry Ford paid premium wages to his workers: he wanted them as customers). But the workers impoverished by Zara cannot afford even its cheaper goods. These private information-based supply chain networks have been the major job-killing machines in the modern Information Age. This is competition by relative size.

As to our current supply-chain networks, we can say that while these private networks are efficient, they aren’t—in terms of larger economic priorities—in any way effective. These winner-take-all closed, efficient systems harm larger economic goals and objectives because they eliminate jobs as part of their natural process. An open, effective supply chain network would allow network members to take advantage of efficiencies of scale and information systems, while reducing the advantages of size alone. An open, public supply-chain infrastructure would shift the emphasis from only cost-per-unit to competition by price, quality, and service, that is, absolute competition.

The existing efficiency-oriented mass production process and mass-market consumption model would be altered into a more effectiveness-oriented, diversified, or individualized production and consumption system. In our example of the private highway-tunnel-bridge system, the owners can keep their closed network. But we’re going to build a toll-based system nearby, open to whoever can pay the reasonable fee. This open, membership-based system means a broad range of businesses—low-tech to high-tech and everything in between—can benefit from shared, intelligent manufacturing and distribution networks.

A public system will spark business growth and lower the cost of entry into any number of domestic markets. Owing to these changes, local employment conditions will improve considerably, and the business environment for middle- and small-sized companies and for the general service industry will ease significantly. Moreover, companies that off-shored and outsourced to lower labor-cost countries would come back to the domestic arena.

This synergy for employment would be a positive force for economic recovery and revitalization. The improvement of the self-generation capability of the market could finally be transformed into a permanent structural force to steady, and then increase, the level of consumer spending. It’s only when we’re ready to discuss the realities of manufacturing’s role in our domestic economic future—and the advantages of an open system to foster innovation, production and distribution—that we can also discuss the realities of a sustained, and sustainable, economic recovery.

Ho-Hyung (“Luke”) Lee (luke.h.lee@ubims.com) is the founder and CEO of UBIMS, Inc (“Ubiquitous Market System”). He is by training a lawyer, an international businessman and entrepreneur – and an inventor. Lee developed the modern world’s first Public Information-Based Supply Chain Infrastructure - UBIMS Inc.

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  • 1

    fds

    definitely food for though but good luck implementing....

  • 0

    saidani

    Yes, let's get the government more involved in the economy. Why not eliminate lobbying and other corruptions then try to find some competitive advantages through tax reductions and the lifting of onerous regulations before we go down that road. The government has already proven to be lousy at economic planning and manipulation.

  • 1

    malfupete

    what we need is a good ol' world war to kick-start the industries again..

    seriously though.. companies will do none of the above mentioned ideas because they only answer to their shareholders. Social responsibility is meaningless to them.. they will cut costs ruthlessly, shift jobs overseas to cheaper labour markets, find all the tax loopholes they can.. even incorporate overseas or in a tax haven to pay less. Hell, once all the chinese factory workers start demanding higher wages, all these companies will just close up shop and move to the next cheapest country.. at some point it may even come back to north america if workers are willing to accept to subpar wages just to be employed...

    or maybe the world is just over-populated at the moment...

  • 0

    Frungy

    ... I'm sorry, but the author clearly doesn't understand modern manufacturing trends. So much emphasis is put on which country's name is put on the final product by laypeople that they lose sight of the fact that as much as 90% of the product may have been manufactured elsewhere. Take a laptop for example. The screen is made by the laptop manufacturer, and maybe the keyboard (but often not), however everything else (i.e. all the bits that make it work) are made elsewhere, and these are the bulk of the cost of the item. Intel Inside has become a global standard, and no matter where those intel chips are produced all the profits are headed back to Intel in the U.S. Naturally Intel needs massive home office staff and infrastructure to run their global empire, so the profits find their way back into the U.S. economy in the form of salaries, consultants fees, etc.

    ... but are any Intel chips made in the U.S.? Not many.

    Manufacturing has changed. Deal with it.

  • 0

    lachance

    Sorry. The authors just don't understand. They've taken a side road and ridden it to a dead-end. This is not what is holding the American economy down. Free Trade Agreements are essentially the reason, taking jobs out of developed countries and transferring them to poor countries where workers work cheap.

    Once, we have made everyone as rich as Americans, then Americans will be able to compete on a global scale with the formerly poor countries like China. It's all an equalization game, designed to raise the living standards of the world while keeping the American standard from reaching sky-high. It's all the in the interests of humanity really.

    As it was explained to me, this is the reasoning for a weak American economy. "After I have a toilet in my house and a refrigerator and a car in the garage, why do I need a new model of each every year? So, let's let China have some of the good life then Africa, etc." That's all it is. Stop worrying. That's just greedy.

  • 0

    Frungy

    lachanceNov. 28, 2012 - 02:38AM JST Sorry. The authors just don't understand. They've taken a side road and ridden it to a dead-end. This is not what is holding the American economy down. Free Trade Agreements are essentially the reason, taking jobs out of developed countries and transferring them to poor countries where workers work cheap.

    Sorry, you don't understand. Here's a simple hypothetical example: I run a company that makes ping-pong balls. I have a global market, everywhere from the U.S. to Outer Mongolia. Most of the work is done by machines, but some needs to be done by people, like regional sales support (10 people per region x 10 regions), and packing and addressing the packages (10 people per region x 10 people). Other bits can be done centrally, like strategy and R&D (100 people).

    What you're proposing is that I get U.S. workers to pack the ping-pong balls at $2000 a month, where I could get Indian workers to do it for $200 a month (India = saving of $80 000 per month). Then you want me to find sales reps in the U.S. who speak Hindi, Gujurati, etc to do telesales to India... or I could just use local sales reps and save another $80 000 per month. That money would go back to the U.S. and I could use it to subsidise the salaries of my highly qualified R&D and strategy people who I employ at head office, and to invest in technology to improve my business.

    At the end of the day outsourcing lower level jobs to foreign countries keeps companies competitive, raises average salaries in the U.S. and ensures that these companies remain competitive and in business.

  • 0

    AKBfan

    Same like Japan. let the Zombie companies go to the wall so new ideas and businesses can be allocated capital and labour and flourish.

  • 0

    edbardoe

    "Effective" markets is just code speak for more government control. Less is whats needed, not more. Whats holding America back is the creation and coddling of the parasite class. Two years of unemployment payments means two years of unemployment to many, working "off the pad" to supplement, selling dope, working the medicaid system to give them pain pills to sell. And they have the support of a political party lead by an admitted former drug user! Four more years of malaise is now guaranteed.

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