Politicians say we have the most productive workers in the world. They don't know what they're talking about.
Alternatively, companies can cut costs by seeking out cheaper suppliers around the world—to use the business school term, they can engage in global supply chain management. A U.S.-based computer company can lower its costs by moving its customer call center from South Dakota to India, Walmart can shift its clothing purchases from a Chinese shirt manufacturer to a cheaper supplier in Vietnam. Apple can find a cheaper offshore supplier for its iPhone display screen.
But here’s the rub: both of these corporate strategies— domestic productivity improvements and global supply chain management—show up as productivity gains in U.S. economic records. When federal statisticians calculate the nation’s economic output, what they are actually measuring is domestic “value added”—the dollar value of all sales minus the dollar value of all imports. “Productivity” is then calculated by dividing the quantity of value added by the number of American workers. American workers, however, often have little to do with the gains in productivity attributed to them. For instance, if Company A saves $250,000 simply by switching from a Japanese sprocket supplier to a much cheaper Chinese sprocket supplier, that change shows up as an increase in American productivity—just as if the company had saved $250,000 by making its warehouse operation in Chicago more efficient.
It’s important to note that the government does make an effort to control for these changes in import prices— for example, the switch from the Japanese to the Chinese sprocket—when measuring national economic output. In fact, the Bureau of Labor Statistics is assigned to this very job. But for a variety of reasons, including underfunding and some important omissions in data collection, the BLS does a poor job tracking the drops in prices that result when companies shift from a supplier in one country to a cheaper one in another. This is what’s known as “import price bias.” If Company A’s sprockets start pouring into U.S. shipyards from China rather than from Japan, the BLS has neither the manpower nor the procedures to know that these two imports are really the same part, albeit with a lower price and a different point of origin.
Import price bias also shows up in a big way when companies shift from domestic suppliers to cheaper foreign suppliers. Consider refrigerators, for example, like the ones made in the Whirlpool plant mentioned earlier. Refrigerator imports from lower-cost countries such as Mexico, Korea, and China now total almost $4 billion annually, up 19 percent since 2007. Clearly these growing imports are displacing domestic production and employment— but how much? Today the official statistics treat imported refrigerators as if they cost the same as U.S.-made refrigerators, so that $4 billion of imports is assumed to displace $4 billion of domestic production. But a more accurate measure would take into account the lower cost of Chinese- or Mexican-made appliances, so that $4 billion of imports might really displace $5 billion, $6 billion, or even $8 billion of domestic production. Unfortunately, the BLS does not track the relative price of imported and domestic fridges—or almost any other product, for that matter. Scale this problem up by a factor of a million, and you begin to see how pervasive import price bias really is.
These statistical deficiencies amount to an incapacitating handicap for anyone trying to understand the truth about American productivity. Because economically, there’s an enormous difference between “domestic” productivity growth and what Susan Houseman of the Upjohn Institute and I have called “supply chain” productivity growth. Over the long run, gains in domestic productivity should translate into higher living standards and more jobs for U.S. workers. Economic theory—and common sense—tells you that companies will want to hire more of the types of workers who are contributing to higher profits. If the profits are coming from improved factory productivity in Dearborn, High Point, or Mountain View, then the company will want to hire more good production workers at those plants.
“Supply chain” productivity doesn’t work the same way. If companies reconfigure themselves to better scour the globe for the lowest-priced goods and services, then their essential personnel are multilingual business school graduates with the ability to parachute into Shanghai or Bangalore and negotiate the best deals with suppliers, logistics experts who can keep the goods flowing, marketers to sell the goods, and software engineers to program the computers that communicate with the suppliers. In other words, the bulk of the company’s own workers essentially perform a creative or coordinating function, rather than a manufacturing one. These workers might be in the U.S., or they might be spread around the world.
The model of success in this vein is Apple, which has no manufacturing facilities. Instead, it maintains enormous profit margins through innovative product development and tough negotiating with suppliers. One thing feeds the other: because Apple brings the promise of huge markets and trendsetting products, it has enormous clout to bargain with suppliers for lower prices.
But not many companies are quite so successful at this game. Any number of American firms have offshored production and even product development to foreign suppliers, only to then see those same suppliers become lowcost rivals. One company that fell into that trap is Hewlett- Packard, which has reduced real spending on R&D since the mid-2000s, focusing instead on supply chain management and outsourcing its computer production and development. The resulting lack of innovation put HP at a bargaining disadvantage relative to its suppliers. That’s why HP’s latest tablet computer couldn’t undercut Apple, and why HP is talking about getting rid of its computer business. Without innovation, a supply chain strategy fails over time.
It’s not clear, then, that an economy-wide shift from a focus on domestic production to one on consumption, trading, and organization will lead to a stable arrangement between the United States and the global economy. Why should the rest of the world consent to being organized by us if we aren’t producing—and if we’re borrowing to support our consumption? In the end, organizing may not pay enough. Yet much of the reported gain in U.S. production seems to be coming from gains in supply chain productivity, rather than domestic productivity. We don’t know for sure about this. As we’ve said, the official data doesn’t reveal much about whether U.S. companies have moved their operations offshore or kept them at home; depending on the circumstances, both can show up as productivity gains. But the manufacturing sector and the economy as a whole certainly feel like they are being hollowed out. And indeed, some recent research suggests that the size of the mismeasurement problem is huge. To cite just one example, a 2011 paper by Houseman and three coauthors from the Federal Reserve found that non-high-tech manufacturing growth from 1997 to 2007 may have been overestimated by as much as one-half because of import price bias. Similarly, ongoing research from a new policy brief from the Progressive Policy Institute shows that the official statistics have significantly overstated GDP and productivity growth since 2007—implying that the recovery has been even weaker than we thought.
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