Offshoring: To Insanity… and Beyond (Long)

Author’s note: This essay has the potential to tread into the political realm. Such is not my aim. Rather, my goals are two-fold. First, to show that I have a wide-ranging curiosity and think about many topics, and second, to hopefully introduce a layer of consideration to offshoring decisions and policy beyond the purely economic one.

In a LinkedIn article, Ron Baker discussed free trade and the trade deficit. Arguing that the trade deficit is meaningless, he proposes essentially unlimited free trade between nations. Baker cites economist and scholar Thomas Sowell, whose book Basic Economics is one of several of his in my library, in support of his arguments. I attempted to argue in the comments, along lines of national security, that there are other issues besides macroeconomic optimization and maximizing consumer choice that must be considered.

Before I begin, in full disclosure, let me be clear: I am overall an advocate of and believer in free markets, and agree wholeheartedly with the late economist titan Milton Friedman:

So that the record of history is absolutely crystal clear. That there is no alternative way, so far discovered, of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by a free enterprise system. (Full video interview – 45 minutes and worth every second – here.)

I freely confess that I enjoy buying some products from overseas (e.g., shameless link to an Israeli website I buy a lot from here). But I also believe that unrestricted, global free trade has drawbacks in practice (see my fifth quote). Why? Because, to quote Lord Palmerston:

“Nations don’t have friends. Nations have Interests.”

(I have some other offshoring concerns too which I will address in follow-on pieces.)

Leverage

In the 1989 book The Japan That Can Say No, Shintaro Ishihara and Akio Morita discussed Japan’s technology and manufacturing prowess; in particular, Ishihara said (quotation from Wikipedia entry):

Japan must use its technological superiority as a negotiating weapon. It should even threaten to trade secrets with the Soviet Union as a bargaining tool against the US and refuse to sell components that go into US missiles.

To my knowledge this threat was never actually leveraged into demands, but the fact that essential parts of our military capability are sourced overseas is folly. As the book implied, having technology (and even basic materials critical for making military goods) sourced from other countries puts one nation in the power of others.

In a related way – and I’d like to claim to be a prophet here but I have no proof I said this “back when” everyone was praising the new energy-and-economic ties between Russia and Europe – the current situation is seeing the European response to Russia’s annexation of the Crimea muted. Why? Because, as I had foreseen, dependency on Russian gas and oil is impacting Europe’s decision-making; according to Seva Gunitsky, an assistant professor at the University of Toronto’s Munk School of Global Affairs:

“In order to get any traction with sanctions you have to bring the EU in and I think that will be a difficult task because of their dependence on Russian oil and gas resources,” Gunitsky said.

Critical Materials

Consider the possibility of critical materials being controlled by a hostile power in an active war. US fighter parts have been sourced from China, because China controls so much of the available rare earth element production. Were China to attack Japan over five tiny islands, obliging us to side with Japan per our treaty into what could become a very hot war (as China builds a blue-water navy and tests hypersonic missiles meant to attack our navy – funded by our trade deficit with them), would that trade be stopped? (Do snowballs melt in Hell?)

Many electronics are made overseas – not just military ones. Two countries that are electronics-manufacturing powerhouses are Indonesia and Malaysia, both majority-Muslim countries. While today their governments are trade-friendly, if a religion-based war started (e.g., Iran vs. Israel with America standing with its ally Israel), what might that do to our trade with these countries? And never mind sourcing, consider the logistical fact that in general goods travel long distances over vulnerable ocean; oil in particular goes through critical choke-points like the Straights of Hormuz.

It’s not just military materials. In the venerable New York Times there’s a critical sentence in this article: Medicines Made in India Set Off Safety Worries: “The crucial ingredients for nearly all antibiotics, steroids and many other lifesaving drugs are now made exclusively in China.” – above and beyond the baseline theme of the article about concerns over medicine and other products from outside the US in general. I’m not a chemical engineer, but I can’t imagine that ramping up human-grade production of these materials in the US would be quick.

Machining centers and so much other production-related equipment also comes from overseas. A global war could mean that, literally, we would have a shortage of the tools to make the tools to make the weapons… and a ramp-up of domestic makers of such equipment would be difficult and slow.

Power, Power… Nowhere

Our power supply is at risk: from the article What if all the lights go out?(Emphasis added):

But according to the Federal Energy Regulatory Commission study disclosed by the Journal, a few dozen of the substations are so important to the flow of energy that knocking out just nine of them would cause a metastasizing blackout that stretched from coast to coast. And replacement transformers for these substations can take more than a year to build, deliver and install, in part because most are made overseas.

Given the criticality of our electrical infrastructure to our economy, and the above-stated vulnerability of that infrastructure to low-tech sabotage, why do we – at the least – not have a significant inventory of these on-hand? (Note: I’m just an “average Joe engineer” with no military experience… but if I can envision having pre-positioned teams of sleeper agents ready to take these locations out as the opening salvo of a war, surely other nations’ dirty-tricks folks have too.)

Another critical vulnerability of our power grid exists; whether from a natural coronal mass ejection hitting the earth causing another Carrington Event (which we dodged two years ago), or a hostile power attacking us with an EMP (watch this video too). Both have the potential to wipe out our power grid. The former would affect the entire planet, making sourcing from anywhere moot for years, and the latter would be the opening salvo of a war involving America. Whether by human intent or Mother Nature, our electricity-powered technological civilization itself is at the mercy of foreign-sourced components.

I’m not alone in voicing this concern over the vulnerability of the electrical grid, either.

What’s More Basic Than Food?

I love garlic. Now when I say I love garlic, I don’t mean I like the stuff. I mean I love garlic; one of my favorite chicken recipes calls for 20 cloves; I put in 25! But peeling it is a pain; so a while ago I saw a package of pre-separated-and-peeled garlic cloves – oooo! Wait; imported from China? This truly shocked me. How can it be cheaper to ship garlic, doubtless refrigerated, all the way from China? (I’ll stick to peeling cloves from bulbs.) I’m not trying to pick on China specifically here, but I think my skepticism about Chinese food has some justification: China says over 3 mln hectares of land too polluted to farm.

More broadly, wars are very disruptive to international shipping on which so much of our food supply – especially fresh fruits and vegetables – depends. During World War II, people were encouraged to plant “Victory gardens” to raise food for themselves. And a military runs on its stomach; while America is blessed with tremendous amounts of arable land, it would take time to ramp up farming on these lands and – depending on the season in which the war started – quite some time before they filled the gap.

Another concerning article:USDA to Allow China to Process Chickens, Ship Back to U.S. The idea is that US birds would be slaughtered here, frozen, shipped to China, unfrozen, processed, refrozen, and shipped back. It boggles my mind that this is more cost-effective than doing it domestically. (Side note: a friend noted that they’d likely keep the feathers and other offal which could be used for animal feedstock or other uses as a part of their economic incentive in forming their pricing.)

Intentional Sabotage

Consider food imported en masse from anywhere. Were such a country planning “something”, contamination could be introduced to draw attention away from planned moves. E.g., a country-wide outbreak of E. Coli contamination from an imported source could distract national attention from overseas events. Distraction and deception are, after all, essentials of military strategy. (Again, reference my “average Joe engineer” comment, above.)

The possibilities are legion and without bounds. On the classic comedic TV show Hogan’s Heroes, the prisoners are volunteered by their commanding officer to help rebuilt a Nazi bridge destroyed earlier in the episode. When questioned by his team as to why they’re going to help, he smirked and said it would be the first bridge in Germany to have a built-in bomb.

Which segues into a question: what are we to make of foreign-sourced military electronics with, it seems, built-in back doors? (emphasis added):

We chose an American military chip that is highly secure with sophisticated encryption standard, manufactured in China. Our aim was to perform advanced code breaking and to see if there were any unexpected features on the chip. We scanned the silicon chip in an affordable time and found a previously unknown backdoor inserted by the manufacturer. This backdoor has a key, which we were able to extract. If you use this key you can disable the chip or reprogram it at will, even if locked by the user with their own key. This particular chip is prevalent in many systems from weapons, nuclear power plants to public transport. In other words, this backdoor access could be turned into an advanced Stuxnet weapon to attack potentially millions of systems. The scale and range of possible attacks has huge implications for National Security and public infrastructure.

Never mind the supply issue; could some signal activate an embedded Stuxnet-like virus, crippling our military at a critical moment? Can we afford the risk of finding out?

Even foreign patents – theoretically a full disclosure of technology – can be deliberately gamed as companies and countries plan ahead “just in case”; while this WW I example was more for industrial advantage, again reference my “average Joe engineer” comment (emphasis added):

Dr. Elmer K. Bolton, director of Du Pont’s research laboratory, was summoned to Chambers Works to solve the sulfur black production problems. But he was just as mystified as the other American chemists and engineers. The German patents, which were confiscated by the U.S. government during the war, could not be duplicated by Du Pont’s chemists. The patents were written in a purposely vague manner with key information omitted. It was apparent that the patents could only be worked by a chemist “skilled in the art”, meaning an experienced German chemist.

What Can We Conclude?

Free trade increases wealth, and can build ties and facilitate culture exchanges and personal relationships that can lessen hostilities. A swelling middle class tends to moderate leaders as their people grow wealthier and happier and less interested in the privations of war, and become accustomed to imported goods and luxury items – let alone travel and tourism that enable a better understanding and empathy with other peoples. Economic ties and dependencies can help in reducing an impetus for combat. Noted economist Fredric Bastiat is purported to have said “When goods don’t cross borders, soldiers will.” I agree.

However, I would like to add a caveat: “Just because goods do cross borders doesn’t mean soldiers won’t.” As we formulate trade policies, and companies consider continued offshoring to reduce costs, we would do well to remember that human nature, ambitions, and failings don’t change. National interests and ideologies, as well as peoples’ loyalties to country over employer, will trump the macroeconomic bottom line.

(Lest people say it can’t happen again, or opine that leaders are wiser now, never forget that WW I, which cost 16 million lives and 20 million more wounded, had many factors piling up fuel – but the seed event was the assassination of one man: Archduke Franz Ferdinand. From such small and unpredictable sparks can global conflagrations begin.)

© 2014, David Hunt, PE

17 thoughts on “Offshoring: To Insanity… and Beyond (Long)

    1. How many angels can dance on the point of a pin? Economists will keep arguing until all economic analysis is devolved to those from India who will work for less than the Columbia University union rate. China and India have hugely increased our manufacturing labor supply, inevitably reducing its price. Our manufacturers and perhaps also their customers like that. Our own manufacturing workers either accept lower world wages or switch to other work.
      I recommend teaching economics at American universities.

      1. John Kenneth Galbraith used to point out that the most avid defenders of free market capitalism were tenured economics professors, who were themselves largely shielded from the discipline of the market.

  1. There are several significant problems with offshoring including:

    Unequal workforce regulation. Countries without the workforce protection rules in place in the US provide products at a lower cost at the expense of their citizens. It’s a race to the bottom on wages and protection, and companies who use offshoring to offer cheaper products are engaging in immoral acts if they do not monitor how the workers (at say, Foxconn) are being treated.

    Lack of IP protection. Companies who send their designs to low cost countries face the continuous threat of IP theft.

    Lack of supply chain visibility and regulation. Without proper regulatory or corporate supervision, cost cutting often occurs which renders products less reliable or safe than the original design calls for. Electronics manufacturers, for example, often find the PC boards to be manufactured with less copper in the connects than the already optimized designs call for, resulting in higher than expected failure rates. Hopefully, you won’t find any of those in you ABS system at a critical time.

    Loss of manufacturing know-how. Manufacturing is a key to creating wealth and sending it overseas diminishes our ability to do so.

    There are other issues but those are the main ones.

      1. David, I’m afraid I can’t provide that information, as it was obtained in a meeting in which I was under NDA. I think if you have contacts with some of the major electronics manufacturers in the US you might get quick confirmation.

  2. You’re focusing on long-term security matters. There’s also the immediate economic impact: increasing the world’s supply of labor (by bringing China, Vietnam, Malaysia, Bangladesh, India on stream — never mind Africa in the future) automatically reduces the price of labor (wages and salaries.) That’s great for holding down the labor cost of manufacture, great therefore for manufacturers and usually also for their customers, but not good for the blue-collar, white-collar, and lace-collar people whose income is reduced by this new competition, let alone those displaced by this new labor supply.
    We have not yet solved this problem, and won’t even get a start until Friedman and other orthodox Western economists are thrown out of work because Indian economists will theorize for less money.

  3. I am a bit puzzled as to where David is going with this. In remarks made both here and in response to the Ron Baker Linked-In article, David professes to be a supporter of both free trade and free market capitalism. Indeed, David reiterates his fealty to the doctrines of Milton Friedman and Thomas Sowell. Yet, David essentially makes out a case for protectionism – advancing arguments such as the national defense argument (and in his comments on the Ron Baker piece other arguments like the effect of unrestricted free trade on skilled workers in the US), that are quite inconsistent with his profession of faith in free trade and free market capitalism. If David were to follow his own arguments to their logical conclusions, then it seems to me that he will have to jettison his profession of faith in the doctrines of Friedman and Sowell. I know that in the past, David has described himself as a libertarian, I wonder where he will end up politically given his crisis of faith.

    1. Jim:

      There’s no true contradiction. Friedman, Sowell, et al describe what “should be” in the best of all possible worlds (a la Voltaire) – and which, in that idealized theoretical world, would result in the best of all possible results.

      Instead, I am pointing out that there are flies in the ointment of that theoretical perfection. National security is one such fly – and I attempted to point that out to get companies and policy makers to understand that national security needs trump the bottom line/the greatest macroeconomic good, and that offshoring decisions – in cold, harsh reality – should factor those considerations in.

      Lenin once said that the capitalists would sell them (the Communists) the rope they would use to hang the capitalists. In the pursuit of “the almighty dollar” corporate executives are setting America up for military defeat at the hands of very real enemies… and that a voluntarily-exercised consideration of these (and other) factors will help preserve the long-term viability of the capitalist system.

      In the science fiction book “The Children’s Hour” the head of a criminal organization is solicited for help in the war against the Kzin. To the intelligence agents’ doing the soliciting’s surprise, that head gives help for free. When he is challenged why, he observes that his organization is doing well for the same reason bacteria do well in a dying body; the gains are immense, but short-term. Far better, he points out, to restore a functioning human government to preserve things for the long haul.

      The destruction of America would end most companies, and destroy the wealth – not only of those executives – but of countless ordinary people. Far better to reconsider pure profit maximization and macroeconomic benefit… for the sake of preserving the system that created such wealth. That doesn’t necessarily mean protectionism imposed from above with legal force, but a mindset change by my (and hopefully others) pointing to long-term self interest.

      What good is a massive stock option when the electric grid is down from a calamitous attack, or a dozen cities are smoking ruins?

  4. David wrote:

    “There’s no true contradiction. Friedman, Sowell, et al describe what “should be” in the best of all possible worlds (a la Voltaire) – and which, in that idealized theoretical world, would result in the best of all possible results.”

    I’m sure that David is well aware of Milton Friedman’s famous essay on economic methodology, “The Methodology of Positive Economics.” (http://www.ppge.ufrgs.br/giacomo/arquivos/eco02036/friedman-1966.pdf). There, among other things he argued:

    “Truly important and significant hypotheses will be found to have “assumptions” that are wildly inaccurate descriptive representations of reality, and, in general, the more significant the theory, the more unrealistic the assumptions (in this sense).”

    In other words, Friedman conceded from the out-start that his theories would be based on unrealistic assumptions concerning economic reality. But we would still be justified in accepting them on the basis of their simplicity and fruitfulness in terms of being able to make testable predictions that are subsequently confirmed. So yes, Friedman conceded that the basic assumptions underlying his (and neoclassic economic theory in general), such as utility maximization and profit maximization, might be quite unrealistic. But we would still be justified in accepting them on the grounds theories derived from these assumptions prove fruitful in generating testable predictions that are confirmed. So on the one hand, Friedman would seem to have been agreement with David here. But on the other hand, if the theory does indeed succeed in generating testable predictions which are confirmed, we would be quite justified in accepting that theory and in using it as basis for public policy.

    Up to a point, Friedman or Sowell might concede that the national defense argument, David embraces, has a certain degree of validity. However, they would most certainly argue that David overstates things here, and that economic policy should, in general proceed, along the lines of free markets and free trade. In those sectors where they might conceded that there is a problem, they might argue that the best thing to do is for the government to stockpile those items that are essential for national defense, so that if supplies are cut off, the military would still have enough to meet their needs. It’s rather unlikely that they would argue for any significant degree of protectionism, except in the case of an all out war.

    David goes on to argue:

    “…Far better to reconsider pure profit maximization and macroeconomic benefit… for the sake of preserving the system that created such wealth. That doesn’t necessarily mean protectionism imposed from above with legal force, but a mindset change by my (and hopefully others) pointing to long-term self interest.”

    I am not quite sure what David is driving at here. If David truly believes businessmen will voluntarily, en mass, sacrifice short-term profit maximization for the greater long-term good, then the very economic models embraced by economists like Milton Friedman or Thomas Sowell would be called into question. There would be more problems with the basic assumptions underlying those models than just a simple lack of realism (which Friedman had always conceded to be the case anyway), but their very utility in being able to generate predictions that are subsequently confirmed, would be called into question. If David is right, then these models would require significant modification. If that is not the case, then it would seem that for David to attain his goals concerning matters like offshoring, government intervention would be required. Either way, there does seem to be a contradiction here.

    1. Certainly this is thoughtful commentary – thank you!

      The only way to convince people of something is to appeal to their “enlightened self interest”.

      If companies are not willing to curb their tendencies to offshore in pursuit of the last dollar of profit, sooner or later the party will end.

      It might end with America’s defeat from all sorts of possible military scenarios. It might end with enough people getting desperate enough to elect protectionist (or worse) politicians. But it will end.

      In order to avert these possibilities, we have to get businesses to understand the long-term ramifications and ripple effects.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s