Reposted from Financial Executive Magazine

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China 2013: The Year of Reshoring to America?

Peter Navarro | January 2013 | Fin’l Executive Mag

“The problem with our system is that everything is short term, so when you say to an American CEO ‘Do you realize that the Chinese are going to take your technology and they’re going to be your competitor?’ the CEO says: ‘Yes, but I only have three or four years to get my stock up so I can get my bonus,’ and they kick the can down the road, and it’s the next guy’s problem.”

This observation from Dan Slane, chairman of the Slane Co. and a commissioner on the U.S.-China Commission, from a documentary film by this author, Death By China, highlights an issue critical to the strategic decision to do business in China: in their rush to leverage cheap labor, a lax regulatory environment, a surfeit of government subsidies and a huge emerging market, far too many corporate executives could be underestimating the risks of putting their eggs into an increasingly dangerous Chinese basket.

Economic risks in China range from outright piracy and counterfeiting to the forced transfer of sophisticated technology to potential Chinese competitors. Geopolitical risks include increasing trade tensions between the United States and China in concert with the transformation of the Chinese military from a primarily defensive force to one increasingly capable of projecting military power all over the globe.

Given these emerging economic and geopolitical risks, 2013 should be the year in which financial executives re-evaluate their China exposure. If that exposure is high, it may well be time to start reshoring — at least some production and operations — back to the U.S.
To date, most executives have viewed China as the proverbial pot of gold — and perhaps with good reason. After all, a company wishing to export back into the U.S. typically could move its production to China and cut costs by as much as 50 percent. It could also gain access to the world’s largest emerging consumer market.

China … Not All As Expected
That said, a rising number of companies have found China simply to be fool’s gold.  The most naïve — typically smaller companies — have seen their corporate blueprints, processes or technologies quickly stolen and have lost their proverbial shirts. But even large American corporations with sophisticated management structures have had their pockets picked.

Consider this case study from the Death by China film told by Forbes magazine columnist Gordon Chang: “Google came into the Chinese market and of course, it ended up with a dominant market share. But Beijing wanted Baidu, a local company, to be able to outpace Google. What Beijing did was it hacked Google’s network, it stole its source code, and now, Baidu has more than 75 percent of the China search market. This shows that basically Beijing wants the local companies to be the national champions.”

Sometimes, however, Chinese pirates aren’t content just to steal the intellectual property of an American corporation. Sometimes, they just take the whole company. Editor and publisher of Manufacturing & Technology News Richard McCormack relates how Fellowes, a company that makes paper shredders “hired a company to run their production for them in China, and suddenly, one day, their employees were locked out of their own plant.
“So Fellowes went from having a large production base in China one day, to the next day their partner suddenly shut them off. Shut them down.” To McCormack, the moral of the Fellowes story is: “You better be very careful when you move your production to a communist country.”

There are also rising labor issues to consider in China. Chasing the siren song of cheap labor, Apple Inc.’s executive team has put virtually all of the company’s production base and supply chain in a single country now increasingly wracked with labor strife and rising wages. Strikes, and even riots, at Apple’s Chinese-run factories have become commonplace; and, shades of the Pinkertons, not even thousands of baton-wielding Chinese security police have been able to keep workers in check.

Neither has the lure of a market with 1.3 billion consumers turned out to be all it was promised for companies like The Boeing Co., Caterpillar Inc., General Electric Co. and Westinghouse Electric Corp. One major problem lies in the protectionist rules that the Beijing government imposes on most American corporations seeking to set up shop on Chinese soil.

For starters, American companies must take on a majority partner. However, it’s not just control of the enterprise surrendered. American companies must also turn over their technologies and/or processes to their Chinese partners. In many cases, these so-called “partners” will use this intellectual property in independent operations — or even turn it over to other Chinese companies.

In Death By China, Leo Hindery, managing partner of InterMedia Partners, describes the longer-run strategic implications for American companies that yield to China’s policy of forced technology transfer: “The next thing you see is you’re not doing any work over there yourself. The Chinese are doing it for you entirely. And we see that. The two mid-range aircraft in the world are the Airbus 319 and the Boeing 737.

“Five years from now, the Chinese have already told both companies, they will no longer buy either aircraft. That mid-range aircraft, the one that is dominate throughout Asia, will be entirely manufactured in China, under a Chinese mark or name, using technology that they took from Airbus on the one hand and Boeing on the other,” added Hindery.

Businessman Slane is even blunter when he observes: “The Chinese have no intention of turning over their domestic market to foreign companies. Once they’re able to master the technology, they are going to make it very difficult for foreign corporations to make a profit.”
Still another high-risk element of China’s protectionist environment is the requirement that firms not only surrender their technology but also move at least some of their research and development (R&D) facilities to China. As publisher McCormack rightly points out about the relationship between manufacturing and R&D: “They’re totally coupled. So as manufacturing has moved offshore, R&D has gone right with it.”

Patriarch Partners CEO Lynn Tilton clearly identifies the long-run danger to America when American-based multinationals move both production and R&D to China: “We are teaching the country how to compete with us, and ultimately they are.” And AFL-CIO President Richard Trumka summarizes the end result: “So that the new products, the next cutting-edge product, is being developed there where the manufacturing’s going on in China rather than here where the manufacturing was and now is no longer.”

Unfortunately, in this day and globalized age, very few corporate executives consider the national interest of America and its workers before the interests of company shareholders. This was not always the case.

As U.S.-China Commission member Pat Mulloy explains: “Corporations used to think they had a stakeholder theory. In other words, they had a responsibility to the nation, to their community, to their workers and to their shareholders. Something morphed in our own system about 20, 25 years ago where shareholder value become the end-all and be-all, and then the CEOs tied their own compensation to shareholder value, and then other countries figured out how to incentivize them to increase short-term shareholder value by transferring production, manufacturing, R&D there.”

With the less-than-peaceful rise of China, 2013 may finally be the year in which the interests of shareholders in American-based multinationals and the interests of American workers and citizens once again begin to converge under a common American flag.

National Security, Center Stage
At center stage, however, should be national security concerns. In this regard, Forbes columnist Chang describes the danger of a rapidly growing and militarizing China: “China has a population which is about five times the size of the United States; and that means that if they have a comparable level of development, they probably will end up with a military five times larger. And I don’t care what kind of technological edge we have. It would be very difficult to prevail over an adversary that is five times larger.”

We are already seeing China flex its military might — and what that could mean for corporations doing business in China. For example, as the dispute over the rightful national owner of the Senkaku Islands has escalated between China and Japan, Japanese corporations have taken a huge hit to their bottom line.

As Change writes: “More than a dozen Japanese companies halted operations in the country as fire bombings, sabotage, and looting took their toll. Manufacturers Honda, Nissan, Toyota, Mazda, Mitsubishi, Yamaha, Komatsu, Hitachi and Canon shuttered plants. Panasonic locked the doors of a factory after employees broke windows, ruined equipment and set fires. Retailers Aeon, Fast Retailing, Ryohin Keikaku, and Seven & I closed stores.”

The lesson here is quite simple: if a company has all its production eggs in the China basket and, perhaps even a good bit of its sales eggs in that very same emerging-market basket, any one of a number of triggers could wipe the company out almost overnight. These triggers range from a possible trade war that leads to stiff retaliatory tariffs by the Chinese; a diplomatic war over, say, the Dalai Lama and a free Tibet; a hot war between the U.S. and China over Taiwan; or even a Maoist takeover within the Communist Party that leads to the expropriation of foreign property.

Within the context of these growing economic, geopolitical and military risks, financial executives must play a much bigger role in better evaluating the costs and benefits associated with playing the China card. Perhaps the most important point to understand is that even if America is to avoid a geopolitical or military collision with China, there is an underlying structural trade imbalance between the two countries that must be resolved if the economic futures of both countries are to brighten.

Structurally, China is simply too export-dependent. This is because for years, China has relied on unfair trade practices — like a manipulated currency and illegal export subsidies — to fuel its export-led growth. However, as China’s unfair trade practices have steadily drained the manufacturing lifeblood out of the U.S. and Europe, China’s two biggest customers are now growing far too slowly to provide the demand for Chinese exports to sustain the Chinese economy.

China’s structural export-dependency is mirrored by America’s own Chinese import dependence and the long-term effect this has had on economic growth and job creation.

Consider that from 1947 to 2000, the American economy grew at an average rate of 3.5 percent annually. Despite the occasional recession, life was very good in this country as the U.S. standard of living steadily rose. Since 2001, however — the same year the U.S. fully opened its markets to a flood of illegally subsidized Chinese exports — the U.S. economy has grown at roughly 1.6 percent annually.

While the loss of almost two percentage points of gross domestic product (GDP) growth a year may not seem like much, every additional GDP growth point leads to the creation of one million new jobs. So losing almost two points of GDP a year over the last decade has translated into the loss of more than 20 million jobs — almost exactly what we need right now to put America fully back to work.

Because the White House, Congress and the Federal Reserve have failed to connect the dots between America’s Chinese import dependence and a stagnant American economy, they have relied on ill-advised and unduly lavish fiscal stimulus packages and “easy money” policies to try and jumpstart an economy that has lost much of its manufacturing base horsepower. This approach has not only failed to put America back to work; it has dug our country ever deeper into debt — with much of that debt ironically owed to China.

To move forward, both China and the U.S. must address these structural imbalances. In the meantime, the risks of doing business in, and with, China are growing exponentially; and corporate executives should take note.

Peter Navarro is director of the documentary film Death by China and an economist at the University of California-Irvine. He can be reached at www.deathbychina.com.