As Asia Goes to Heck, Remember Factory Asia

The system of production spread throughout East/Southeast Asia has been dubbed "Factory Asia" as we make goods for the rest of the world. In doing so, we (or is it MNCs more accurately speaking?) take advantage of our comparative advantages in splitting production activities country by country. At its apex is Japan which makes leading-edge componentry, closely followed by manufacturing-oriented Asian tigers Singapore, South Korea and Taiwan that are very nearly at the cutting edge technology-wise. Next up are China, Malaysia and Thailand--sites that combine technical expertise with lower labor costs, followed by locations whose attractions are mainly lower costs of production--Indonesia, the Philippines and Vietnam. 

As with all good things however, I think "Factory Asia" as we know it is coming to an end as territorial disputes mean that politics disrupt economics. Witness Vietnamese rioters killing Chinese workers after the PRC's excursions in the Paracels. With Chinese roughhousing now blamed for the sinking of a Vietnamese fishing boat--it's amazing how Chinese "fishing boats" are used as paramilitary forces--I fear things will only get worse. The Philippines' case against Chinese territorial overreach further agitates the increasingly belligerent PRC. Meanwhile, other Southeast Asian nations with territorial disputes with China--namely, a majority of them--are becoming wary of PRC strong-arm tactics. On top of everything, Japan and China are locked into yet another territorial dispute over another set of rocks in the East China Sea. Being the two regional bigwigs, that one probably matters the most. In total, we may have reached the point of no return.
***

Anyway, I recently found a 2013 publication from the WTO commissioned in conjunction with the Temasek Foundation (funded by Singaporean sovereign wealth fund Temasek) and the Fung Global Institute that provides a lot of information on the operations of "Factory Asia" entitled Global Value Chains in a Changing World. It discusses how these chains no longer flow in one direction but are bidirectional between different countries in the Asian example.

To understand the difference between Asian and, say, North American production networks, consider this example taken from Funukari Kimura's contribution (chapter 15), "How Have Production Networks Changed Development Strategies in East Asia?" Having contributed a lot to the supply chain literature, Kimura adds more insights here into how these networks contrast with the maquiladoras of North America:

Some East Asian developing countries have been successful in starting up industrialization by fully utilizing the mechanics of production networks and they have now attained middle-income levels. Today, the issue has become how to make the transition from a middle-income to a fully developed economy. If we simply extrapolate GDP per capita, a number of East Asian developing countries including Malaysia, Thailand, China, Indonesia and the Philippines may reach US$ 10,000 or higher within 10 to 15 years. Such simplistic macroeconomic growth cannot be automatic. Indeed, it will certainly require substantial economic transformation.

The strength of East Asia lies in the formation of its industrial agglomerations. Production networks in the region have reached a new stage of development (Figure 15.5). Fragmentation of production between the United States and Mexico, on the other hand, mostly consists of “cross-border production sharing” in which transactions can be characterized mainly as simple “go and come back” ones, and these transactions remain typically intra-firm ones. Fragmentation between Western and  Eastern  Europe  has  so  far  remained  at  a  similar  stage  of  development.  Yet,in the case of East Asia, many countries and regions are involved, interlinked by a sophisticated combination of both intra-firm and arm’s length (inter-firm) transactions, and it has truly become a “network.” There is a tendency for intra-firm transactions to be long-distance ones while arm’s length transactions are limited to shorter distances due to high transaction costs (Kimura and Ando, 2005). This generates one of the major forces forming industrial agglomerations in East Asia.

Using conventional trade figures, admittedly a compromised source of data, how can we measure the emergence of this "Factory Asia"? See chapter one of Richard Baldwin who coined the term "second unbundling" to differentiate production stages being dispersed internationally from the "first unbundling" of production from the Global North to the Global South that was still accompanied by clustering effects of factories near each other in, say, the same urban areas of a particular nation. Quoth Baldwin:

One measure of supply chain internationalization focuses on products where nations are exporting and importing an extraordinary amount. This makes little sense from a first unbundling perspective; nations seem to have both a comparative advantage (extraordinarily large exports relative to other nations) and a comparative disadvantage (extraordinarily large imports relative to other nations). From a second unbundling perspective, the extent of such overlapping comparative advantage and disadvantage provides a proxy for global supply chains.

Thus the sum of such overlapping trade as a fraction of world manufacturing trade provides a conservative measure of supply chain trade. The evolution of this measure by region...is shown in Figure 1.3:

Going by Baldwin's figures, us Asians are (were?) far more integrated in a "second unbundling" sense that I despair is now under attack from jingoism and other idiocies. Ah, how the politics always intrudes on the economics, but I guess that's why we need an IPE Zone. I just hope "Factory Asia" won't fall apart as quickly as it rose because of these inane regional tussles. As always, my priority is development for all.

Foxconn's Terry Gou & OEM's Global Pecking Order

Designed in the US, manufacturing logistics determined in Taiwan, made in China.

Actually, the post's title is a bit inaccurate insofar as all except two of the world's top electronics contract manufacturers--otherwise known as original equipment manufacturers (OEM)--are Taiwanese in origin. Both Flextronics (which makes XBox One among other things) and Jabil have American roots, but the rest hail from Formosa. Something they all share, though, is that they have been among the biggest winners from setting up shop manufacturing electronics in the PRC. The global value chain is eerily familiar regardless of the OEM concern in question: Some Western firm comes up with new designs--say, a tablet or smartphone that rotates images together with screen orientation--and then these OEM manufacturers devise ways of producing such designs on a large scale. Once they figure out how to efficiently manufacture these widgets, the grunt work of assembling and finishing them is then transferred to China.

In the value-added chain, then, Taiwanese occupy the middle position. They don't quite harvest the largest profits like Apple does by virtue of having a commercial monopoly on a globally recognized brand name. At the same time, they aren't just stuck with the grunt work either which is Chinese manufacturing, Rather, they represent fairly sophisticated middlemen who are able to translate others' designs into production on a large scale together with distribution to key consumer markets such as North America. Their place in global value chain governance is thus modular or relational in that they are able to deal with complex transactions given their formidable and expanding capabilities as suppliers. According to Terry Gou (founder and chairman of Foxconn - Hon Hai Precision, the world's largest OEM concern):

Our company grew from being a mere EMS (electronics manufacturing service) provider, or assembler, quite a while ago. Today we do upstream processes for our customers. For instance, we provide BlackBerry with IIDM (innovative integrated design manufacture) services, in which we take over from the product planning. We also work with the Canadian company in sales in Asia as well as customer support. We make our own smartphones under the InFocus brand by engaging in all stages, from planning to sales, and this helps to bolster our IIDM service.

There are some questions here, though. For one, wouldn't the likes of Foxconn want to take the next step in the supply chain and be the next Apple instead of just making stuff for them? Terry Gou rightly points out that there are very few name brands that have made it globally--readers of a certain age will remember consumer electronics forays by Nixdorf and Olivetti--both of whom now just display those wares in museums. By leaving marketing challenges to those brave enough to take risks, Foxconn remains in a safe position insofar as many of them will have their products made on an OEM basis anyway. In other words brands will come and go, but the (Taiwanese) folks who actually make these things remain the same:

Foxconn aspires to become a high-tech service company for the information age. We do not have to be a brand name. The business results of brand companies justify that. Except for a handful of them, these companies haven't generated sizable profits.

In the information age, a long-established brand can't necessarily retain consumer trust and adoration. Tesla Motors of the U.S. is a case in point. Its history is far shorter than that of Toyota Motor, or Germany's Daimler and Porsche. Nevertheless, Tesla cars are gaining popularity against those brand automakers at bay area. I myself own two Teslas. The vehicles offer a totally new driving experience.

Quibble if you will with his business practices, but few would doubt that Terry Gou knows what direction to take his business in. He is obviously a smart guy, and the other Taiwanese aren't too far behind. BTW, kudos to Nikkei Asian Review for another fine article with this interview. It is becoming a go-to source for Asian business news.

'Reshoring' Fad: Fed by 'Made in the USA' Fad?

I am in the minority over at Yahoo! News

Country of origin remains a sticking point in IPE no matter what economic liberals say. Today, let us look at a possible 'multiplier effect' where inviting manufacturing back home to America may be complemented by retailers advertising that more of their products are made there. In case you missed it, there's a 'reshoring'  fad going on Stateside wherein manufacturers who once decided to go to China and coming back since the cost savings they expected did not materialize. Often, transaction costs in the from of chronographic, geographic or linguistic differences negated labor cost savings. With China rapidly industrializing and its working age population falling, it was perhaps inevitable that even the labor cost advantage would be eroded. Whatever the cause, the net effect is more American firms coming home to America:

The Boston Consulting Group survey found 21 per cent of a sample of 200 executives of large manufacturers were either already relocating production to the US, or planning to do so within the next two years. A further 33 per cent said they were considering it, or would consider it in the near future.

Retailing giant Wal-Mart recently put more emphasis on selling US-made goods for obvious reasons. In difficult times, it becomes harder to justify selling boatloads of goods made elsewhere regardless of cost savings passed on to consumers. There's even a feature trumpeting "Made in the USA" products on their website. With Wal-Mart setting a quota for Stateside purchases, it was perhaps inevitable that the reshoring movement gained even more momentum:

Wal-Mart's new emphasis on U.S. goods spells opportunity for Lip Yow, a Malaysia-born entrepreneur who until recently made everything in China. Mr. Yow's company, AFC Trident Inc., Ontario, Calif., uses contract manufacturers in Shenzhen, China, to make plastic cases that shield smartphones and tablet computers. In April, Trident began production at a small factory in Rancho Cucamonga, Calif. Mr. Yow aims to shift most production from China to the new California plant, partly to appeal to retailers like Wal-Mart.

Getting on the shelves of Wal-Mart, the nation's largest retailer, is "very important," Mr. Yow said, showing a visitor his new plant where an American flag hangs from an overhead crane. [Yeah! USA #1!]

Wal-Mart has promised to increase purchases of U.S.-made merchandise by $50 billion, which would work out to an average of $5 billion a year. That affects just roughly 2% of what Wal-Mart spends annually on merchandise at U.S. stores, said Matthew Nemer, an analyst at Wells Fargo Securities. It is less than 1% of the U.S. trade gap in 2012. 

It could be a perverse sort of trade diversion if US retailers expressed trade preferences for buying American despite the economic case not being there. However, it appears that, in certain instances at least, doing so only reinforces the incentives manufacturers increasingly have of making stuff Stateside.

Screw Panama; Chinese & $40B 'Nicaragua Canal'

It's been a long time since we've had a video feature, but now is as good a time as any. Recently, a young Chinese telecoms magnate came to an arrangement with the (rather impoverished) Nicaraguan government to develop a Panama Canal alternative slicing through that Central American republic:

Wang Jing, a 40-year-old Chinese telecommunications billionaire, has emerged as the next mogul to give it a go. Nicaraguan President Daniel Ortega, who fought the U.S.-backed contras in the 1980s, signed a 50-year concession on June 14 that grants Wang’s HK Nicaragua Canal Development Investment Co. (HKND) rights to develop a $40 billion project that includes a canal, an oil pipeline, two deepwater ports, an interoceanic railroad, and two airports.

Apart from his youth, question marks surround whether a telecoms guy knows anything about infrastructure development. Certainly there is no lack of such projects in the PRC--it just so happens that Wang has no experience with any of them. So obscure is this guy that the Nicaraguan leader even described him as a "ghost" during the signing ceremony:

Wang, whose HKND Group launched its website just days prior to the concession signing, is relatively unknown. “Why Wang Jing?” asks Margaret Myers, China and Latin America program director of Inter-American Dialogue, a Washington research group. “He has no experience in canals or large infrastructure projects. He is a telecommunications guy in China.”

Wang is chairman of more than 20 enterprises in 35 countries, including Beijing Xinwei Telecom Technology, according to the website. He’ll be owner and chief executive officer of HKND, which describes itself as an international infrastructure developer that will design, build, and operate the canal, its first project. “Here is the ghost,” Ortega said when Wang appeared to sign the concession on June 14. “He’s flesh and bone.”

Still, there is a commercial oportunity here insofar as cargo ships become larger and larger. Pretty soon, the Panama Canal may no longer be able to handle all the volume passing through:

The project comes as Panama prepares to finish a $5.25 billion expansion of its 99-year-old canal. On June 20, Honduras announced plans to work with a Chinese company on an Atlantic-to-Pacific railroad to boost trade across the Central American isthmus. “I think it is the right time now given the expanded ship sizes out there,” says Bill Wild, a former deputy CEO of Australia-based contractor Leighton Holdings (LEI:AU) and HKND’s chief project adviser. “Even the Panama Canal can’t come close to handling the big ships being built.” The Panama Canal Authority refutes this.

Despite the understandable scepticism, it will be interesting to watch whether this is a work of genius or a boondoggle on the part of the Nicaraguans in placing their bets on an unknown quantity.

UPDATE: It seems Ortega and Wang have already disagreed in public over the canal's route. Once more, I am not so optimistic about it coming true since so many grand plans to build this canal have been mooted over several decades.

Car Talk: Detroit is Dead; Long Live S Carolina!

Despite giving up its distinction of being the world's largest car market to China in 2009, the United States remains comfortably in second place. What's more, the average price of a passenger vehicle sold in the US remains higher than one sold in China for the simple reason that US income per capita remains higher despite income being on an opposite, downward trend. We've talked a lot about cars recently, from the demise of Detroit to its replacement by (foreign-owned and non-unionized) plants in the American South alike in Alabama. Today, let's turn our attention to another rising Southern state.

It is well known that BMW chose to site in South Carolina while deciding where to put an American factory to meet US demand (especially for super-sized SUVs popular with these super-sized people). It was only natural that key suppliers would follow BMW Stateside, such as the legendary German transmission manufacturer ZF. Despite not being widely known outside of car cognoscenti circles, its reputation for cutting-edge engineering is unimpeachable. Their latest product blows the mind: a nine-speed automatic transmission boasting superior acceleration, imperceptible shifts, superior economy and smaller size.Truly, the best of all worlds is possible. Nine speeds! When I was growing up, the move from 3- to 4-speed autos was regarded as a technical achievement, but nowadays those are primitive. As it so happens, South Carolina will once more benefit from ZF marketing more of these super transmissions to German and other automakers operating Stateside. From the press blurb:

ZF Friedrichshafen AG has opened a new plant for automatic passenger car transmissions in the U.S. Located in South Carolina, ZF Transmissions Gray Court, LLC is the manufacturing site of the 8-speed automatic transmission, which is already successful in the market, as well as the world’s first 9-speed automatic transmission [...] About 1.2 million transmissions are expected to be produced at this plant annually; this includes 400 000 8-speed and 800 000 9-speed automatic transmissions. The new plant expands the existing capacities at the Saarbrücken location to produce 8-speed automatic transmissions.

Confidence is such that ZF's largest investment ever regardless of country just so happens to be FDI in America:

So far, ZF has invested around EUR 300 million in building the new location, which is around 130 kilometers north-west of Columbia, the capital of South Carolina. A total of approx. EUR 450 million is planned for investment into the new location. “It is the largest single investment in the almost century-long history of ZF,” emphasized Dr. Konstantin Sauer, ZF Board Member responsible for finance and the North American region. This reflects ZF’s vision of great potential for the region and the company’s desire to continue expanding its successful course with adequate production capacities.

And here's an important point for ZF locating in South Carolina aside from all those incentives offered by the state. Unlike bombed-out and deserted Detroit, opportunities for hiring and training workers in German-style apprenticeships is much greater:

ZF chose South Carolina because numerous automobile manufacturers and suppliers are already located in the area, and the local government provided a number of great opportunities to build a new facility. In addition, Piedmont Technical College established a new facility near ZF to aid in the training of a skilled workforce. With Clemson University in the area, it provides a great opportunity to recruit future engineers. Furthermore, the new ZF U.S. employees have been trained in the subtleties of transmission assembly by experienced, specialized ZF workers from Saarbrücken via the “Buddy Program”. The employees, trained internally through this program, now work as multipliers in Gray Court and are passing on their knowledge to the subsequently recruited U.S. colleagues.

There's no substitute for on the job training for cutting-edge production  Meanwhile, I eagerly await the 12-speed automatic transmission. [German] progress marches on.