ETF Investment News & Articles

Come Home Corporate America – Follow the Rising Sun

Op-ed submittal by Carlton Delfeld: (719) 264-1503, cdelfeld@adelphia.net

During the last decade, a hot topic in Japan and America has been the “hollowing out” of
their respective industrial bases. The share of Japanese-owned productive capacity
located abroad has grown from 8% in 1994 to 40% today. The United States currently has
about 50% of its manufacturing base located offshore.

For both Japan and America, the large outflows of direct investment, especially to China, have caused an uneasy feeling that both countries had bleak futures as manufacturing centers.

Surprisingly, the pendulum is now moving back to Japan as large Japanese multinationals are busy investing in manufacturing plants at home. Here are just a few examples of this trend. Canon is building a large digital camera facility and plans to spend 80% of its $7.2 billion capital budget in Japan over the next three years. This is a reversal from the past ten years when 80% of its capital budget was spent overseas. Toshiba is building a $2 billion semiconductor facility. Sharp, Matsushita and Nippon Steel are also building major plants in Japan. Overall, spending on plants and equipment in Japan is rising at a 10% clip.

It’s not that China is not important to Japan’s economic growth. China has passed the
U.S. to become Japan’s largest export market. In addition, it needs a strong presence in China to tap its rapidly growing consumer market as well as a low cost base to
manufacture lower tech products. For certain products like cars it is also likely to keep

large manufacturing bases in countries like America. For example, Toyota produces more
than 1 million cars annually at eight manufacturing plants in America and has two plants
under construction in Texas and Tennessee. But for the more advanced capital-intensive
products, the investment is clearly coming home.

How can we account for this surprising turnaround and what are the lessons for America?
First, Japanese firms have learned the drawbacks of outsourcing. Supply bottlenecks,
poor infrastructure, power shortages, uneven quality, difficult inventory management and
high employee turnover are just some of the problems.

Secondly, even though China’s wages are about 5% of Japan’s, its increasingly
sophisticated factory automation has lessened the importance of labor costs. For
advanced high tech products it accounts for only 10-15% of total costs. Having
manufacturing closer to home also shortens new product lead times and increases
cooperation between R&D and production teams leading to a crucial edge in staying
ahead of its nimble competitors. Supply lines of 2,000 miles can be problematic.

Lastly, and perhaps most importantly, there is the critical issue of protecting intellectual
capital. Having research, development and production closer to headquarters better
protects proprietary technologies.

Unfortunately, here in America the outsourcing trend does not appear to be reversing
even in capital-intensive products. Many of the new high tech jobs are for managers to
manage the outsourcing process. Microsoft, Intel, IBM and Motorola all have large and
growing R&D centers in China to take advantage of Beijing’s cheaper pool of talent.

Given China’s total disregard for intellectual property rights, perhaps American
executives should pause and reconsider the long-term costs of growing outsourcing
programs. Their offshore R&D staff may very well walk off with proprietary knowledge
and the company’s future.

This is not a call for isolationism or rolling back globalization, just a reminder that
outsourcing has its downside. How about a little common sense and balancing short term
cost savings against long term strategic risks?

Instead of just taking the comparatively easy step of lowering labor costs by outsourcing,
let’s roll up our sleeves like the Japanese, improve manufacturing techniques and reap the
benefits of keeping more production and technology closer to home.

Carlton Delfeld is President of ChartwellETFadvisor.com, a global investment advisory firm,
He is the author of the “New Global Investor” to be published in December. He was a Japanese Government Scholar at Keio University’s School of Commerce and served on the Board of Directors of the Asian Development Bank.