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Originally published Sunday, July 4, 2010 at 10:00 PM

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We must rebuild structure to create U.S. jobs

Recently an acquaintance at the next table in a Palo Alto, Calif., restaurant introduced me to his companions, three young venture capitalists from China. They explained, with visible excitement, that they were touring promising companies in Silicon Valley.

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Recently an acquaintance at the next table in a Palo Alto, Calif., restaurant introduced me to his companions, three young venture capitalists from China. They explained, with visible excitement, that they were touring promising companies in Silicon Valley. I've lived in the Valley a long time, and usually when I see how the region has become such a draw for global investments, I feel a little proud.

Not this time. I left the restaurant unsettled. Something did not add up. Bay Area unemployment is even higher than the national average. Clearly, the great Silicon Valley innovation machine hasn't been creating many jobs unless you're counting Asia, where U.S. tech companies have been adding jobs like mad for years.

The underlying problem isn't simply lower Asian costs. It's our own misplaced faith in the power of startups to create U.S. jobs. Americans love the idea of the guys in the garage inventing something that changes the world.

New York Times columnist Thomas L. Friedman recently encapsulated this view in a piece called "Start-Ups, Not Bailouts." His argument: Let tired old companies that do commodity manufacturing die if they have to. If Washington, D.C., really wants to create jobs, he wrote, it should back startups.

Friedman is wrong. Startups are a wonderful thing, but they cannot by themselves increase tech employment. Equally important is what comes after that mythical moment of creation in the garage, as technology goes from prototype to mass production. This is the phase where companies scale up. They work out design details, figure out how to make things affordably, build factories and hire people by the thousands. Scaling is hard work but necessary to make innovation matter.

The scaling process is no longer happening in the U.S. And as long as that's the case, plowing capital into young companies that build their factories elsewhere will continue to yield a bad return in terms of American jobs.

Scaling used to work well in Silicon Valley. Entrepreneurs came up with an invention. Investors gave them money to build their business. If they were lucky, the company grew and had an initial public offering, which brought in money that financed further growth.

As time passed, wages and health-care costs rose in the U.S. China opened up. U.S. companies discovered that they could have their manufacturing and even their engineering done more cheaply overseas. When they did so, margins improved. Management was happy, and so were stockholders. Growth continued, even more profitably. But the job machine began sputtering.

The 10x factor

Today, manufacturing employment in the U.S. computer industry is about 166,000, lower than it was before the first PC, the MITS Altair 2800, was assembled in 1975. Meanwhile, an effective computer-manufacturing industry has emerged in Asia, employing about 1.5 million workers.

The largest of these companies is Hon Hai Precision Industry, also known as Foxconn. The company's revenues last year were $62 billion, larger than Apple or Intel. Foxconn employs more than 800,000 people, more than the combined worldwide head count of Apple, Dell, Microsoft, Hewlett-Packard.

Until a recent spate of suicides at Foxconn's giant factory complex in Shenzhen, China, few Americans had heard of the company. But most know the products it makes: computers for Dell and Hewlett-Packard, Nokia, cellphones, Microsoft Xbox 360 consoles, Intel motherboards and countless other familiar gadgets.

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Some 250,000 Foxconn employees in southern China produce Apple's products. Apple, meanwhile, has about 25,000 employees in the U.S. That means for every Apple worker in the U.S. there are 10 people in China working on iMacs, iPods and iPhones. The same roughly 10-to-1 relationship holds for Dell, disk-drive maker Seagate Technology and other U.S. tech companies.

You could say, as many do, that shipping jobs overseas is no big deal because the high-value work and much of the profits remain in the U.S. That may well be so. But what kind of a society are we going to have if it consists of highly paid people doing high-value-added work and masses of unemployed?

Since the early days of Silicon Valley, the money invested in companies has increased dramatically, only to produce fewer jobs. Simply put, the U.S. has become wildly inefficient at creating American tech jobs.

More than jobs

There's more at stake than exported jobs. With some technologies, both scaling and innovation take place overseas.

Such is the case with advanced batteries. It has taken years and many false starts, but finally we are about to witness mass-produced electric cars and trucks. They all rely on lithium-ion batteries. What microprocessors are to computing, batteries are to electric vehicles. Unlike with microprocessors, the U.S. share of lithium-ion battery production is tiny.

That's a problem. A new industry needs an effective ecosystem in which technology know-how accumulates, experience builds on experience, and close relationships develop between supplier and customer. The U.S. lost its lead in batteries 30 years ago when it stopped making consumer-electronics devices. Whoever made batteries then gained the exposure and relationships needed to learn to supply batteries for the more demanding laptop PC market, and after that, for the even more demanding automobile market.

Key to job creation

Scaling isn't easy. The investments required are much higher than in the invention phase. And funds need to be committed early, when not much is known about the potential market. At Intel, the investment to build a silicon manufacturing plant in the '70s was a few million dollars. By the early '90s the cost of the factories that would be able to produce the new Pentium chips in volume rose to several billion dollars. The decision to build these plants needed to be made years before we knew whether the Pentium chip would work or whether the market would be interested in it.

Lessons we learned from previous missteps helped us. Some years earlier, when Intel's business consisted of making memory chips, we hesitated to add manufacturing capacity, not being sure about the market demand in years to come. Our Japanese competitors didn't hesitate: They built the plants. When the demand for memory chips exploded, the Japanese roared into the U.S. market and Intel began its descent as a memory-chip supplier.

I still remember how afraid I was as I asked the Intel directors for authorization to spend billions of dollars for factories to produce a product that did not exist at the time for a market we could not size. Fortunately, they gave their OK even as they gulped. The bet paid off.

My point isn't that Intel was brilliant. The company was founded at a time when it was easier to scale domestically. For one thing, China wasn't yet open for business. More importantly, the U.S. had not yet forgotten that scaling was crucial to its economic future.

How could the U.S. have forgotten? I believe the answer has to do with undervaluing of manufacturing. Consider this passage by Princeton University economist Alan S. Blinder: "The TV manufacturing industry really started here, and at one point employed many workers. But as TV sets became 'just a commodity,' their production moved offshore to locations with much lower wages. And nowadays the number of television sets manufactured in the U.S. is zero. A failure? No, a success."

I disagree. Not only did we lose an untold number of jobs, we broke the chain of experience that is so important in technological evolution.

Job-centric economics

Our fundamental economic beliefs are that the free market is the best of all economic systems. Our generation has seen the decisive victory of free-market principles over planned economies. So we stick with this belief, oblivious to emerging evidence that while free markets beat planned economies, there may be room for a modification that is even better.

Such evidence stares at us from the performance of several Asian countries in the past few decades. These countries seem to understand that job creation must be the No. 1 objective of state economic policy. The government plays a strategic role in setting the priorities and arraying the forces and organization necessary to achieve this goal.

How do we turn such Asian experience into intelligent action here and now? We need a job-centric economic theory and job-centric political leadership to guide our plans and actions.

The first task is to rebuild our industrial commons. We should develop a system of financial incentives: Levy an extra tax on the product of offshored labor. (If the result is a trade war, treat it like other wars: fight to win.). Keep that money separate. Deposit it in the coffers of what we might call the Scaling Bank of the U.S. and make these sums available to companies that will scale their U.S. operations.

Every day, that Palo Alto restaurant where I met the Chinese venture capitalists is full of technology executives and entrepreneurs. Many of them are my friends. I understand the technological challenges they face, along with the financial pressure they're under from directors and shareholders. Can we expect them to take on yet another assignment, to work on behalf of a loosely defined community of companies, employees, and employees yet to be hired? To do so is undoubtedly naive.

Yet the imperative for change is real and the choice is simple. If we want to remain a leading economy, we change on our own, or change will continue to be forced upon us.

Andy Grove was chairman and chief executive of Intel and now

is a senior adviser to the company.

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