In this season of ghosts and demons, I thought it might be interesting to review the horror and scariness of working in supply chain over the last three decades.
First, let me set the stage. U.S. economic policy over the last three decades has been one of pursuing low-wage-country materials and products overseas, specifically in China. This led—at least initially—to lower material prices and later, to lower-priced consumer products.
The transition of U.S. purchases of Chinese imports from low value-add materials to higher value-add products should not be a surprise. Why? Because this aligns exactly with China’s long-term economic policy, which has been to use its initial foray in supplying low-price materials to gain the expertise needed to manufacture more complex products and—not a minor issue—finance its industrial expansion.
The end-result of these two contrasting economic policies is that over the last generation, U.S. consumers enjoyed low prices, and corporations have seen expanding profits. Some might say, “What’s the problem with taking advantage of lower-priced goods from low-wage countries?”
I admit that there is some validity to this reasoning. For instance, Britain maintained financial prosperity for over 200 years by buying low-cost raw material—mostly commodities such as tea—from its colonies and then selling higher value-added finished goods back to the colonies, facilitating the Industrial Revolution. But in the case of U.S.-China trade, exactly the opposite has occurred the buyer of the low-priced raw material has facilitated the seller’s own industrial revolution.
In other words, U.S. trade policies have meshed with China’s to facilitate that country’s growth into a worldwide economic power based on manufacturing. It’s difficult to think that this is a coincidence. China obviously knew what it was doing. And for the most part, we have been snookered.
Purchasing departments happily went along in the above since their performance bonuses and raises are primarily—or exclusively—based on obtaining lower material cost, regardless of the consequences.
Are there further differences between Britain’s approach to foreign trade in the 1700s and 1800s and our country’s recent trade policy with China? Yes, at least three significant ones. First, Britain had almost all of the leverage over its subservient colonies, backing this up with military might and administration. In effect, the colonies toed the line relative to the role Britain intended for them to play. As a result, change in that role transitioned very, very slowly. On the other hand, the U.S. government and its manufacturers assumed that China’s role as a supplier of low value-add materials would remain constant over a significantly longer period. Whatever trade leverage our country may have had over China in 1990 has pretty much evaporated today.
Second, over the past 30 years, the contribution of manufacturing to the U.S. economy has shrunk from over 20% to just over 10%. This is different from Britain’s “empire” experience, where cheap raw materials led to Britain greatly expanding its manufacturing power and dominant world trade. Along with manufacturing’s drop in our country’s economy, there has been a parallel drop in manufacturing employment.
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Over that time, economic pundits have pointed to significant increases in manufacturing efficiency as a reason for manufacturing’s employment loss and, in truth, some of it is due to increases in operational effectiveness. But what those economists don’t tell you is that material cost is a major driver in productivity calculations. Consequently, a significant amount of our county’s productivity gains are due to the lower cost of materials from overseas sources, primarily from China. So, all is not as rosy as it seems in the rising productivity in this country. Manufacturing employment is down not so much due to productivity gains as Original Equipment Manufacturer (OEM) low-wage-country sourcing policies.
Think about this a minute. While during its hey-day—in addition to the efficiency improvements derived from lower material cost—Britain led the world in developing internal operational efficiency which, in turn lead to a growth in the financial impact manufacturing had on Britain’s overall economy.
Finally, China has become our largest trading partner, by far. Britain purchased its raw material and sold its manufactured goods fairly evenly across the world.
When I was a purchasing manager, a rule I established for my buyers was that we should not source with any supplier whose business was significantly beholden to a single OEM, including our company. My maximum limit for this was 20%. The point here is that we couldn’t control markets—either ours or those of our suppliers’ other customers—and we needed to limit our risk of non-supply if our supplier faced financial difficulties from losing a big chunk of business.
I think there is a parallel here, in reverse. We have become dependent on China as a supplier. They are our largest trading partner. As stated above, this led to the expansive maturation of their manufacturing base. But it also has led them to be the largest holder of U.S, debt—by far—in the world. Talk about leverage. Should China stop buying our debt—or horror of horrors, starting selling what they have—the U.S. would have to pay higher interest on its debt since demand for it would be significantly reduced. Not a good thing.
As a consequence of all of the above, China is able to significantly build up their military, which is resulting in increasing tension in that part of the world. One could easily posit that while U.S. consumers got lower price televisions and other appliances, China—as a country—got nuclear powered submarines; i.e. they didn’t have any in 1990. If that’s not scary, what is?
Another consequence is that U.S.-based OEMs have been tasked with trying to manage extended supply chains. Which, I might add, presents significantly higher degrees of difficulty to deal with during disruptions, as seen with the COVID-19 pandemic. Collaboration becomes more difficult with distance, particularly the kind of firefighting that many OEMs are facing today regarding continuity of supply.
So, what does this country do? First, recognize that the solution to this problem is long-term; it can’t be fixed overnight. In other words it is unrealistic to expect any one action—such as tariffs on Chinese goods—to be a solution to the mess our trade and purchasing policies and practices relative to China have led to. As I said above, China has developed a lot of leverage.
For instance, when we applied our first tariffs to Chinese goods, they stopped buying our country’s grain. There were two consequences to this. First, the U.S. Treasury had to spend $43 billion to support our agricultural markets, i.e. not a free-trade tactic by any means. And second, to get China to again start buying our agricultural goods, we had to cut tariffs on several categories of goods our country buys from them.
Don’t get me wrong, I think tariffs can be an effective tool for getting another country’s attention on our trade concerns. But it should not be relied on as a long-term solution, nor should it be the only tool on our tool belt.
So, I ask again, what’s to be done? Overall, I’m not sure. But one thing I do know that is continuing with our current trade and purchasing policies will only make the world a scarier place for U.S. citizens. For instance, at first, U.S. OEMs were able to “eat” the tariff-related price increases on the material they purchase from China. If you haven’t noticed it recently, though—and I suspect you have—prices on goods from China having been creeping up due to those tariffs, along with pressure from holders of company stock.
It should be obvious that our country needs a consistent long-term trade policy: One that recognizes our current predicament and realistically works to address the dire state of our small-and-medium-sized manufacturers. I’m convinced this will require more governmental involvement in our economy.
Another point I believe is necessary is that OEMs will need to significantly adjust their understanding of the impact their purchasing function can have on company financials, above-and-beyond material cost. If you are interested in understanding these impacts and how they would raise the practice of the purchasing profession—as well as reduce the current advantage low-wage countries have due to current OEM sourcing strategies—you can read about it in my recent book, “Better Business: Breaking Down the Walls of the Purchasing Silo.”
I suspect to “fix” our financial quandary, there will need to be some belt-tightening by Original Equipment Manufacturers, their stock holders and the consuming public. This will not be pleasant but will result in rebuilding America’s position in overall world-trade. I wonder if we are up to it.
Paul Ericksen’s book is Better Business: Breaking Down the Walls of the Purchasing Silo. Ericksen has 40 years of experience in industry, primarily in supply management at two large original equipment manufacturers.
