Andrew Grove: How to Create Jobs

Includes: FXCNY, IBM, SPY
by: John Lounsbury

As a young man Andrew Grove escaped Hungary in the turmoil of the 1950s. He earned bachelor and Ph.D. degrees in chemical engineering after arriving in the U.S. He entered the semiconductor industry, eventually becoming CEO of Intel, where he remains a Senior Advisor today.

Grove has written an interesting article about job creation in Businessweek. He discusses the decades long decline of manufacturing jobs in the U.S. A graphic accompanying the article illustrates the point:

For large image, click here.

Foxconn (OTCPK:FXCNY) is a Chinese company that does contract manufacturing around the world, with the largest amount in China, for many computer, communication device and electronic subassembly companies. Included in that group are all of the companies mentioned in the above graph. The growth of employment by Foxconn has been linear (see above graph) while the revenue growth has been exponential, as shown below:

For large image, click here.

Grove did not mention IBM (NYSE:IBM), but Big Blue could be a poster child for globalization of employment. IBM announced in March that it would no longer report U.S. employment numbers in its annual reports. This company, that had around 400,000 U.S. employees a couple of decades ago, now has such a small percentage of the current 400,000 world wide total employment residing in the states that it is not worthwhile (or too embarrassing) to report.

Grove feels that one of the biggest impediments to growth of jobs in the U.S. is the investment cost per job, which he has displayed as a graph. The graph shows investment cost per job in 2000 dollars and grows from the early years (mid 1950s to mid 1970s - $2,000 to $9,000 for most companies) to over $50,000 for nearly half of the companies after the early 1990s.

For large image, click here.

He makes the following statement about the rising investment cost per U.S. job created:

The obvious reason: Companies simply hire fewer employees as more work is done by outside contractors, usually in Asia.

The rapid growth of Foxconn may also have received "investment" but it is not a public company and the source of funds for expansion is not clear. The very uniform growth of revenue over the years indicates that the growth could have been at least partially organic, with expansion funded out of increasing revenue. However, internal capitalization by the government is also possible.

An estimate of the investment cost per job created is not something for which I can make an precisely accurate estimate, but here is one possibility. If we make an assumption that 10% of revenue ($22 billion) was reinvested into expansion, the investment cost per job over the past decade is of the order of $50,000 (estimating 400,000 to 500,000 jobs added). By this estimate, the investment cost per job created in China is similar to the cost for the U.S. The primary difference between the U.S. and China therefore comes down to the cost of labor. See more about the cost of labor in the later discussion of education.

Grove does not go into enough detail to make me completely happy with his essay, but he does tackle one area that is symptomatic of the U.S. employment problem. He writes:

We got to our current state as a consequence of many of us taking actions focused on our own companies' next milestones. An example: Five years ago a friend joined a large VC firm as a partner. His responsibility was to make sure that all the startups they funded had a "China strategy," meaning a plan to move what jobs they could to China.

Grove goes on to state that VCs (venture capitalists) need to also have a "U.S. strategy". He talks about the process of scaling inventions into production which was the basis of our economic success until about 15-20 years ago. This is a skill that we have lost at the manufacturing operations level.

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 American operations. Such a system would be a daily reminder that while pursuing our company goals, all of us in business have a responsibility to maintain the industrial base on which we depend and the society whose adaptability—and stability—we may have taken for granted.

It seems to me that there is more to the problem than simple financial incentives. U.S. companies can't find qualified applicants for job openings. We aren't talking about engineers here, but ninth grade reading and basic math skills. We have an educational system that is not preparing our students to compete in the modern world. Education is a factor Grove does not mention and it is critical for the U.S. to have competitive labor costs.

If the cost of labor is 10% of the manufacturing cost in China and added transportation costs are 10%, then the U.S. is competitive only at 2x the labor cost of China. This is far short of a "living wage" for Americans. For a manufacturing worker earning $5,000 in China, the corresponding $10,000 for the U.S. doesn't cut it. The U.S. worker has to get to a 3x productivity advantage to approach $30,000, and, of course, $30,000 gets to the median income level only for a two income family. Note: the average manufacturing wage in 2008 for the U.S. was approximately $36,000.

Note: The estimate of $5,000 per year for the average manufacturing wage in China might be a little low. In 2008, data shows a monthly average manufacturing wage in China of 2,016 yuan per month. The wage has been growing at about 20% annually. This would give a 2010 figure around $5,100 per year. Wages may continue to rise rapidly in China as many job openings do not receive applicants. Foxconn recently announced a plan to double wages at their large plant in South China after 10 workers committed suicide (Bloomberg).

Grove calls for a "jobs-centric economics". It is a noble plea. He cites how long range capital investments were necessary to achieve the economic advances of the 1950s through the 1980s. The implication is that real time reward seekers have diminished our capability to compete because long range investments have no short term rewards. The types of financial incentive actions Grove is calling government to make are worthwhile ideas, but only part of the equation. There is a societal issue here, as well. Americans as individuals are not hungry enough to hone the skills necessary to compete with Asians on a cost and productivity basis. Until Americans get hungry enough, Asians will keep eating their lunch.

Standing in line behind the Chinese, manufacturing wages are even lower in places like Viet Nam and Bangladesh. The lowest skill level jobs are likely to migrate there as labor shortages and rising wages in China continue. The only place for Americans to compete will be at the highest skill levels where productivity advantages can be obtained. That brings us right back to needing to address the problem of the poorly educated American citizenry.

Disclosure: No positions.