Covid-19 Exposes America’s Vulnerability — and Resilience

Article By : Dan Breznitz

The plague upon us also affords an opportunity to revive our productive capacity, ensuring prosperity for future generations — if we act now.

The unfolding Covid-19 crisis exposed America’s significant economic and security vulnerabilities. We no longer produce — indeed are unable to develop — many of the things we need to run a modern, prosperous economy.  From swabs, facial masks, drugs and ventilators to simple computers to advance 5G telecommunication products, we are largely dependent on overseas suppliers. The supply networks that underpin both the production and innovation of those goods long ago moved from the U.S. to Greater China. In so doing, that exodus left us with hollowed-out capabilities, broken production capacities, underutilized engineering and technical talent as well over-reliance on one relatively small region of the world.

This is precisely why the pandemic might be our last opportunity to regain prosperity. In the last two decades we have been lulled into following a specific path of financialization-induced offshoring. The huge short-term profits, coupled with the impressive decrease in the prices of consumer goods, soothed us to such degree that we lost sight of the critical requirements of a vibrant economy.

Indeed, death by despair has been claiming the lives of hundreds of thousands of working Americans. But for many of us, staring as we often do at our screens, watching our favorite company stocks continue to rise, the illusion emerged that all was well. In so doing, we became the mythical frog floating in a pot of water on the stove, slowly, unwittingly being boiled alive without realizing it.

Covid-19 represents a sudden burst of heat that should awaken us to the fact that we are being cooked to death. Nonetheless, let us be clear: We are already damn-well cooked, losing so much productive capacity that to revive our economy will require us to overcome significant coordination and collective action challenges, and then sustain those efforts over multiple years — even as the pandemic recedes to the background.

This we must do. Not only is our long-term prosperity is at stake, but also because the next crisis disrupting our global production chains is already around the corner, be it medical, natural, political or manmade.

Creating incentives, engineering a response

 

There are two critical spheres of action. First, dealing with the managerial and financial regulations and incentives that have made offshoring the rational, sometimes the only, option, for too many U.S. companies. Second, engineering a response to rebuild our depleted production capacities, from skills to the production networks of suppliers and sub-suppliers that will allow us to both produce and innovate in producing finished products.

I will focus on the second set of tasks. However, we should not expect public companies to stop offshoring without changing the financial incentives of both managers and investors. That requires a fundamental shift away from focusing on short-term stock prices utilizing financial engineering tools such as stock buybacks and the use of a complex network of offshoring companies (Double Irish with a Dutch Sandwich, anyone?). Further, we must move beyond worshiping performance metrics such as simplified return-on-assets, which incentivize moving as many holdings off balance sheets as possible.

After two decades of accelerated offshoring, the obstacles to reshoring are currently so significant that we should not assume that even our best-run corporations can overcome these financial obstacles by themselves. In order for a high-end manufacturer to produce, it needs a constant supply of two resources: components, from screws and pins to various sub-systems; along with technicians, engineers and managers with highly honed production skills.

We are severely lacking in both.

Even mighty Apple Inc. found itself unable to overcome those obstacles when it tried to shift production of its Mac Pro laptops to Austin, Texas, in 2012. The consumer electronics giant quickly realized it could not even locally source components such as simple screws (when demand dried up in Texas, local producers shut down production lines and sold their equipment to China manufacturers). Worse, Apple could not find enough tooling engineers, and its top management — having developed the best global talent for offshoring and outsourced supply network management — lacked the skills necessary for actual in-house production. As Apple CEO Tim Cook observed, “In the U.S., you could have a meeting of tooling engineers and I’m not sure we could fill the room. In China, you could fill multiple football fields.”

In June 2019 Apple announced that the next version of the Mac Pro will be produced in — you guessed it — China.

Thus, we shouldn’t expect North American companies, working in isolation, to solve what is now a systemic problem.  It is not rationale to expect a single corporation to expose itself to the higher costs and bottlenecks that come with reshoring. The market will not fix by itself the sub-optimal Nash equilibrium we created over twenty years. Nor will a massive one-time injection of stimulus funds.

Needed: stable demand
Instead we need to acknowledge the obstacles and figure out how to solve them, collectively.

The first such obstacle is demand, and not just a momentary peak demand.  Rather, it must be stable, long-term demand. Without demand for domestically produced products and components, no company would invest in building up production capacity, and no worker, manager, and investors will invest in acquiring and honing the necessary skills. Demand cannot be a one-time spike. For long-term reshoring and the rebuilding of our production capabilities and innovation facilities, all economic actors need to know that an elevated level of demand is here to stay.

How then can we ensure a minimal level of stable demand for U.S.-produced products, subsystems and components?

The first tool should be government purchasing — at all levels, county, state and federal. All purchasing should include a “Made in America” component. Further, those steps should not be narrowly focused just on the healthcare supply network, but in all sectors and industries. Additionally, companies that are given federal aid as part of the Covid-19 response should be required to move a minimal (but economically significant) percentage of their sourcing and production back to the U.S. This should be done in both direct government procurement programs as well is in authorizing reimbursement programs such as Medicaid.

A key challenge is defining “Made in America.”  For example, as many of us who tinker in our garage know, most tools, all manufactured in China, are prominently promoted as “Proudly American.” The situation is even murkier for products such as pharmaceuticals, where so-called American drugs are made with 100-percent Chinese-manufactured active ingredients.

What’s clear is that better measurement and disclosure are necessary. Industries should disclose how much of critical production actually takes place in the U.S. With the right branding, consumers would be willing to pay a premium on such products, both for quality and moral (e.g., organic good) reasons. Further, it should be illegal for producers to claim anything that implies that they are “Made in America” without a significant (preferably more than 60 percent) of all components and sub-systems (and not just final assembly) actually produced in the United States.

Disclosure would also create opportunities for exclusive branding, allowing such products to fetch a higher price, as has been aptly demonstrated by both moral branding, such as fair trade in food, or quality, along the lines of “Made in Germany” for well-engineered white goods.

Often the problem is not one of absolute demand, but fragmented demand. This makes it difficult to match existing demand with supply. With its large land mass and multiple local markets, the U.S. is especially prone to such problems. Government policy can relatively easily solve this issue by mapping out and aggregating demand, then promoting it. Indeed, just demonstrating there is significant demand to be tapped in the U.S. will change the investment rational of most economic actors.

Production tech ingenuity
If there is one area where the United States still leads the world, it is new production technologies. If properly utilized, such technologies can give the U.S. a sustained dual advantage. The reason is emerging production technologies allow for the development and manufacture of new products that cannot be produced using older technologies. Thus, American companies can develop and produce domestically products as much as a decade ahead of global competitors. Those rivals would need their Chinese contract manufacturer to first master the new technologies before they can even start to play with them. This will also allow American producers to help shrink the ever-increasing U.S. trade deficit.

Too often, however, those technologies never reach the market; in their infancy, no single company has sufficient demand to make it financially rational to prototype new production technologies, much less build a full-scale factory.  Among the solutions is a form of “infant production technologies protection.” This approach should include the availability of matching funds to build the new factories that would be utilized as shared assets, that is, production facilities that allow multiple companies to produce small batches of products based on the new technologies. This approach would allow producers to demonstrate their potential and begin generating profits. Once up and running, those facilities can be then spun-off as a stand-alone high-end contract manufacturer.

The second prong in infant production technology protection should be legal covenants preventing the transfer of those technologies abroad for at least a decade, thus ensuring that all American taxpayers, who after all paid for their development, also enjoy the prosperity they generate.

Bridging the skills gap
The second obstacle to reshoring is skillsHere, the problem is not just shop-floor production skills, but also system, production and tooling engineering and production management. Add to the mix investment skills needed to grow, develop and sustain organizations that produce, instead of organizations that outsource and manage offshore supplier networks.  American workers are often faulted by U.S. corporations for lacking the necessary production skills.  But given how much of production has been offshored, how do those managers expect workers to gain or retain these skills?

Nonetheless, those skills are not gone — not yet. They exist, either in several isolated pockets across the United States, or are embodied in the many industrial retirees — either forced or voluntary. While apprenticeship programs ought to be expanded, we also need training programs that diffuse skills residing in the heads and hands of the remaining pool of skilled workers.

Two such initiatives can target each of the existing sources of skills in America. First, various programs under the the Departments of Defense and Commerce, including the Manufacturing Extension Partnership Program, and initiatives such as the Advanced Manufacturing Partnership, preserve and improve regional pockets of manufacturing skills and resources. However, they are isolated. And in the case of the Pentagon, sometimes from their very own communities. It behooves us to find ways to diffuse those skills quickly and widely.

A second approach would be targeting skilled retirees (or workers that have been displaced due to offshoring) to serve as mentors and instructors to new productions facilities across the nation. Many of those highly skilled people will gladly devote their time and knowledge to help America prosper again.

It is also our time to learn from China. During the many years doing field work in China with my coauthor Michael Murphree, we were struck by how well local planners in the Pearl River Delta understand production and the key role played by a local supply chain in ensuring innovation and continued economic growth and prosperity. City and regional leaders also understand the need for collective goods and coordination. To provide both they continuously map their local supply chains, identifying gaps and skills, components and knowledge, and boldly act to bridge them.

This is exactly the role local policy makers should play: coordination, support and ensuring collective action to supply public and semi-public goods we should not expect companies to provide by themselves. Chinese policy makers mapping and sustaining local supply networks have been instrumental in building and sustaining China’s impressive production system. It is high time we learn from them.

Last, but not least, are production research intermediaries, organizations that specializes in two critical domains for advance production. First, they help to transform and translate academic research into practical production technologies and solutions. Second, their contributions become the first cohort of engineers who work in and with those technologies.  This approach is widely used around the world, including Germany’s Fraunhofer-Gesellschaft and Taiwan’s Industrial Technology Research Institute. No such institutions exist in the United States. While there has been widespread interest in their research translation functions, the mechanisms for suppling high-skilled production talent is significantly underappreciated.

Last Chance to Act
Covid-19 has brutally exposed our weaknesses. Fortunately, it did so just before our frog was boiled to death. The task in front of us is difficult and will take years to bear fruit. However, the pandemic gives us one last chance to secure prosperity for future generations of Americans, as well as ensuring that the next crises will not find us so vulnerable.

It is time, then, that we believe again in American ingenuity and give Americans the chance to show the world what its people are capable of doing, innovating and producing.

Let us all take collective leadership and action in shaping our future for the better.

— Dan Breznitz is the Munk Chair of Innovation Studies, and co-director of the Innovation Policy Lab at the Munk School, University of Toronto, as well as a Fellow of CIFAR where he co-directs the program on Innovation, Equity and the Future of Prosperity. 

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