For quite some time in the US, there has been a lot of buzz from all sides about offshoring. Offshoring is when companies move operations out of the country in search of cheaper operating cost. Operating cost is made up of both labor and material cost. Lots of times, these costs are fixed, meaning that reducing those costs can have a dramatic effect on improving a company’s profitability. In Deloitte’s piece on share buybacks, they point to the effect offshoring has had on increasing profits for companies, while also reducing the need for business investment:
“When businesses based in the developed world shift away from domestic suppliers to low-cost suppliers in China, business investment shifts overseas while domestic profits increase.16 The offshoring of capital-intensive work and the outsourcing of services to lower-wage countries helps explain higher domestic profits and lower domestic corporate investment and therefore a lower share of corporate profits spent on domestic investment.” [From Deloitte]
With cheaper costs, and higher profits, offshoring leaves companies with cash they simply don’t need to invest. Offshoring operations inherently means less domestic investment. This is the effect that globalization has; it enriches corporations while forcing costs down domestically. If the jobs that went offshore ever have the chance of coming back, either domestic costs needs to be driven down, or foreign operating costs driven up. Fortunately for companies, and unfortunately for US laborers, there are still many countries around the world that are more than willing to undercut on costs just for the chance to land the jobs that come with a multi-national US firm. As a result, wages for workers in the US, have stagnated (and fewer of them exist in some sectors), while US corporate profits have soared since the year 2000, as seen in the FRED chart below.
On a side note, from the above chart, notice how before tax profits have been stagnant since Q1 of 2012, while recently after tax profits have jumped noticeably, starting in Q1 of 2018. That would be the Trump Corporate Tax cuts taking effect. The below chart from FRED shows that in the same time period as above (2000-2018), weekly earnings adjusted for inflation, and before taxes and deductions (health insurance, social security, taxes, etc…) have barely budged; they had only gone positive in Q3 of 2014 (since Q1, Y2000). To sum it up with the bottom line numbers, while corporate profits increased 256%, real wages have gone up 5%. That 5% may very well have been eaten up by rising health care costs alone!
Whether it’s China, or India, or Bangladesh, globalization has redistributed wealth in different ways. And its not just to poor countries where factories and factory labor are going; it’s also occurred from Main Street to Wall Street. How you ask? Simple: when costs go down (as a result of offshoring), profits go up. This is wealth transfer from laborers who lose their jobs, to shareholders who pocket the cost reductions. Furthermore, companies ask for, and receive ridiculous incentives from foreign countries when transferring operations from the US, enriching corrupt politicians in the 3rd world, and contributing to wealth inequality outside of the US. Something synonomous to off-shoring is actually happening domestically, and its aclled near-shoring. Amazon has been in the news for many reasons lately, not least of which is it’s selection process for Amazon HQ2; cities all over the country, from Chicago to Austin, to Atlanta and Boston, are offering ridiculous tax breaks to Amazon for the chance to be home to Amazon HQ2. But who pays for these incentives and tax breaks?In the end, the tax payers of those cities are on the hook, regardless how many of them benefit from HQ2. For example, Chicago, my home city, is in fiscal crisis, but it is also a finalist for Amazon HQ2. How can Chicago, a city some say is insolvent, offer any tax breaks to Amazon?? The answer is that the money is transferred to Amazon not from the bankrupt city coffers, but from future tax income, which ultimately is the future earnings of taxpayers. This is just another example of wealth transfer, this time from tax payers to corporations. Some will argue that Amazon will bring jobs, and therefore tax payers will benefit; that is nonsense. I say, in reality, only a subset of taxpayers will benefit, the rest face only the cost.
Capital goes wherever it can earn the best return; that is free market economics. Whether it be Chicago, or Columbus, Amazon HQ2 will go wherever Amazon can benefit the most. Factories moving out of, and sometimes back in to, represent the exploitation of capitalist opportunity. As foreign markets, such as China’s, become more and more exploited, factories will one day move out, and go somewhere where costs are lower, and returns better. It is nothing more than a natural process of diffusion, like heat transfer; as economic activity overheats (becomes expensive) in one area, it naturally shifts to cooler (cheaper) parts of the globe. Both costs and risks play important factors.
Silicon Valley’s Changing Role
The US, and specifically Silicon Valley, is an incubator for cutting edge technology. No other country can compete in attracting the human and monetary capital required to develop these technologies. With that said, once these ideas have matured and become marketable products, companies need to go overseas to find the highest margins, and sustainable growth. Facebook has seen it’s overseas growth catch up to its domestic growth rate, but costs are rising massively in the US due to Facebook’s content cleansing campaign, and political ad scandal. It’s no wonder articles like this one from Business Insider and this one from CNBC are signaling overseas expansion might need to be it’s new priority.
Tesla is a perfect example of a company going overseas to capture higher margins. For Tesla, China represents the economy with the most potential, in terms of sheer population, and in terms of consumer purchasing power. The US consumer is riddled with debt, and the consumer market is shrinking as baby boomers die off and adults have fewer children. An LA Times article I found states that a proposed Tesla China factory will,
“…turn out 500,000 vehicles a year, primarily for the China market.”
How many cars does Tesla currently produce for the US market on an annual basis? In 2017, the most recent completed year, Tesla produced 103,200 cars, according to Statista. Tesla plans on putting out 5x their US production numbers in China. That is telling. The larger numbers make the unit production cost of the vehicles lower, so the effect of having a larger consumer base not only increases revenue, but also profits. Furthermore, according to Michael Dunne of Zozogo, any tariffs Tesla may have to deal with in China will have no real effect, given the price insensitive Chinese consumer:
“People buying at that end of the market are highly price insensitive to begin with. If they want to buy a Tesla they’ll buy a Tesla. The price hike [from tariffs] is simply an ‘irritation’.”
How much exactly is that irritation he speaks of? Also from the LA Times:
“…Tesla raised prices on cars it exports to China by $20,000, after it got hit by China with retaliatory tariffs that total 40%.”
Just a $20,000 “irritation”! This is very telling. The Chinese consumer is a gold mine for Tesla, because of his/her price insensitivity. There are other interesting points in the LA Times article, like the fact Tesla would own 100% of the factory, and would not have to partner with, or be sponsored by, a Chinese firm. This would be a first. Tesla would most likely never agree to a forced partnership with a Chinese firm. You can read this article from Reuters to see how those types of partnerships have worked out for Ford. Just like Ford’s business in the US was helped to ruin by union contracts and pension liabilities, Ford’s business in China has struggled because of it’s Chinese partners. Ford is able to operate in China because of its partnership with the Changan Automobile Group. The partnership is known as Changan-Ford. Ford has had that partnership for over 20 years, and given Ford’s declining market share in China, it’s clearly not working. In this Forbes article, Michael Dunne of ZoZoGo again gives us insight into what Ford needs to do to get back into the China game. The most significant recent action Ford took was to partner with Zoyte, a relatively new Chinese electric car company. From Forbes, Mr. Dunne states that,
“China leads the world in electric vehicle sales (777,000 in 2017). Beijing technocrats want that number to reach 1 million this year and then zoom to 6 million by 2025. An earlier, less nimble, version of Ford would have studied the various partner options for a couple of more years before settling on Zotye as a partner.”
Tesla doesn’t need a partnership in China, at least not one that will be involved in producing and selling electric cars. That part, Tesla has down. The fact Ford partnered with Zoyte shows Ford is far behind Tesla in being able to built electric cars en masse, in the quantities Beijing envisions. It’s possible that going forward, American companies in China may gain leverage over their partners in China. China has no incentive for American business to fail in China. The fact that Ford’s China business was nearing a crisis, may have been just what it needed to gain leverage in China. As noted from Reuters, Ford’s legacy partners, Changan and JMC, have agreed to Ford’s demands on combining vehicle distribution and service into one company, as away to unify the Ford-Changan and Ford-JMC brands. This was a huge win for Ford, and signals a “new phase of our partnerships”, according to Ford. This progress from Ford’s perspective may have been just what it needed to be more aggressive forming new, more market relevant partnerships, like the ones it recently made with Zotye, Alibaba, and Baidu. With their Alibaba partnership, they have massively increased their access to the Chinese consumer. We shall see if this optimism holds. This recent news shows it may not; tariffs are apparently far more destructive for Ford than Tesla.