Tuesday, November 23, 2004

The Great Wal-Mart Of China, Part II

In Part I of this series, I discussed the shift in the balance of power within the American economic framework - in favor of retailers to the detriment of manufacturers and suppliers. At the forefront of this revolution is retailing juggernaut Wal-Mart. Through innovation, aggressive business practices, and the implementation of a radical new employer/employee business model, Wal-Mart has been blazing a trail that is having widespread ramifications throughout the US economy. In the wake of this hard charging corporate superstar lies the ruins of countless thousands of once coveted manufacturing jobs, and with it, the whole concept of high valued employment for life. Following Wal-Mart's lead, other retailers - as evidenced by the recent merger of Kmart and Sears Roebuck & Company - have begun to pattern their business practices accordingly: lowering costs by reducing salaries and benefits, putting increased pressure on US manufacturers by using the clout of their far reaching buying power, and encouraging outsourcing.

It is the last part of that tripartite approach, encouraging outsourcing, that I will focus on in Part II. In particular, Wal-Mart's increased intertwining of interests with the restive giant that is China.

To The East

Wal-Mart maintains its high profit margins, which it needs to continue expansion as well as reward shareholders and Wall Street, by streamlining its processes to reduce costs. This is accomplished through technological advancement, a low wage/low benefit employment mode, and demanding ever lower prices from the manufacturers that produce the products Wal-Mart sells. This model has created a good deal of tension between Wal-Mart and US manufacturing firms because the latter's profits have been consistently reduced, diminished and eliminated by the relentless demands of Wal-Mart. There is only so far the manufacturing firms can go while still paying workers a living wage and comporting with US labor laws.

Perceiving these limitations, Wal-Mart began soliciting cheap imports as far back as the 1970s. At that time, however, Wal-Mart was already lagging behind its competitors like Sears, Montgomery Ward, JCPenney and Kmart in the quest for imports from abroad.

In addition, Wal-Mart seemed conflicted between its desire for ever cheaper products, and its instincts to support US industries. Founder Sam Walton initiated a famous "Buy American" campaign during the 1980s and early 1990s. Walton even went as far as to bail out some U.S. companies, in a few highly publicized cases, by purchasing their wares when imports were threatening to put them out of business.

But the allure of cheap merchandise has steadily eroded Wal-Mart's more noble sentiments. Throughout the same period that Walton was touting "Buy American," Wal-Mart was increasing its percentages of imports from Asia and elsewhere. As Wal-Mart increased its competitive advantage through its computerized supply chains, it soon overtook its rivals and became the biggest global importer, with a list of suppliers stretching into the tens of thousands and representing many different nationalities and localities.

The change in philosophy for a company that once urged domestic purchasing is evident in the rhetoric of the company's management. For example, when CEO Lee Scott and CFO Tom Schoewe talk with Wall Street analysts, they are boastful in their emphasis on global sourcing as vital to maintaining and increasing Wal-Mart's bottom-line profits.

Over time, Wal-Mart began to narrow its importing partners, increasingly focusing on one giant resource: China. According to

Wal-Mart inherited a massive list of global suppliers, now winnowed down to 6,000
global suppliers, 80 percent in China...

Today, it is a massive conveyor belt to the U.S. consumer of $15 to $30 billion a year in products from China. By the estimate of Retail Forward, Wal-Mart now imports more than half of its non-food products. [emphasis added]
But Wal-Mart has taken the process of global sourcing several steps farther than mere bargain hunting by forming a multifaceted partnership with China. The migration to the East was exemplified by Wal-Mart's establishment of its primary global procurement center in Shenzhen, the "miracle city" and hub of South China's export industries. This new locus for Wal-Mart's corporate activities is just the culmination of years of pro-active efforts to shift production and manufacturing facilities to China.

In fact, both academics and business executives report, American retailers have actively driven outsourcing -- teaching East Asians how to design and manufacture products for American consumers, creating their own house brands in league with Chinese and Asian producers, and then bluntly warning beleaguered U.S. manufacturers that they'd better move their American plants to China and Asia if they want to survive...

Chinese entrepreneurs describe how Wal-Mart presses them to integrate their operations into Wal-Mart's business plans and supply chain. Frank Ng, a partner in Force Electronics, which makes radio-controlled toys and other high-tech gadgets for Japanese toy firms to sell to Wal-Mart, told me Wal-Mart requires his firm to send managers for training to Wal-Mart's center in Shenzhen, makes the firm use Wal-Mart's computer software, and then monitors its production...

Collaboration with its firms now extends to joint efforts at creating, designing, and producing products for the American market. "Wal-Mart gives Chinese suppliers the specifications for Wal-Mart products," says Professor Gereffi. "And they teach those suppliers how to meet those specifications. They have to do with price. They have to do with quality. They have to do with delivery schedule. So, in a sense, Chinese suppliers learn how to export to the U.S. market through large retailers like Wal-Mart."
China's economy is expanding at rates that have given some economists cause for concern for its own health, and to such a degree that it is rapidly becoming an economic superpower - a potential rival for even our own economic interests especially throughout the rest of Asia. And the whole time, their transformation into capitalist titan has been aided and abetted by an unlikely midwife: Wal-Mart. Wal-Mart has been spending time, effort and resources in helping Chinese firms to outcompete American ones. But they are not even content with their own migration to China. They are encouraging - even coercing - US manufacturers to relocate to China or face extinction.

Case in point: Bill Nichol, CEO of Kentucky Derby Hosiery, a sock manufacturer that has supplied Wal-Mart for 40 years. He credits Wal-Mart with forcing his company to be more disciplined and efficient, but he adds: "Their message to us, surprisingly, is, 'There's a broad market out there. If you want to focus on the lowest-cost part of the market, it's obvious that you can't do that in the United States'." So half of Nichol's 1,500 U.S. employees will soon be out of work and he'll have to open plants in China and other low-cost countries to hang onto his Wal-Mart account.

We heard that story again and again from American manufacturers in sectors as diverse as electronics, apparel, bicycles, furniture, and textiles. They expressed private dismay at the relentless pressure from the likes of Wal-Mart and Target to cut costs to the bone in America and then, when that did not satisfy the mass retailers, more pressure to move production to China or elsewhere offshore. But most did not dare to go on camera and tell their story publicly for fear of jeopardizing their remaining sales to Wal-Mart.

Privately, they report that Wal-Mart house brands, made in China, are undercutting their American-made products. Some add that Wal-Mart buyers "advise" and push them to move a certain share of their production abroad, up to 30 percent, and then periodically check to see whether American firms are meeting Wal-Mart's quota for overseas production.
Wal-Mart's representative seemed to acknowledge this part of their corporate strategy in an interview given to Frontline. He certainly didn't deny it:

When I asked Wal-Mart's Ray Bracy about the complaints of U.S. suppliers that they were being pressured to shift production overseas, he said he could not confirm that happened but added, "I suspect that this is a legitimate occurrence that you're citing and, and there may be some validity to that."
Thus Wal-Mart and China have formed a type of joint venture. Not only does Wal-Mart purchase enormous quantities of its products from China, it has also moved its global procurement operations there, trained and tutored aspiring Chinese workers in the business of exporting to America, pressured other US firms to migrate to China, and even went as far as to begin developing branded products with Chinese manufacturers.

Wal-Mart and China are a joint venture," Gereffi replied. "And both are determined to dominate the U.S. economy as much as they can in a wide range of industries." This hand-in-glove partnership increases the squeeze on U.S.-based manufacturers to outsource or shut down. Privately, they report that Wal-Mart house brands, made in China, are undercutting their American-made products.
Crouching Tiger

Despite the bitter political division in Washington during the late 1990s, there was a growing consensus on one big issue. Most Republicans and Democrats agreed that trade with China would be a boon for America. I, for one, was strongly in favor of the moves to increase economic ties with China because I believe that engagement, cooperation, and interaction can act as a catalyst for democratic reform in countries that have a tradition of despotism and totalitarianism. In many ways, these economic ties have borne such fruit as China continues to move, albeit incrementally, toward the adoption of democratic reforms.

But economics, not foreign policy concerns, were the primary impetus giving rise to the bipartisan support for expanded trade with China.

President Clinton summed up the mainstream consensus in Washington with a message to Congress in the spring of 2000. In a letter circulated to House members, he wrote, "China with more than a billion people is home to the largest potential market in the world...if Congress makes the right decision, our companies will be able to sell and distribute products in China made by American workers on American soil, without being forced to relocate manufacturing to China...We will be able to export products without exporting jobs."
The mood was optimistic, the size of the market proved too tantalizing an inducement to ignore. But despite the grandiose expectations, the record has been a mixed one - especially regarding claims of job losses.

The benefits of trade with China largely depends on what business sector you are in. Expanded trade with China has paid dividends for large U.S. multinationals like Boeing, Caterpillar, and Cargill, but the results have been underwhelming for small and mid-sized firms.

China is the world's fastest growing market for commercial aviation, and needs billions of dollars worth of airplanes from Boeing. Its growing infrastructure has been a boon for companies like Caterpillar, which produces tractors and other heavy equipment. And it is importing billions of dollars worth of farm products, a boon to companies like Cargill...

But China has been a tougher market to crack for smaller and mid-sized American companies, like those selling bicycles, vacuum cleaners, and lawn mowers, who face stiff price competition from Chinese manufacturers of these products. And they also face discriminatory rules, burdensome red tape, language difficulties, and a population that earns only a fraction of what U.S. consumers make, and therefore lacks the purchasing power to buy consumer goods made in America.
Not only have these smaller and medium sized companies been unable to ply their wares in China's marketplace, they have increasingly found themselves crowded out of domestic and other international markets by China's burgeoning manufacturing sector - aided, of course, by Wal-Mart. So in this sense, not only has trade with China not delivered any tangible benefit, it has actually hurt these businesses greatly - for many even fatally.

In fact, aside from the bigger companies like Boeing, Caterpillar and Cargill, there is a bizarre inversion of the general rule governing trade relationships between developing nations and industrialized states. In the current dynamic, the United States is playing the role of developing nation, exporting raw materials, and China is acting every bit the part of the industrialized state, sending back finished products manufactured from those same raw materials.
"We export cotton, we import clothing," [Yvonne Smith, the communications director at the Port of Long Beach] reports. "We export hides, we bring in shoes. We export scrap metal. We bring back machinery. We're exporting waste paper, we bring back cardboard boxes with products inside them."
Alan Tonelson of the U.S. Business and Industry Council argues that the majority consensus on the benefits of trade with China underlying the various free trade agreements was wrong because of the relative strengths and weaknesses of the respective economies.
"China had too much production power and too little consumption power to be digested into the world trading system all at once," he says. To Tonelson, this is why the U.S. is hemorrhaging jobs to China.
But its not just jobs. Overall, the U.S. trade deficit with China reached a record $124 billion dollars in 2003 and the figure is headed even higher this year. Today, U.S. imports from China outpace U.S. exports to China by more than five to one, and the deficit shows no signs of abating.
These deficits are much larger than the trade deficits that the United States experienced in the 1980s and 1990s with Asian trading partners such as Japan. Put in historical perspective, America's current trade deficit with China is roughly double what it was at its height with Japan in the mid-1980s, when trade frictions between the U.S. and Japan led Sen. Lloyd Bentsen (D-Texas) to famously declare on the floor of the U.S. Senate: "We're in a trade war, and we're losing it."
These unprecedented trade deficits have raised the eyebrows of many economists of all political persuasions, including Alan Greenspan, who warned of the deleterious effects such deficits could have on our currency valuation last week at a conference of European economists.
Conservative economist Paul Craig Roberts, who served in the Reagan administration, predicts the trade deficit will cause a crash of the U.S. dollar before long, and warns that the U.S. will wind up having a third-world economy, supplying raw-materials to other countries, who then ship back finished goods to the U.S. Economist Larry Mishel, president of the liberal Economic Policy Institute, contends that the trade deficit with China has cost the United States more than a million jobs over the past decade...

"We have a trade deficit now that's running around 5 percent of GDP," says Mishel. "This is very large by historical standards, and you run the risk of foreign investors losing confidence in the United States, pulling back from the dollar, the exchange rate falling, and interest rates rising, and all that could cause a major recession in the United States."
The problems seem worse when you consider that there is no end in sight. China's industrial strength lies in the sheer size of its massive population. Its workforce is far larger than the combined populations of Japan, Korea and the other so-called "Asian Tigers," and even then, China has not fully tapped its full potential as large segments of the working age population remain uneducated and agrarian. As education and affluence reach more of China's population, China's workforce will increase in size, expertise and ability. That is why China is taking a lead role not just in the realm of factory production of such products as footwear, clothing, furniture and toys, but also such technologically advanced items as computers, big-screen television sets, lasers, space components and huge port cranes.
Analysts concerned with long-term U.S. economic security see China's seemingly inexhaustible supply of cheap labor, coupled with the Chinese government's commitment to a rapid development strategy and the movement of Chinese industries into high-tech sectors, as posing a long-term threat to American producers across the board.
That is what sets China apart from other markets opened by free trade agreements, such as Mexico and Africa. China's labor force is vastly larger and more able than any other market previously introduced to the world's economic system in such a manner. In addition, the infrastructure is infinitely larger and more capable than any comparable new entry. In many ways, these factors have provided a shock of severe proportions. Tom Hopson, the president and CEO of Five Rivers Electronics Innovations, which assembles televisions for companies like Philips, Samsung and RCA in the US had this to say about China's potential:
I think the biggest thing that we've recognized is the infrastructure China has. They can build every television that's needed, that's going to be sold in the United States this year. They have the infrastructure in place to do that. And they're not shipping all those today, but they have production facilities sitting with capacities to satisfy the U.S. market today, which to me is pretty amazing that they continued to invest in the infrastructure.
Hidden Dragon

In the rush to tap the enormous potential of China's markets, we have tolerated much in terms of inequity and economic manipulation on the part of the Chinese government. Eager to commence trading, we have allowed China to dictate the terms of its entry into the world's economic system, and they have been meticulous in securing every advantage and benefit - safe in the knowledge that the size of their market would assuage all fears. In Wal-Mart, they have found a complicit partner to lobby on their behalf.

As a testament to the comingling of interests, consider the reaction to the practice of dumping that China has notoriously engaged in. Dumping is the process by which Chinese producers export and sell products in the U.S. below the price in China, or below what it costs to manufacture and ship abroad. This has the effect of bankrupting competition who could not possibly offer their products at such rates, and then, once the competition is eliminated, the dumper would then restore higher prices, free from the downward pressures of competition.

When Tom Hopson's company, Five Rivers Electronics Innovations, filed suit with the International Trade Commission accusing Chinese firms of dumping television sets on US markets, Wal-Mart spent a considerable amount of time testifying and supporting one side of the litigation - the Chinese side. They defended the Chinese firm's practices in the face of a valid complaint from an American manufacturer. Despite Wal-Mart's efforts, Five Rivers prevailed on the merits. Wal-Mart remained unapologetic.

Wal-Mart has also been increasingly active in Washington, ramping up its lobbying efforts and increasing its campaign contributions as many sensitive issues of trade loom on the horizon. One such issue, involving China, has to do with currency valuation.
China's currency, which is pegged to the U.S. dollar, is a major point of contention with many U.S. manufacturers and trade groups. Skip Hartquist, an attorney at Collier Shannon Scott, a Washington law firm that specializes in international trade matters, estimates that Chinese manufacturers get an unfair advantage because the Chinese currency is undervalued by about 40 percent, making Chinese products much cheaper for Americans to import. Many American manufacturers share this view.
But Wal-Mart vigorously opposes all efforts to force China to play by the rules and allow the value of their currency to be determined by the market. In this regard, Wal-Mart is simultaneously for free trade, and against it. The disturbing trend, however, is that Wal-Mart is consistently siding with China and their interests when they conflict with those of the United States and its companies.

Dragon Slayers

The peculiar dilemma presented by the ascendancy of giant retailers like Wal-Mart, and their close relationship with China, is a cautionary tale about the limits of the efficacy of two economic cults: free trade and efficiency.

Free Trade

Despite the proclamations by die-hard free traders that all free trade is an unequivocal good no matter what the context, the truth is that there are limitations and drawbacks.
Free-traders like Brink Lindsey of the Cato Institute take issue with that assessment. "Trade policy, or trade flows, one way or another don't have an effect on overall employment numbers," says Lindsey. "They affect the kinds of jobs we have. And so some number of jobs have definitely been eliminated because of Chinese competition. Elsewhere in the economy, other jobs have been created because of Chinese competition. Because American consumers have saved at Wal-Mart buying Chinese goods, they've got more money in their pocket to buy something else, which creates business opportunities for those other business, which means they hire workers they would not have hired, otherwise. The net effect, most economists think, is a wash."
But I think Lindsey's contentions are not supported by the evidence. Job numbers are down as an overall tally. Furthermore, wages are down, which seems to indicate that Americans losing manufacturing jobs are replacing them with lower paying alternatives. So, in the end, we should not only look at the number of jobs in total, which are down regardless, but also at the type and quality of jobs and whether those new jobs will support a middle class lifestyle that has been the cornerstone of American society for the past century.

Some of these changes in job types are inevitable as, to some degree, these jobs would be lost eventually anyway. But that doesn't mean that any mechanism that causes the outsourcing of jobs is acceptable. There are ways to ease the economy into transitions that will not cause as drastic a crisis for so many Americans who suddenly find themselves out of work and without the necessary skills to find gainful employment in a rapidly evolving economy. Despite President Bush's claims during the debate, No Child Left Behind won't help these workers - and there are tens of thousands of them. The introduction of so unique a market and labor force as China's has caused upheaval in our economy in a very short time period. That is not always a net positive.
Others, such as Alan Tonelson...argue that the U.S. needs to change course and raise trade barriers. "We have to recognize that our trade and manufacturing crisis has become so grave that we have no choice but to start thinking seriously about restricting trade in various ways," Tonelson asserts.
While I believe that protectionism can be counterproductive if taken too far, and it often is, in the present situation a measured and targeted dose could be useful. Our relationship with China is not a healthy one. The staggering trade deficits have no historical precedent, and their effects on the valuation of the dollar are beginning to be felt, though the full parameters of the potential damage are an unsettling unknown lurking in the distance. We must figure out a mechanism to bring those deficits under control - despite the objections of Wal-Mart, and what will surely be a new Chinese ally, Kmart/Sears.

At the very least, we should be vigilant about some of China's more unsavory practices such as dumping, currency manipulation and their own protectionist tendencies. The free traders tend to turn a blind eye to China's protectionist policies, remaining steadfast in their refusal to countenance retaliatory measures. I think that a bit of quid pro quo is in order.


I think Americans suffer from the widespread misconception that "efficiency" has an inherent normative quality - that it is a good thing in all contexts. That is not necessarily true. Efficient methods are morally neutral, and should only be judged, normatively, by the outcome. For an example in the extreme, labor laws such as the mandatory work week, child labor prohibitions, safe workplace rules, environmental regulations, minimum wage mandates, etc. probably detract from the efficiency of a given business, at least in the short term. Businesses could be more productive and efficient if workers were compelled to toil 80-hour work weeks for paltry salaries, in factories that are not as safe or clean, with no regard for the environment, etc. Yet, we as a society have decided that certain "efficiencies" are morally repugnant, and thus we have opted for more humane alternatives.

So we should not be misled by the siren's song into thinking that efficiency justifies itself. Yes efficiency often leads to desirable outcomes, but not always. Wal-Mart is the quintessential example.
The Wal-Mart model is a double-edged sword. On the one hand, Wal-Mart is probably the most efficient company in the history of American business. It's pushed a low-cost, global-sourcing model to the nth degree. It's created suppliers that produce goods cheaper than they ever could before.

The flip side of that model is that this has come at the cost of U.S. jobs that are actually moving offshore, and even Wal-Mart's own suppliers are concerned that by pushing costs down so low, companies can no longer be profitable. So in a sense, it's like we have two models in the world economy. We have the efficiency model, which is based on low cost and global sourcing, and Wal-Mart is the best company of its kind in promoting efficiency, low-cost sourcing. But we also have an innovation model based on higher wages, new products, good benefits for U.S. workers.

And those two models are in conflict to some degree. I think Wal-Mart has actually been producing global efficiency, but it's as though the efficiency model doesn't have a floor.
Thus we see that extreme efficiency on the part of one party in an economic model does not necessarily lead to an outcome that we as society must accept. If efficiency ultimately leads to lower wages, fewer benefits, and the loss of jobs, then what good is this efficiency? When hard working Americans can't practice their trade, or are forced to toil for a breadth above minimum wage with minimum benefits, why is that desirable? I'll take the American dream over low prices at Wal-Mart any day.

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