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Decrying the loss of ‘industrial commons’

When government invests in a company that goes bankrupt, critics haul out the predictable indictment: Politicians don’t understand business, and shouldn’t try to pick winners and losers in the competition that is capitalism.

But in the case of the the October bankruptcy of A123 Systems, a Massachusetts green-jobs company that won a $249 million government grant to make batteries for electric vehicles, Harvard Business School Professor Willy C. Shih says that focusing too much on that criticism might be blinding business and political leaders to the real reasons the company failed.

President Obama, who invested political capital in using billions from the 2009 stimulus package to support several environmentally focused companies that administration officials believed would kick off a revival of manufacturing and “green jobs,” faced heavy Republican criticism when A123 filed for bankruptcy, as he did in 2011 when the solar-panel maker Solyndra collapsed.

Shih, in a post on the Harvard Business Review’s blog, said he agrees that A123’s fall is “yet more evidence that the government should not pick winners and losers among companies.”

But in the post and in a new book, “Producing Prosperity: Why America Needs a Manufacturing Renaissance,” co-authored with Gary Pisano, Shih does not argue, as many Republicans do, that the government should leave every decision to the free market. In fact, Shih says, market-based decisions by corporate executives looking for a short-term boost to the bottom line created the climate for A123’s failure.

Decades ago, the U.S. was a leader in designing and making batteries. But then the consumer electronics industry began its move to Asia, and the battery-makers followed.

Batteries weren’t a very glamorous business when they were mostly used to power clocks, flashlights and transistor radios. Executives viewed the move from U.S. to overseas production as a simple way to improve the bottom line.

Now, however, high-value products like notebook computers and electric and hybrid vehicles need portable energy engineered to meet infinitely higher standards for reliability and power, but in lightweight packages that don’t saddle the product with an ungainly design. It has been a long-established goal of U.S. environmental leaders that the pursuit of clean, efficient battery solutions to power such products result in more U.S. jobs, as a way of proving that the economy is not threatened by stricter environmental regulation.

When A123 Systems arrived on the scene to meet the need for advanced batteries to power cars, the quality of its technology meant it could get money from venture capitalists and the Obama Administration.

But it couldn’t re-create what already was in Asia – what Shih and others call an “industrial commons,” meaning “the R&D, engineering, and manufacturing capabilities needed to turn inventions into commercial products.”

The industrial commons for design and production of batteries was outsourced long ago, and now Asia is where many inventors of consumer and portable electronic products go for manufacturing. A123’s isolation from its commons weakened the company. Its failure was, in Shih’s view, caused by its isolation from the industry to which it belonged.

In a longer study Shih and Pisano published in 2009, they found that “Being geographically close to the commons is a competitive advantage.” While geographic boundaries to trade are falling with the evolution of the global economy, “when it comes to knowledge, distance does matter.”  That is because knowledge tends to be transferred best in a face-to-face manner, through colleagues talking at a local watering hole, and especially when people switch jobs.

They cite the solar panel industry, for which Solyndra was the great U.S. hope, as an industry that is booming in several Asian countries such as China, Taiwan and Japan because of capabilities developed when semiconductor foundries and flat-panel display manufacturing were outsourced there.

That manufacturing base allowed businesses in these countries to develop “deep expertise in processing ultrapure crystalline silicon into wafers and applying thin films of silicon onto large glass sheets.” China is also a leader in what were deemed “mundane” manufacturing jobs, like building the semiconductors, housing and controllers that finished solar panels need. As a result, the U.S. is “no longer a significant player in crystalline silicon-based solar panels,” and produces only 14 percent of the world’s photovoltaic cells.

A similar pattern of outsourcing of what was deemed a “mature” industry that didn’t need any more American innovation drove battery manufacturing to Asia, Shih and Pisano wrote. The “locus of R&D and manufacturing” shifted there. Writing three years before A123’s demise, the Harvard authors saw A123’s efforts to revive rechargeable battery manufacturing in the U.S. to be “an uphill battle.” As it happened, despite more than a quarter of a billion dollars in taxpayers’ money, A123 could not survive.

“If the leaders of American companies weren’t so focused on short-term profits, they would have identified portable energy storage (e.g. batteries) as a strategic long-term capability that should be nurtured. But the sad fact of the matter is all too many of these executives rely on overly narrow financial criteria when making investment and supplier decisions that cause them to cut internal R&D and abandon suppliers with critical capabilities,” Shih wrote in his recent blog post.

Rebuilding an industrial commons “is difficult and expensive once you have let it erode,” Shih adds. To have kept it going, however, would have required saying no to an immediate infusion of profits. That used to be so only because manufacturing in Asia was cheaper. Now it’s also because Asia, especially China, is where the up-to-date manufacturing expertise in many strategic industries resides.

In the 2009 article, Shih and Pisano examined the components of an Amazon Kindle for a chart entitled “Why Amazon’s Kindle 2 Can’t Be Made in the U.S.”

The Kindle’s wireless card is made in South Korea, which became a center for mobile phone components. The controller board is made in China, because “U.S. companies long ago outsourced the manufacture of printed circuit boards to Asia, where there is now a huge supplier base.” The injection-molded plastic shell for the e-reader is also made in China because that’s where toys and electronics are made.

Shih and Pisano said in 2009 that there was no easy answer to rebuilding America’s industrial commons in the high-tech and green industries that most of our political leaders view as so strategic. However, they said, restoring government subsidies for basic and applied science, and boosting “world-class universities” will give the U.S. a better opportunity to form the industrial commons of the future. The old model of the U.S. as a buyer of innovative products, which occurred during the development of the space program, could also help.

Andy Grove, the former CEO of Intel, sees the current American culture of startup entrepreneurialism as inadequate to create jobs. That’s because, Grove says, a startup’s key early move seems to be finding an Asian manufacturing partner.

Grove wrote in Bloomberg BusinessWeek in 2010, “Startups are a wonderful thing, but they cannot by themselves increase tech employment. Equally important is what comes after that mythical moment of creation in the garage, as technology goes from prototype to mass production. This is the phase where companies scale up. They work out design details, figure out how to make things affordably, build factories, and hire people by the thousands. Scaling is hard work but necessary to make innovation matter.

“The scaling process is no longer happening in the U.S.,” Grove said. “And as long as that’s the case, plowing capital into young companies that build their factories elsewhere will continue to yield a bad return in terms of American jobs,” because China offers cheaper manufacturing and even engineering, increasing profits of Silicon Valley companies, but devastating job creation in the U.S.

Grove’s proposal is, in short, levying an extra tax on each “product of offshored labor.” The tax money would be used to develop industrial commons. It would be loaned to companies that agree to enlarge their American operations. Because all companies would be eligible for the loans, it would not be a system of picking winners.

Some observers, like Forbes columnist Reihan Salam, disagree with Grove and Shih, and say that as long as the U.S. retains its leadership in inventing and designing new products, the outsourcing of manufacturing doesn’t matter to the U.S.’s leadership position.

Salam, a fellow at the New America Foundation, wrote in Forbes that “although the U.S. badly needs job and income growth … it won’t come from the manufacturing sector.” Efforts to rebuild the industrial commons for existing industries would only result, Salam said, in more automation, which is “reduc[ing] the number of domestic manufacturing jobs even faster than the offshoring Grove decries.” Salam worries that if Grove’s ideas ever became American policy, “[I]t seems entirely possible that Grove’s brand of industrial policy would destroy more American jobs than offshoring ever has or ever will.”

He believes instead that “a wrenching series of labor market and entitlement and tax reforms designed to improve work incentives is needed to facilitate the transition to jobs in trades like nursing and plumbing that can’t as easily be outsourced. Like many economic policy analysts, he also wants to reduce taxes for U.S. corporations.

The word protectionist is applied to Grove now, but Grove says he is not trying to protect current jobs so much as fashion a way to create new ones. Outsourcing “broke the chain of experience that is so important in technological evolution. As happened with batteries, abandoning today’s ‘commodity’ manufacturing can lock you out of tomorrow’s emerging industry.”

John Stodder Jr., is The Dolan Company’s national affairs correspondent and web-editor-at-large.

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One comment

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