Has America Outsourced Too Much?

SARAH GREEN: Welcome to the HBR IdeaCast from Harvard Review. I’m Sarah Green. I’m talking today with Harvard Business School professor Gary Pisano. His new book, which he wrote with HBS professor Willy Shih, is called Producing Prosperity, Why America Needs a Manufacturing Renaissance. Gary, thanks so much for joining us.

GARY PISANO: Sure, great to be here.

SARAH GREEN: So Gary, I think what I find appealing about the angle you take in the book is about manufacturing is how you tie it to innovation. Because that isn’t so much a partisan argument as it is a very practical one. So tell us about the connection you see there.

GARY PISANO: Well, I think what is often unrecognized is that in the course of innovating new products, there’s often an awful lot of innovation on the manufacturing technology, the process technologies that go into making it.

And what we tried to draw attention to is the fact that if a country loses its capabilities for manufacturing, with that can go a lot of capabilities for innovation. And it’s something that I had been observing for years in my career in looking at industries like biotechnology and others where the idea that you do the R&D in one place, and it’s a compartmentalized activity. And you just send it the technology over the wall to manufacturing somewhere else, and there’s no interaction, that’s pretty rare. There’s a lot of interaction between R&D and manufacturing in the innovation process.

SARAH GREEN: Can you tell us a little bit more about how this connection began to dawn on you?

GARY PISANO: It really began to dawn on me very early in my career. My background was in studying the economics of R&D. And then, I came to Harvard Business School and was teaching a manufacturing course. So I had to learn an awful lot about manufacturing and was going into a lot of manufacturing plants at the beginning of my career back in 1988 here, writing cases.

And began to see that what I had thought of as the innovation process went well beyond R&D. So it really started by firsthand observation. And then, I did a lot of research. And a lot of my work has been in the biotechnology industry.

And there, I just kept coming across case after case of companies with really great product ideas, great potential new drugs. And then, as they went into manufacturing, they couldn’t manufacture. They struggled to manufacture the drug. Or they had huge delays in their development lead times.

And it just really started to strike me that process innovation was a hidden source of advantage for companies who wanted to innovate. And I think it really just came that way.

SARAH GREEN: Now, you mentioned the biotechnology sector there. And there’s another tech sector that you mention that you’ve talked about that’s really captured people’s imaginations, I think, is when you say that Amazon could not produce a Kindle in the United States.

GARY PISANO: Right.

SARAH GREEN: Why is that, and why is that a problem?

GARY PISANO: Well, in the electronics industry, the supply chains have been migrating to Asia slowly since the ’60s. It started when American consumer electronics companies like RCA and Magnavox decided that consumer electronics, televisions, were a mature industry. And they should outsource their production to Asian subcontractors, some of whom were little known at the time. But companies like Sony got their start that way.

And so since then, the electronics supply chains, the locus of manufacturing, has been shifting for decades there. It started with assembly, then went the component suppliers, and all the sub-assemblies. And now, really those supply chains are centered in Asia. We have very little of that here in the United States.

So if you come up with an innovative idea like an iPad or a Kindle, it’s not a matter of cost, per se, of not manufacturing in the US. It’s just simply the capabilities really aren’t here for that kind of production.

Now, why is that a problem? Well, it’s not a problem, as you can see, for the Kindle because it is manufactured outside the United States, or the iPad. But what concerns us is there’s an awful lot of technologies that go into that, pretty sophisticated process technologies in terms of the displays and some of the enclosure technologies and even the polished aluminum.

And those sort of things that if you don’t have those here, then a future company, a future innovator may need access to those to be able to launch their innovation. So I think the danger is as those capabilities have moved outside the US, it makes it harder and harder for future companies to start up companies and others to do innovation here.

SARAH GREEN: Now, I am on the record as saying that your book is practical, not partisan. But since this has become such a political topic, I did want to ask you, what do you make of the current policy prescriptions on the table for restoring the American manufacturing sector?

GARY PISANO: I think there’s some good ideas on the table. There’s a number of proposals that have been made by the current administration and also that are winding their way through Congress in various committees.

So first of all, I’m happy to see that kind of manufacturing is on the agenda as part of our national economic strategy. I like some of the ideas around creating these national institutes of manufacturing that are designed to spawn, invest in research, basic and applied research in various kinds of manufacturing technologies and that it’s both government and the private sector in partnership.

I think those kind of efforts can help lay the groundwork and the seeds for long-term manufacturing innovation and the kind of Renaissance we’re talking about. I’ve been less enthusiastic about some of the direct subsidies that the current administration followed in terms of supporting specific industries like solar where, as we know, some companies, many companies, got subsidies or tax breaks.

I think where you get to government trying to pick specific companies or very specific technologies, that is a very tough thing for governments to do right. It’s a very tough thing for private venture capitalists to do right. And government is not in a position to do that.

So I think what I like is the spirit of trying to invest in our manufacturing infrastructure and capabilities. I think when the government leaves it at that level, it’s a great thing to do. Once government tries to go beyond that and intervene in specific technology, specific companies, I think that kind of industrial policy has shown itself through history, both in the US and elsewhere, to not be very effective.

SARAH GREEN: Mm. And there’s another topic that comes up often talking about this. But people worry about the specter of protectionism. What do you make of that?

GARY PISANO: I agree. I think it’s too easy to use. If you read our book– and we are very clear that we are all for open trading and we’re globalists. We are completely against protectionism.

Yet, it is way too easy for many to misinterpret the argument. Or I shouldn’t say it’s too easy. Hopefully we’ve written the book in a way that it’s not easy. But still, it doesn’t stop some from saying, well, the only way to restore manufacturing in the US is to build barriers.

And that just does not work. It doesn’t do the US economy any good at all. Competition, global competition, is a great thing to increase every country’s game. And if you want to see the negative effects of protectionism and closing yourself off from the rest of the world, just go back to Eastern Europe a few decades ago before the fall of the Iron Curtain.

It was essentially closed off from the rest of the world’s economy. And it was completely economically undeveloped. You had people with training in computer science who were sweeping streets.

Once Eastern Europe began to open up to the rest of the world, their economies have by and large thrived. There’s been ups and downs. But it’s really important to be pushing for open trade.

So we think part of government policy should be to where other countries are erecting barriers, to be working very hard to bring those down, to create as many free trade agreements as we can. The US tends to run surpluses with countries it has free trade agreements with. So we’re all for free trade. And the last thing on Earth we would want is for our book to be read as some excuse for creating protectionism. We’re really against that.

SARAH GREEN: Mm. And one of the counter-examples that often comes up here, especially with regard to the solar industry, is that manufacturers in China do get so much help from their government that’s it’s not really, as some would say, a level playing field. So how do you take down those barriers in our environment but then still compete with competitors in a country like China?

GARY PISANO: Well, I think what we’ve seen– in fact, just recently, there were rulings to impose some measures against the Chinese solar panel producers. So I think we have to be aggressive in fighting back where we see things which break international trade laws. And they’re pretty clear about what you can and can’t do. And these kind of subsidies or other forms of protectionism are against the rules.

And where we see countries systematically trying to break the rules, we have to be very prepared to be aggressive in trying to fight back through the legal system.

Now, at the same time, if we’re going to do that, we also have to make sure our economy’s open. So we can’t be the ones to also erect subtle barriers and then not allow other countries in and then claim that we want to open trade.

So it goes both ways. But I think it’s really important that when we say we’re for open and free trade, we mean that. We don’t mean, allow some countries to get away completely with tilting the playing field completely in their direction. And then, we just stand by. That’s not good policy. So we do need to be aggressively pursuing these kind of trade cases where we see countries trying to break the rules.

SARAH GREEN: Mm-hm. So I’m also curious to know– we’ve talked a little bit about now China, Eastern Europe. I know that if we’re looking for best practices from around the world, often people will hold up Germany and Japan as examples of advanced economies that still have very robust manufacturing sectors. Do you see lessons there that we could learn best practices?

GARY PISANO: Well some, and more on the case of Germany. There are some that we should and some we have to be careful of. First of all Germany, the last decade has been great for Germany. And that’s because they made a series of economic reforms in the late ’90s to make their economy much more flexible. So in some sense, Germany offers a lot of lessons for other countries in Europe around just the power of having much more flexible labor markets.

Germany’s also done well because its growth in China has propelled a lot of growth in Germany because of huge demand for machine tools, which is a large German sector, and automobiles, which is another large German sector. So Germany’s done well by that. And those lessons are hard to copy.

But the lesson, I think, that is really important, I think what Germany has done very well that we need to do a much better job here is training. And it’s this post-secondary training for technical or vocational training that goes beyond high school that is quite specialized and that creates a manufacturing workforce that is quite technically skilled.

We have tended not to do that. So in America, we have tended to focus, I think greatly and I admire it, on higher education, university education. But for those who don’t go on to university, our training options have been somewhat limited. And I think that’s because in the past, manufacturing in the US really served the role for people who did not go to college. They could get a job in a factory, a pretty well-paying job– I’m talking decades ago– and lead a pretty good middle class life.

What is happening now is because of the changes in the nature of manufacturing and changes in global competition, America can only compete in the most skill-intensive, complex part of manufacturing. That requires a very skilled workforce. And that requires a lot more investment in training.

And I think the Germans have done a very good job of that through their apprentice systems and other kinds of investments in the post-high school education that provides deeper technical skills. I think that’s one of the key lessons. It’s all about human capital. The country with the strongest human capital wins. And we’ve got to be investing much more in our human capital and not just at the university level, but also for the bright kids who don’t necessarily find it the best fit for them to go off to a university. We still have to make sure that they have great skills so they can be working in more complex jobs that the economy requires.

SARAH GREEN: Mm. I’m glad you brought up this issue of jobs and wages and skills because I think it’s really become impossible to talk about manufacturing without talking about those issues. It’s often said that manufacturing produced these high wages and these good jobs and a lot of jobs.

But it seems to me it’s actually slightly more complicated than that. Manufacturing did produce middle skilled jobs. But I’m wondering if the high wages were really a function of the rise of collective bargaining and labor unions. So my question to you is even if America can restore a healthy manufacturing sector, with the decline of the unions, should we expect those jobs to pay well? Or will they pay more like what their counterparts pay around the world?

GARY PISANO: No. I think certainly if you go back a few decades ago, we did have two things which propelled higher wages. So partly was yes, unions gave bargaining power.

But the reason they were able to exert that bargaining power is we had less global competition. So a union could, in the ’60s, negotiate for pay increases that a company could afford to agree to because it could raise its prices, because it didn’t face competitors from around the world.

Now, American workers have to realize they face– it’s not just the companies who face competitors from around the world– they themselves face competitors around the world. So I think today even if unions were stronger, we had more unions, their ability to bargain for high wages are limited by global markets.

So what’s the answer? How does the American workforce maintain high wages and not have them gravitate down to the low levels that you see elsewhere? Because that’s a losing strategy. The name of the game there is productivity. We have to increase productivity.

That’s how we’re going to preserve wages in America. So I think if somebody said the answer is just, gosh, if unions were stronger, we’d be great. No, without strong gains in productivity, there’s no basis to gain higher wages.

And so the message that I have about the long-term growth in wages, it’s got be about increasing the productivity of the American workforce. And that goes back to investing in training and skills and technology. And we’ve got to be in a position where we can– and when I say we, the American worker– can be competing for the kind of work that can’t be done elsewhere or that is too complex to be done elsewhere. And I think that’s what will drive real wage growth in the US.

SARAH GREEN: Mm-hm. Gary Pisano, thanks so much for joining us today.

GARY PISANO: Thank you. It was my pleasure.

SARAH GREEN: That was Harvard Business School’s Gary Pisano. His book with HBS professor Willy Shih is Producing Prosperity, Why America Needs a Manufacturing Renaissance. For more, visit hbr.org.