Platform companies

Economist Brad Setser has been discussing platform companies as the future for US industry. The idea is that high value-add activities such as design, engineering and management are performed here, and low value-add manufacturing is done abroad. A good example of this is the iPod, which was designed in Cupertino but is manufactured in Taiwan. Apple sold $1.2 billion worth of iPods in Q1 2005, making iPods almost as big as their computer business! Apple's margin on iPods is healthy - estimated at up to 20% -- while I am sure the manufacturer's margin is very slim. So, the conventional wisdom goes, let those low cost countries have the cutthroat manufacturing business. We clever Americans will simply go upstream, creating new products and markets through innovation.

There is a problem with this, and it is related to the winners and losers issue that arises in the usual story of comparative advantage. Overall, societies may enjoy a net benefit from trade (heck, there are even "theorems" going back to Ricardo "proving" this), but even in the optimistic cases the benefits (and losses) will be unevenly distributed. As autoworkers are displaced by Delphi moving production to China, investment bankers or consultants in the US benefit from demand for globalization strategists. But who ensures that some of the benefits are redistributed? Of course we all benefit from lower prices for manufactured goods, but that is only partial recompense to an unemployed auto worker.

I would go even further, and guess that only a small fraction of the population in advanced countries has the cognitive capabilities to be on the winning end of this process. That is, the Apple iPod designers, investment bankers, CEOs, etc. who win at this game are very able -- in terms of conventional IQ or special abilities such as leadership, design creativity, etc. It is questionable whether the average person will ever be able to contribute on a "high value-add" team! Instead, they'll be caught in a process taking place over a generation in which low-skill wage costs equilibrate worldwide. The theorems might still be satisfied by the huge returns to very able people (whether in China, India, Russia or the US), but the trend for the average American might be negative. Instead of an auto worker in Detroit earning enough for a good retirement and college education for their kids, they'll instead make $10-20 per hour, including benefits. (See earlier post Equilibration can hurt.)

Previous discussion of outsourcing here and here.