19 July 2012

Manufacturing: Lessons from the Olympic Apparel Debate

Over the past week a debate has erupted over the sourcing of apparel to be worn by US Olympic athletes in the upcoming Olympic games. The Washington Post explains:
With their bright white pants, double-breasted blazers and bizarre berets, the uniforms designed for the United States Olympic athletes to wear at the opening ceremonies in London won’t be making anyone’s summer fashion list.

But days after Ralph Lauren released images of its 2012 outfits, U.S. lawmakers responded with a surprisingly visceral reaction to the news that the red, white and blue uniforms were made in... China.

“I am so upset. I think the Olympic committee should be ashamed of themselves. I think they should be embarrassed. I think they should take all the uniforms, put them in a big pile and burn them and start all over again,” Senate Majority Leader Harry Reid (D-Nev.), told reporters Thursday. “If they have to wear nothing but a singlet that says USA on it, painted by hand, then that’s what they should wear.”
 Rep. Steve Israel (D-N.Y.): “It’s not just a label, it’s an economic solution. Today there are 600,000 vacant manufacturing jobs in this country and the Olympic committee is outsourcing the manufacturing of uniforms to China? That is not just outrageous, it’s just plain dumb. It is self-defeating.”
The issue cuts to the core of ongoing debate over manufacturing in the United States and what, if anything, policy makers should be doing about this particular sector of the economy. Here we have an issue where Republicans and Democrats have found common ground.

The Olympic uniform kerfuffle provides an opportunity to discuss what is wrong with policies focused on protecting certain sectors of the economy from the inexorable forces of globalization and productivity gains, which if well managed, can benefit everyone. These lessons are more broadly applicable to the larger debate over US manufacturing.

To appreciate these lessons, let's dig a little deeper into the Olympic apparel debate.

New York Senator Chuck Schumer (D) has an idea about what should be done:
U.S. Senator Charles E. Schumer today called on the U.S. Olympic Committee to abandon their current uniforms that were made in China and replace them with uniforms made in the United States, and suggested Rochester-based suit maker Hickey Freeman to do the job. This week, ABC News revealed that the U.S. Olympic Committee decided to outfit the American athletes at the opening ceremonies of the Olympics in uniforms made in China, instead of enlisting American workers and companies to support their national team. In the wake of this report, Schumer secured a commitment from President Mike Cohen of Rochester-based suit maker Hickey Freeman to produce the sport coats and dress trousers for the Olympic team’s uniforms for the opening ceremonies. Today, Schumer called on the Olympic Committee to scrap their current uniforms, have them made in the United States, and consider hiring Hickey Freeman to lead the charge in producing the uniforms in the United States.
The company that Schumer is promoting is of course located in his home state.It is also the same Hickey Freeman that was sold to an Indian company to avoid bankruptcy back in 2010. That is right, Schumer is arguing for Americans to be outfitted by an Indian company.

For his part Schumer argues:
“It’s far better to have foreign capital come here and create American jobs than American capital go there and create foreign jobs.”
But this is not correct at all.

The reason that Hickey Freeman has any jobs at all in New York is arguably not because of foreign capital investments, but because the NY and US governments have repeatedly propped up the industry and the company with subsidies.
For instance, in 2004 the state of NY and city of Rochester put together a $5 million package to help the company modernize its factory in an effort to remain competitive. In addition, the US Congress has repeatedly supported the industry via tariffs and industry assistance through the "Wool Fabric Trust Fund"  created in 2000 and repeatedly reauthorized, most recently in 2010 (see this Congressional description in PDF, at p. 11).

At the time Senator Schumer explained the significance of the legislation to the fate of Hickey Freeman, arguing that that eliminating the Wool Trust Fund, which
provides Rochester’s iconic Hickey Freeman with substantial import tax relief, could lead to the closure of the Rochester facility, leading to the loss of 400 good paying jobs. Schumer said that to eliminate this program to pay for a jobs bill would be a bitter irony. Schumer today announced that the Wool Trust Fund program is safe and the Hickey Freeman employees could breathe a sigh of relief.
Louise Slaughter (D-NY) also takes credit for helping to save the company as well, "She was also instrumental working with Hickey Freeman’s former parent company Hartmax, their creditors and the Chairman of the House Financial Services Committee Barney Frank to avoid liquidation of the company."

Let's take a look at the bigger picture. Shown in the graph below are data on US jobs in the "apparel" sector and its sub-sector "mens and boys clothing" (under which Hinkley Freeman would be found), both of which are sub-categories of "manufacturing."
Since 1990 employment in the apparel sector has declined by 83% and in mens and boys clothing by 87% (data from BLS). Of note, almost all policy attention has been paid to efforts focused on preserving the (now) ~15% of remaining jobs rather than the fortunes of the ~85% of jobs which have been lost (e.g., skill development, job retraining, etc.). More generally, have a look at the graph and ask yourself, how well have the protectionist policies implemented since 1990 worked in any case?

Why have jobs in this industry sector declined? Because low-skilled, low-paying textile jobs are better sourced from outside the US, where "better" means at lower cost to production. Securing lower cost inputs is a key factor in sustaining productivity, which means getting more output for less input, a key factor in how we collectively become wealthier.

Back in 2009, the Indian company (SKNL) that acquired the parent company (HMX) of Hinckley Freeman explained (PDF) the logic of their investment and the strategies that they would employ to return the business to profitability:
At the onset, the first leg of value-creation opportunity is a backend-frontend integration synergy that will boost gross margins significantly. A 30% gross margin is extremely low for a business the size of HMX and operating in the market segment that HMX brands operate in. We believe we will be able to boost gross margin up significantly by backward integration of production through our Indian manufacturing operations and also through opportunistic sourcing from the Far East and Central America. . .
As per our investment plan, we envision outsourcing part of HMX’s manufacturing to our plants in India. SKNL is adept at manufacturing products currently manufactured and sold by Hartmarx, including suits, shirts and slacks. SKNL will be able to supply fabrics from Reid & Taylor and Belmonte to HMX and finished garments from our suits and shirt factory in Bangalore which will be operational within a year. This would facilitate diverting export production of factories to better value-added products from our fabric division and also provide immediate capacity for the new shirt and suit factory. By conservative estimates, it is anticipated that the back-end synergy will provide substantial additional profitable business to us within the next 3 years.
The globalization of the apparel industry is a good thing. Resources are used more efficiently. Profits are increased. The economy grows. More jobs are ultimately created. There is downside, as well, such as in jobs lost and skills that have become obsolete or uncompetitive. Policy should focus on effectively managing the downside rather than trying to stop change from occurring in the first place.

Writing at Blomberg Businessweek, Larry Popelka explains clearly why politicians from both parties have things wrong on this issue:
Garment manufacturing is a low-cost commodity business. Most of the value in the apparel industry comes from design, technology, sales, marketing, and distribution—not manufacturing. The successful players in apparel, such as Ralph Lauren and Nike (NKE), figured this out long ago.
Because the economics are bad, most U.S. apparel manufacturing operations folded decades ago. Only 97,000 Americans still have jobs in apparel production, according to the U.S. Department of Labor, and most of them are making highly specialized products like DuPont (DD) Kevlar uniforms that cannot be made elsewhere.

But just because America doesn’t manufacture apparel anymore doesn’t mean we can’t lead the industry. In fact, the world’s largest apparel companies are almost all U.S.-based, including Nike, VF (VFC), PVH (PVH), and Ralph Lauren, to name a few. These companies have grown a combined 146 percent during the past 10 years, adding more than $27 billion in revenue. Nike has created more than 15,000 new jobs in the U.S. during this time, Ralph Lauren almost 10,000. And unlike the low-paying production jobs next to sewing machines, these are well-paying jobs in marketing, accounting, design, and management.

These companies are winning globally by out-designing, out-innovating, and out-marketing the competition. Nike, for example, is unveiling a new TurboSpeed running suit at the London Olympic Games that it claims can reduce 100-meter sprint times by .023 seconds. Nike’s gear will be used by teams from many countries, including Russia, China, and of course, the U.S.

What Nike and Ralph Lauren don’t do is make their own products, in the U.S. or elsewhere—and this has become their competitive advantage.
But maybe the solution here is not to be found in policy debate. Maybe the athletes should just go back to the original uniforms worn in ancient Greece ...

10 comments:

Christopher said...

Blah, the real travesty is the uniform design.

Why do our uniforms look like they're designed by the Pentagon?

stan said...

David Ricardo explained it all 2 centuries ago. The logic still holds. The politicians still ignore it. Wouldn't it be nice to have a news media capable of explaining it the people?

Brian said...

Just a minor correction, the Congresswoman from NY is LOUISE Slaughter.

Roger Pielke, Jr. said...

Brian, Thanks, Fixed!

Jonathan Gilligan said...

@Stan. Ralph Gomory and William Baumol wrote a really nice book in 2001, "Global Trade and Conflicting National Interests," in which they emphasized that Ricardian comparative advantage analysis assumes a Malthusian world in which production functions have diseconomies of scale (remember that Ricardo was writing about agriculture, which does tend to follow Malthusian production functions if you are working a finite amount of land with fixed technology).

Where there are positive economies of scale (Julian Simon's industrial world instead of Malthus's agrarian one), Gomory and Baumol demonstrate mathematically that there are both "zones of mutual gain," in which free trade is a Ricardian win-win, and "zones of conflict," in which one nation's gain is another nation's loss.

Zones of conflict can arise in technological industries between very undeveloped nations and very developed ones. In these circumstances "the newly developing partner becomes harmful to the more industrialized country" and a the profit-maximizing decision by a company in the developed country to outsource production to the less developed one "can constitute an actual loss of national income for the company's home country." In contrast, the less developed country tends always to win by opening up trade.

Returning to Roger's post (the book discusses athletic shoe manufacture, which is very analogous to Olympic uniforms), Gomory and Baumol find that conflict zones tend to be associated with highly technological industries characterized by high cost of entry and requiring specialized expert workforces. Garments have very low cost of entry and low skill requirements, and thus tend to fall in the Ricardian zones of mutual gain.

The book is worth reading.

n-g said...

The Ancient Greek Uniform solution would solve not just the problem discussed here, but the problem discussed in your previous blog entry as well.

Smart fellows, those Greeks.

SC Mike said...

Popelka’s Blomberg Businessweek article notes that “Most of the value in the apparel industry comes from design, technology, sales, marketing, and distribution—not manufacturing.” The same is true for other industries. Look at Apple’s products, made in China for a relative pittance, with the high-value work and profits remaining here.

I don’t doubt that over the short-term that the profit-maximizing decision by a company in the developed country to outsource production to the less developed one "can constitute an actual loss of national income for the company's home country." But over the longer term, savvy folks figure that out and make corrections. Dynamism is both a feature and bug, what seems to work today is viewed as a flaw next year or next decade. Policymakers seem to think that everyone can be forced to make the right decision the first time, every time. Heck, even they can’t, but they rarely admit that.

What I fear is the political class’s involvement in specific companies and industries, an eternal problem. What is the true cost of supporting a Hickey Freeman and cui bono, especially in New York? I understand the politicians’ desire to aid companies in their districts or states, but the costs are spread so widely throughout the economy that figuring out what collateral damage is being done is difficult. Not only are their good intentions rarely as pure as they pretend, the unintended consequences are discovered much too late, if at all. My only hope is that budget realities will end such meddling, but I’m not too hopeful about that.

Coincidentally, on the date this blog entry appeared Fortune’s Nina Easton published an article about a South Carolina-based apparel manufacturer who’s getting “killed by unemployment taxes that are on their way to quadrupling since 2009.” Details are at the link except for specifics on the “Knockout Panties” the company is making for Angela Newnam… Hmmm. I Binged and found more than I wanted to know.

The article does point out that extending unemployment benefits creates a moral hazard in which beneficiaries postpone serious job searching. That, in turn, contributes to a higher unemployment rate. It concludes with this:

Critics of the current system also call for giving states more flexibility to create programs to help people get back to work. And clearly, a funding mechanism that still discourages small businesses from hiring -- more than three years after the recession officially ended -- needs review.

One final thought: New York does not treat its successful folks very well. Three-time NY gubernatorial candidate Tom Golisano was so distraught over the state’s 2009 income tax hike on the wealthy that he moved to Florida to save $13,000. Ooops! Make that $4.75 million, $13K per day, his state income taxes were to increase from $3.6M per year to $4.75. Not everyone is wishing him well:

Working Families Party Executive Director Dan Cantor, who championed the tax hike, called Golisano's move "selfish."

"It's a disgrace that this is how he pays back the state where he was presumably educated and that's been so good to him," Cantor said. "Taxes are the price you pay for civilization. He's moving to a space where there's a little bit less civilization."

Frontiers of Faith and Science said...

Taxes are not the price of civilization, when the taxes are punitive and unfairly applied, as they are in places like New York, France, California, and possibly increasingly so at the US federal level.

stan said...

I have not read Gomory and Baumol. I'm willing to concede that there is always a chance that they might even be correct. But color me as very skeptical.

Ian Random said...

We need to encourage every participant in the Olympics to make their own stuff. Brazilians should be outraged that we are making their saddle pads.

http://www.wkrn.com/story/19035989/wilkers-saddle-pads-brazilian-olympic-team

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