"Productivity" and Trade

Michael Perelman writes:

EconoSpeak: The Mysterious Productivity Lead of the US Economy: The International Labour Organisation just released a report showing that labor in the United States is the most productive in the world.... [C]onventional economics teaches us that wages reflect productivity, yet for more than three decades hourly wages (corrected for inflation) have shown a slight decline, while productivity has soared....

[P]roductivity can mean something very different from what people might think I was productivity. This statistic is nothing more than the gross domestic product divided by the amount of labor. Consider a fictitious country named Nike. It has a single product — shoes, which it can market throughout the world. This country has four workers: a lawyer to make contracts, a marketer to advertise the product, a shipping clerk, and an accountant. Rather than making shoes by themselves, they contract with a sweatshop in China which sells them shoes for $5 a pair. The country exports 4 million pairs of shoes year for $100 a pair.

A statistical agency would credit each of the four workers with producing a million shoes, representing a net increase in value of $95 each. Nike would certainly be the most productive country in the world. Or would it be?

Michael is pushing a possible argument I first heard from Larry Summers--that much of modern-day globalization involves large Galbraithian corporations with brands and market power figuring out how to use less-costly foreign sources for their own premium-branded goods. Because of their market power, these Galbraithian firms can and do increase their markups. Domestic workers who used to be the source for branded goods have to find other jobs doing other possibly less-productive things. No individual American worker is doing anything different and more productive than he or she did in the past. Yet economy-wide productivity is up.

This is, I think, a genuine increase. Productivity is up. Productivity is up even though no worker's productivity is risen because there are productivity gains from an expanded division of labor. The gains are badly maldistributed in that all the gains from trade--more than all the gains from trade, in fact--accrue not to workers in tradeables or workers in non-tradeables or consumers but to profits. (In the long run things will be different: if Nike is so profitable, competitors will enter and erode its market power.) But the gains are there.

Larry finds--or found, for I don't know if he is still playing with it--this Galbraithian theory to be interesting because it creates a powerful link between globalization and rising inequality, and it is hard to get such a link out of more standard neoclassical models. The people who have a true beef with this situation, it seems to me, are the Chinese manufacturers who can make the good but can't sell it for more than peanuts because they lack the brand and the marketing and distribution system. China is worried about this. See James Fallows on the smiley-face economy:

http://www.theatlantic.com/doc/200707/shenzhen ...something called the "smiley curve." The curve is named for the U-shaped arc of the 1970s-era smiley-face icon, and it runs from the beginning to the end of a product’s creation and sale. At the beginning is the company’s brand: HP, Siemens, Dell, Nokia, Apple. Next comes the idea for the product: an iPod, a new computer, a camera phone. After that is high-level industrial design—the conceiving of how the product will look and work. Then the detailed engineering design for how it will be made. Then the necessary components. Then the actual manufacture and assembly. Then the shipping and distribution. Then retail sales. And, finally, service contracts and sales of parts and accessories.

The significance is that China’s activity is in the middle stages—manufacturing, plus some component supply and engineering design—but America’s is at the two ends, and those are where the money is. The smiley curve, which shows the profitability or value added at each stage, starts high for branding and product concept, swoops down for manufacturing, and rises again in the retail and servicing stages. The simple way to put this—that the real money is in brand name, plus retail—may sound obvious, but its implications are illuminating.

At each factory I visited, I asked managers to estimate how much of a product’s sales price ended up in whose hands. The strength of the brand name was the most important variable. If a product is unusual enough and its brand name attractive enough, it could command so high a price that the retailer might keep half the revenue. (Think: an Armani suit, a Starbucks latte.) Most electronics products are now subject to much fiercer price competition, since it is so easy for shoppers to find bargains on the Internet. Therefore the generic Windows-style laptops I saw in one modern factory might go for around $1,000 in the United States, with the retailer keeping less than $50.

Where does the rest of the money go? The manager of that factory guessed that Intel and Microsoft together would collect about $300, and that the makers of the display screen, the disk-storage devices, and other electronic components might get $150 or so apiece. The keyboard makers would get $15 or $20; FedEx or UPS would get slightly less. When all other costs were accounted for, perhaps $30 to $40—3 to 4 percent of the total—would stay in China with the factory owners and the young women on the assembly lines.

Other examples: A carrying case for an audio device from a big-name Western company retails for just under $30. That company pays the Chinese supplier $6 per case, of which about half goes for materials. The other $24 stays with the big-name company. An earphone-like accessory for another U.S.-brand audio device also retails for about $30. Of this, I was told, $3 stayed in China. I saw a set of high-end Ethernet connecting cables. The cables are sold, with identical specifications but in three different kinds of packaging, in three forms in the United States: as a specialty product, as a house brand in a nationwide office-supply store, and with no brand over eBay. The retail prices are $29.95 for the specialty brand, $19.95 in the chain store, and $15.95 on eBay. The Shenzhen-area company that makes them gets $2 apiece.

In case the point isn’t clear: Chinese workers making $1,000 a year have been helping American designers, marketers, engineers, and retailers making $1,000 a week (and up) earn even more. Plus, they have helped shareholders of U.S.-based companies...

Comments

[michael perelman]

You make an interesting point that the Chinese are making the shoes for five dollars because they have not yet developed brands to market them for themselves. When they do, the US GDP will go down accordingly.
This process seems to be already beginning. The idea behind the expectation of the future success of US intellectual property economy was people in the United States would do the high-value work while leaving the country to others.
I'm reminded of an exchange between Boswell and Samuel Johnson:
"Very little business appeared to be going forward in Lichfield. I found however two strange manufactures for so inland a place, sail-cloth and streamers for ships: and I observed them making some saddle-cloths, and dressing sheep skins: but upon the whole, the busy hand of industry seemed to be quite slackened. "Surely, Sir, (said I,) you are an idle set of people."
"Sir (said Johnson) "We are a City of Philosophers: we work with our Heads, and make the Boobies of Birmingham work for us with their hands."
But already, South Korea seems to be making great progress in design work, supposedly the domain of the brilliant people in the United States who honed their minds on the complexities of Paris Hilton and cage fighting.
How long will it be before Chinese brands win a reputation for quality? Some older people may recall when Japanese cars were considered junk.