First came manufacturing. Now companies are farming out R&D to cut costs and get new products to market faster. Are they going too far?

The result is a rethinking of the structure of the modern corporation. What, specifically, has to be done in-house anymore? At a minimum, most leading Western companies are turning toward a new model of innovation, one that employs global networks of partners. These can include U.S. chipmakers, Taiwanese engineers, Indian software developers, and Chinese factories. IBM (IBM ) is even offering the smarts of its famed research labs and a new global team of 1,200 engineers to help customers develop future products using next-generation technologies. When the whole chain works in sync, there can be a dramatic leap in the speed and efficiency of product development.

The downside of getting the balance wrong, however, can be steep. Start with the danger of fostering new competitors. Motorola hired Taiwan’s BenQ Corp. to design and manufacture millions of mobile phones. But then BenQ began selling phones last year in the prized China market under its own brand. That prompted Motorola to pull its contract. Another risk is that brand-name companies will lose the incentive to keep investing in new technology. “It is a slippery slope,” says Boston Consulting Group Senior Vice-President Jim Andrew. “If the innovation starts residing in the suppliers, you could incrementalize yourself to the point where there isn’t much left.”

Such perceptions are a big reason even companies that outsource heavily refuse to discuss what hardware designs they buy from whom and impose strict confidentiality on suppliers. “It is still taboo to talk openly about outsourced design,” says Forrester Research Inc. (FORR ) consultant Navi Radjou, an expert on corporate innovation.
Outsourcing Gains Momentum
External service providers apply pressure on businesses to shrink their in-house staffs.

Red Herring

Pressures from external service providers will soon force changes in business technology employment, according to two independent reports issued Wednesday.

The reports, released by Gartner and The Yankee Group, suggest that competition from external service providers is forcing business managers to make tough decisions about their internal business departments.

Gartner warned that competition from outsourced IT providers will offer higher standards of service and price, and predicts that by 2015 the number of IT staff in business technology will decrease by 15 percent.

The research firm predicts that six out of 10 people in information systems (IS) will assume business-facing roles by 2010, resulting in a one-third decrease in IT departments within large and mid-size companies.

John Mahoney, chief of research for IT services and management at Gartner, advises managers either to focus on the reinvention of business management processes or to shift their focus to the outsourcing of IT services.

Offshoring Accelerating
US study puts number of jobs sent overseas in 2004 at 406,000, double the estimates

Kimberly Blanton        The Boston Globe

Data on numbers of US jobs moving overseas in recent years are scattered and unreliable. As the AT&T example shows, jobs may be cut in the United States, and employment may increase overseas, but companies are reluctant to draw connections between the two, while unions are only too willing to do so. Groups such as the US Chamber of Commerce peg the number at perhaps 200,000 jobs a year. But a new report commissioned by a bipartisan congressional commission said 406,000 US jobs will migrate overseas this year, double the conventional wisdom. This trend is expected to continue for several years as a greater variety of jobs are offshored, including to Latin America and the Caribbean.

Job movement overseas ”is absolutely accelerating, and it’s changing in its nature,” said Kate Bronfenbrenner, a professor in Cornell University’s School of Industrial and Labor Relations, who prepared the report for the US-China Economic and Security Review Commission. ”Whereas in 2001 it was almost all in manufacturing, now we see an increase in information technology, communications, financial services, and white-collar work, from research and design to back office.” The report will be presented at public hearings in Seattle in January. Some economists cite growing numbers of US jobs transplanted overseas as the main reason for slow employment growth during the current economy recovery. Another 400,000 jobs added to the total 1.8 million jobs created in the United States in 2004 would be ”a big deal,” said Stephen Roach, Morgan Stanley’s chief economist. ”Offshore labor pools have become increasingly attractive,” he said, and ”more and more of the new hiring incrementally is occurring offshore.”
China’s rise on economic stage raises questions about free trade
By Kevin G. Hall, Knight Ridder Newspapers

WASHINGTON – The rapid rise of China as a major actor in the global economy is provoking a reconsideration of whether free trade is still in America’s interest.

For 60 years the United States has promoted free trade as a powerful way to generate prosperity at home and abroad. Trade tripled over the past 40 years as a proportion of the U.S. economy, thanks in part to eight successive global negotiations that opened markets by lowering trade barriers. Now, efforts to expand free trade rules are stalling from Congress to Europe and in an ongoing round of global negotiations.

U.S. policy assumes that free trade benefits all who engage in it. The assumption dates back to 1817, when classical economist David Ricardo defined his doctrine of comparative advantage – that when nations specialize in what they do best and most efficiently, each will win by trading with the others.

Today, that concept is being questioned as never before. China’s rapid rise is feeding a common fear: that developing nations led by China and India may out-compete the world for high-tech jobs and keep the low-skill, labor-intensive manufacturing jobs they won already. China already is the world’s biggest exporter of electronics.

The fear is that China, so foreign and large, might soon gain advantages of labor, capital and even technology that will allow it to dominate the world economy – and the strategic advantages that go along.

To be sure, smaller nations have raised the same complaint about the United States for years. Could China really displace America?

China has more than 1.3 billion people and a work force of 700 million. Last year’s total U.S. work force was 147 million. Thanks to current technological advantages, U.S. workers are far more productive. But China’s catching up fast.

China began to introduce market forces into its economy in 1978, though it retained strict authoritarian control over civil society. Since then, its economy has grown by 9.4 percent annually. Its gross domestic product – the broadest measure of goods and services – has soared from $147 billion in 1978 to $1.6 trillion last year. The United States’ GDP last year totaled $11.75 trillion – still far ahead.

Want a snapshot of China’s rapid growth? Right now, subway systems are being built in 84 Chinese cities.

For a decade now, debate has swirled over whether China – a “socialist market economy,” according to its constitution – is a strategic trading partner or a budding rival.

Charlene Barshefsky, who was U.S. trade representative from 1996-2001, believes it’s both. Over time, she said, China will evolve from merely adapting technologies from others to developing its own innovations, which will affect the world.

“There is no historic precedent to the rise of a country this vast and this rapid, changing trade and investment flows around the world, with China the hub of Asian manufacture,” she said in an interview.

Author Ted Fishman recently documented the challenge in his book “China Inc.” He believes China soon will have two distinct economic platforms that will rival the United States. One is low-wage manufacturing. The second will be a high-tech industry that matches the West’s in sophistication, and that will drive down wages in other nations as they try to compete.

“It’s everything from Christmas ornaments to aerospace. Other economies do not come at us this way,” Fishman said in an interview. “That’s kind of a unique set of problems. The world has to find an `out.’ We have to figure out how everyone can prosper along with China.”

Barshefsky made the same point: “China’s rise is not a function of pervasive unfair trade – although trade disputes must be addressed. But resting concerns on claims of unfair trade as the basis of China’s rise obscures the real challenge facing the U.S., and that is the utter absence of any focus on our own longer-term competitiveness, formulating and implementing policy measures – from the fiscal, to education, to the state of our scientific infrastructure to business incentives – that answer the challenge of an emergent, vibrant, smart Asia, with China at its center.”

Late last year, Paul Samuelson, a Nobel Prize-winning economist, author of the long-standard college-economics textbook and an ardent supporter of free trade, suggested that China’s growing economic might calls into question whether free trade is a win-win game for America.

Samuelson said open trade helped the U.S. economy grow since World War II, but that competition from abroad drove down wages in lower-skilled jobs. Over time, China and India could displace U.S. high-tech jobs, too, and more American wages could be cut to help the United States sustain competition. Even though U.S. consumers get less expensive Chinese-made goods, many Americans could be net losers from such trade, he wrote.

Other experts say China trades by rules aimed at building its national power rather than economic exchange.

“What we’ve been calling free trade is not free trade,” said Clyde Prestowitz, a former top trade negotiator in the Reagan administration and author of the new book “Three Billion New Capitalists.”

In it, Prestowitz warns that China is building an export-based economy. China’s approach mirrors the mercantilist policies of 17th century Europe, when kingdoms tried to minimize imports, maximize exports and strictly administer their domestic economies to develop national wealth and power at rivals’ expense.

Last year, the U.S. trade deficit with China was $162 billion.

“I think we have to go through a rethink” of trade policies, Prestowitz said.

China is the world’s largest importer of steel, iron ore, copper, tin, other crude commodities and many semi-finished goods. It uses those to build an economy fueled by high-value manufactured exports, building surplus capital in the process.

China is already the world’s largest exporter of electronic and information-technology products; it sold $142 billion worth of such goods in 2003, up from $39 billion in 1999.

Meanwhile, the United States borrows deeply from China to sustain its national debt; as of April, China’s central bank held $230 billion worth of U.S. Treasury bonds.

Some experts think critics exaggerate the China threat.

“I think there is a tendency to overreach and think that they are going to move up the food chain very rapidly,” said Nicholas Lardy, a China expert at the Institute for International Economics, a pro-free-trade research center in Washington.

In the book “The United States and World Economy,” Lardy cautioned that China will continue to be hampered by its large population and lagging technology.

With all its people, China desperately needs to create jobs. Wage levels will remain low for many years, Lardy said. Because Chinese workers won’t have much money to spend, that will constrain domestic consumption and China’s internal economy.

Chinese President Hu Jintao laid out China’s economic goals through 2020 in a May 16 address in Beijing. He vowed to quadruple to $4 trillion the nation’s 2000 gross domestic product. That would still be only about one-third the size of today’s U.S. economy, which itself will grow significantly by 2020.

Even if China’s economy quadruples, the average Chinese will remain poor. If China succeeds, Hu said, per capita income would rise to $3,000. In contrast, U.S. per capita income was $40,100 in 2004.

Experts may differ on China’s threat potential, but no one questions that fear of China is influencing politics here and abroad.

In an effort to reduce China’s U.S.-trade surplus, 67 U.S. senators endorse a bipartisan measure by Sen. Charles Schumer (news, bio, voting record), D-N.Y., and Sen. Lindsey Graham (news, bio, voting record), R-S.C., to slap a 27.5 percent tax on all Chinese exports to the United States unless China revalues its currency.

Schumer said in an interview that China’s failure to revalue the yuan and to protect U.S. copyrights and trademarks is souring policy-makers.

“There’s always been dislocation and pain caused by free trade, but it’s never prevented free trade from being the dominant policy because people felt overall that the benefits outweighed the liabilities. Nothing will fray the (pro free-trade) coalition more than the view that it’s one-sided,” Schumer said.

Frustration with China is also hurting President Bush’s proposed Central America Free Trade Agreement.

“Many members of Congress from both parties have told me that they simply can’t afford to cast another free trade vote until they do something that shows that they `Get It’ – that they get the American anxiety about globalization,” said Nancy Roman, the vice president in Washington for the Council on Foreign Relations. “A lot of it does tie to China.”

Across the Atlantic, such fears are expressed in a general wariness about globalization. Voters in France and Holland recently rejected a European constitution that aimed to extend integration of the 25-member European Union. The negative votes were seen in part as a reaction to globalization, against the disruptive economic and cultural changes that flow from open borders.

“People do not know exactly what the implications are, but they intuitively see some potential dangers with China becoming bigger and bigger and the world becoming smaller,” said Hugo Paemen, who was Europe’s top trade negotiator in the early 1990s. “They feel pushed into a defensive position because of new developments in China and India.”