We call them the LLCC's – the Low Labor Cost Countries – and we rationalize having the goods we buy made there through a convenient, but entirley fabricated, interpretation of an economic theory called 'Comparative Advantage'. It is a fabrication because the theory is based on productivity – not hourly wages. It is driven by the idea that goods should be made wherever the collective combination of hours results in the overall minimum consumption of human effort – not wherever the economic and regulatory framework is most abusive. And it is convenient because it enables us to avoid acknowledging why we are really buying from these countries.
We could just as accurately call them LWSCC's – Low Workplace Safety Cost Countries – just as great a contributor to the low cost as labor – but it doesn't really have a moral ring to it, does it?
The similarities between the fire in Bangladesh last week and the fire at the Triangle Shirtwaist factory in New York in 1911 are striking Locked doors, blocked exits, abusive management in a factory full of over-worked, grossly underpaid women doing garment work.
Those practices were shamefully common in the Unites States a hundred years ago, but we don't allow that sort of thing any more. We collectively examined our consciences and decided that, while we want the things we buy to be cheap, we don't want to save money so badly that workers should suffer and even die in the process.
That's the way of it in democracies with functioning economies driven by free enterprise principles. We strike that balance, or attempt to anyway. Similar decisions have been made in the UK,and in Australia and New Zealand, in Japan and throughour western Europe, in Canada and in every legitimate democracy.
Or we could call them LECC'c – Low Environmental Cost Countries – again, a big contributor to why the costs are low, but not the sort of thing people in advanced countries want to acknowledge.
Or perhaps we could call them NCLLC''s – No Child Labor Limit Countries, but, again, we don't want to live with that.
There are lots of reasons why the cost of the shirt in Bangladesh or Gutamala is lower than in North Carolina. It is most convenient to focus on the hourly labor rates and to hide behind an economic theory from a book no one has read, even though everyone connected with manufacturing knows that the cost of production labor is a pretty low element of the total cost of shirts or much of anything else.
It is also convenient to delude ourselves into thinking payng those women in Bangaldesh 18 cents an hour helps them – it's better than nothing. In fact, the only thing that is going to help the women in Bangladesh is a functional economy with a government that is a whole lot better than 120th on Transparency International's corruption index.
Walmart, Target, Sears, Disney and the rest of the retailers whose goods were made in the factory that burned claim ignorance, as I imagine their customers do who Walmart and the rest say compel them to buy in Bangladesh rather than in countries that have chosen to preclude such human tragedies from happening. But they knew … maybe not about that specific factory, but they knew they were buying from factories where such events are likely to happen. It is why they are there – to avoid the cost of such things not happening.
Giving these countries a free pass on what we know is fundamentally right and fundamentally wrong because they are 'developing nations'? Another senseless, but convenient, rationalization. How about they develop to the point that they have a basic level of respect for their citizenry first, then we help out with the economics … but such respect adds to the cost of running their factories – doing things the right way is often not doing them the cheap way – and that cost will be embedded in the Disney shirt we want to wear … hence the convenience of the free pass for developing nation status.
I am foursquare in the camp of those who believe that the United States and most other western nations have let the pendulum swing too far – that we are grossly over-regulated, burdening manufacturing with exhorbitant costs to comply with unnecessary restrictions. But I am also a firm believer that we solve the over-regulation problem by battling it out with the regulators in Washington – not by throwing out the collective morality that drove us to resolve that another Triangle Shirtwaist factory fire would never again happen.
It is high time all of us westerners took a good, long, honest look in the mirror and asked ourselves just what it is we really stand for. Our predecessors had the principles to decide that our natural desire to have the good things in life at the lowest cost was not worth killing workers, trashing the planet and abusing children. I sure don't want for anything badly enough that women should die, children should be abused or people in China can't breathe so I can have it.
“…even though everyone connected with manufacturing knows that the cost of production labor is a pretty low element of the total cost of shirts or much of anything else.”
That’s probably true of everyone that has read more than one post here at EE, but manufacturing accounting traditionalists won’t get it. It’s always fun to ask old-time CFOs to compare actual cash labor cost vs calculated labor cost that includes allocations from every nook and cranny (and is presumably “accurate”), and then ask them where the opportunities for cost improvement really are.
David Hallsted says
Thanks for the history lesson.
I am passing it on.
John Hunter says
Very well said. The other costs (environment, labor laws…) are a huge factor today. Ethics do preclude doing business in the ways that damage others but sadly the actions of many of our executives today show ethics is not something they care about.
As you say the USA and even moreso Europe have somewhat the oposite problem of so many protections (and just poorly designed systems aimed) against negative externatlities (pollution, child labor, dangerous working conditions…). As countries get richer they demand a reduction in negative extrernalities which is good for their society. But they need to increase productivity to allow for them to have safe working conditions and still be accepted by the MBAs filling out their spreadsheets in the USA and deciding what to do.
Andy Wagner says
Ronald Coase, the 102-year old economist, recently had an article about what’s wrong with his profession today: http://hbr.org/2012/12/saving-economics-from-the-economists/ar/1
But let’s not blame Comparative Advantage. Comparative advantage is real. It’s why Kevin Meyer makes medical devices and I make airplanes. If he had to make his own airplane, he would never get to go to Hawaii on vacation. Specialization and Comparative advantage are good things.
The bad things that you highlight here are not the result of economic theory. They are the bad behavior of business people. Plain and simple. Don’t dress it up.
Bill Waddell says
Comparative Advantage is valid enough, Andy, in explaining why you make airplanes and Kevin makes medical stuff, but it is not a valid explanation for people in Bangladesh making shirts while people in North Carolina are unemployed.
Trade within the United States (you and Kevin, for instance) and trade within the developed nations in which labor costs and productivity levels are roughly similar can all be explained by Comparative Advantage; but to compare that with trade between the United States and, say, China or Bangladesh is to compare apples and oranges … or more appropriately, apples and ugli fruit.
I suspect you learned Comparative Advantage from an economics book, rather than from actually reading David Ricardo’s “On the Principles of Political Economy and Taxation” where the Theory of Comparative Advantage was laid out for the first time. Am I right? I sure hope so, because if you read Ricardo’s book you must have read Chapter 1, Page 1, Paragraph 1, Sentence 1 (kind of hard to miss) where Ricardo writes:
“The value of a commodity, or the quantity or any other commodity for which it will exchange, depends on the relative quantity of labour which is necessary for its production, and not on the greater or less compensation which is paid for that labour.”
Hmmmmm ….. it would seem that, by its very definition, buying from a LLCC – Low Labor Cost Country – is buying based on the “less compensation which is paid for that labour” – making justification of trade with countries for their Low Labor Cost on the basis of Ricardo’s theory absurd.
You and Kevin, however, having similar compensation for your labor, are trading based on the quantity of labor – clearly what Ricardo had in mind when he conjured up the theory.
This begs the question, if a simple minded old manufacturing guy like me can read the very clear opening lines in Ricardo’s book, how did whoever wrote the econ text book you learned the theory from miss it?
Of course you are right, Andy, that it is bad management – bad management all the way around … in Bangladesh, in China, at Walmart and in the western companies that lay off productive workers and move work to lower-productivity-but-even-lower-wage-places.
But that bad management is aided and abetted, encouraged, in fact, even turbo-charged by governments entering into virtually free trade agreements with places like China and Bangladesh. They do so with hordes of economists behind them roaring in unison about Comparative Advantage.
In his 2009 Economic Report of the President, Obama explained Comparative Advantage saying “that nations specialize in producing the goods that they can produce cheaply relative to other goods.”- not more productively, as Ricardo explained, but “cheaply”.
And that bad management is aided and abetted by all of us who complain about losing jobs and shake our heads at the abuses and horror of events like the Bangladesh fire, but are only too happy to have prices at Walmart low and don’t really want to know very much about why those prices are as low as they are.
I find it interesting that so many, or maybe all, industrialized societies started out the same way – low wages, child labor, pollution. In order to solve the current problems and keep history from reapeating over and over as more societies industrialize, we need to understand the root cause of why these are the methods of choice when trying to break into the industrialized world. We need to offer viable alternatives for starting up businesses that can compete in the world market. Money talks, and offers of low wages and other low costs speak very loudly. We need to speak louder about better alternatives and offer incentives for businesses to look at these alternatives. Penalties need to be enforced that make it unattractive to take advantage of these societies trying to break in. We need to help them, not take advantage of them. And the effort needs to start here at home.
Bryan Lund says
“But that bad management is aided and abetted, encouraged, in fact, even turbo-charged by governments entering into virtually free trade agreements with places like China and Bangladesh. They do so with hordes of economists behind them roaring in unison about Comparative Advantage.”
Bingo! Get the government out of the way and let the free market regulate management behavior here in the U.S.
Erik Nordin says
Bill, great article. In the ~18 years I have been in manufacturing, the COGS breakdown is generally as follows:
Materials – 80% of total costs
Overhead allocation – 12% of total costs
Labor – 8% of total costs
Yet topics such as value engineering and design for manufacturing, focusing on the materials and process side of the cost equation, are rarely heard in the board room. The BOD wants a quick fix to the cost equation and the first area of discussion is almost always labor. Without strong operational talent on the board, bad decisions will be made and the result is what you are showing us through these photos and comparisons.
Michel Baudin says
The discussion seems to equate Ricardo’s theory of comparative advantage with the idea each product should be made by those who can do it best, which sounds more like Adam Smith’s division of labor. Ricardo’s theory is about the benefits for free trade between two countries when one is better at everything than the other. Ricardo only discusses cloth and wine to be made either in Portugal or England. Both are cheaper to make in Portugal but wine is much cheaper while cloth is slightly cheaper. In this case England is said to have a comparative advantage on cloth even though Portugal has an absolute advantage on both. The practical consequence is that more wine and cloth are produced overall if England focuses on cloth and Portugal on wine.
It sounds like a hypothetical example, contrived for the purpose of illustration, and that is what I first assume it was, but it’s not. It is a real case that unfolded in the century before Ricardo wrote, and in which it was not just the free play of trade that determined the outcome. If we believe the following excerpt from the Wikipedia article about the history of Portugal, the visible hand of government played a key role:
“The 1703 Methuen Treaty between England and Portugal had both direct and indirect effects on the Portuguese wine industry. The treaty not only stipulated that the amount of duties on Portuguese wines was to never be more than two-thirds that of which was levied on French wines, it also allowed English woolen cloth to be admitted into Portugal free of duty. This second stipulation ended up having a devastating effect on the Portuguese textile industry, leading to huge numbers of shepherds and weavers becoming unemployed. In and around the Douro region, this segment of labor turned to the wine industry and encouraged a boom in vineyard planting.”
This elegant theory is not easily generalized from two countries trading two products to many countries and many products, and it is not obvious that it can be used to justify outsourcing. On the other hand, I have applied it in production to the allocation of work among machines with overlapping capabilities by the visible hand of management. (http://wp.me/p1UTIj-4E)
The comments also made several points made about what countries and companies do. Governments decide which other countries to embargo, give most-favored-nation status, or sign free-trade agreements, and generally set and enforce trading rules. Company managers can decide to play or not, but their only duty is to make the best deals they can wthin the rules, however their strategy defines what ‘best’ means. Making ethical judgements on the mores of other countries is not part of their duties.
In discussions of manufacturing, China is often front and center. US government policy towards China should be based on enlightened best interest looking forward maybe not 100 years but at least 20. Personally, I think the best interest of the US is a prosperous China, with a large middle class and strong economic ties with the rest of the world.
I know a few Chinese, but I don’t know any who think they are worse off today than they were 20 years ago. Manufacturers complain about rapidly rising wages and new regulations reducing work hours, all of which are signs of maturation. For all its faults, China’s leadership is trying to lift more than 1 billion people out of poverty in a few decades. It has never been done, by anyone and it can fail, with the country falling back into the political chaos it has known in the 20th century.
As manufacturing matured in the US, the practices that caused the deaths at the Triangle Shirtwaist factory were abandoned because they were bad business all around, not because management grew a conscience. The way we developed our own manufacturing industry in the 19th century gives us little moral authority, and we must be cautious in our judgements. Child labor is a bad idea; children should be in school, not on the shop floor. If, however, we convince another country’s government to forbid the use of child labor, what will the consequences be? If the alternative to work is starvation, have we accomplished anything? Are we willing to fund the schooling of the children?
A few years ago, there were reports in the press that Levi’s had done exactly that in Pakistan. It stopped using child labor and paid the kids to go to school. But is it a proper role for a company? Can we count on private, for-profit organizations to solve this problem? I don’t think so. It is what governments exist for, and it is the sort of things that foreign aid is supposed to be for when local governments are too poor to do it.
Bill Waddell says
I think we are going to have to agree to disagree on a number of levels:
“Ricardo’s theory is about the benefits for free trade between two countries when one is better at everything than the other. Ricardo only discusses cloth and wine to be made either in Portugal or England. Both are cheaper to make in Portugal but wine is much cheaper while cloth is slightly cheaper.”
As I stated earlier, he didn’t say “cheaper”. His theory was all about labor utilization. When you substitute cost for productivity you advocate a theory that drives the entire world to one common wage rate. It means workers in the USA get no benefit from their higher productivity levels, and steadily see their wage rate erode until it is in equilibrium with the rest of the world. Great for the third world, workers in the USA are screwed, however.
“Company managers … only duty is to make the best deals they can within the rules”
Sounds like the Wall Street philosophy. Ethics and morality have no place in business – whatever makes money and won’t get you tossed in jail is OK no matter who suffers along the way. Misses the entire, basic lean concept of creating value for all of the stakeholders.
“China’s leadership is trying to lift more than 1 billion people out of poverty in a few decades”
If you think the goals of Chinese leadership are that altruistic you are very naïve. They want to lift people just enough out of poverty to keep them from storming the palace with torches and pitchforks. One yuan above that level that finds its way into a workers pocket is money that leadership thinks they wasted – it should have gone into their own pockets. China’s leadership is driven by lust for power and wealth – personal wealth and power and national wealth and power. Period, full stop. If there is a place on the planet with less regard for the quality or even existence of human life I have yet to visit it.
“If, however, we convince another country’s government to forbid the use of child labor, what will the consequences be? If the alternative to work is starvation, have we accomplished anything?”
How convenient – we are actually helping feed children when we buy shirts they made for the price of a bowl of rice. It smacks of the words of southern slavery advocate, John C Calhoun when he said, “Never before has the black race of Central Africa, from the dawn of history to the present day, attained a condition so civilized and so improved, not only physically, but morally and intellectually.” In other words – yeah, they are being abused but not as badly as they would be if they weren’t being abused by us.
The country they live in is not inherently “too poor to do it” It is too corrupt to do it. Women and children are starving in these countries because they are run by dictatorships and have dysfunctional economies. Only fixing that root cause will lift these people out of poverty.
I will agree that governments and foreign aid are more appropriate if we want to be sure the women and children are fed while we wait for the corrupt government to straighten itself out. Throwing American workers out of their jobs and paying rice money to the women and kids in corrupt countries and calling it morally good, however, is absurd.