October 2010

In the Financial Times, possibly the best newspaper in the world and full of intelligent reporting and comment, John Kay stands out for his incisive take and economy of expression. One of his most recent articles, “Why you can have an economy of people who don’t sweat,” takes to task the “manufacturing fetishists” who believe that any economic activity apart from manufacturing, agriculture, or mining is of minimal real value. We are all prey to this attitude to some degree, especially in the wake of the financial crisis, in which economies that rely heavily on a somehow “unreal” financial sector fared worse than those economies more focused on production of things you can drop on your toe.

I have long been troubled by this attitude. Somehow, a banker inventing and flogging new forms of derivatives or trading algorithms seems morally and economically less worthy than someone who makes pig iron or beer for a living, and this view may be justified. But on close examination, many other jobs, which involve more brains than brawn, generate far more real value, however you care to measure it, than tightening bolts or stitching sleeves on an assembly line.

Kay mentions Apple’s iPod  as a product in which the value added from manufacturing the device itself, including the extraction and processing of the metals and plastics it contains, amounts to three or four dollars of the two or three hundred dollars the finished product sells for. Product and production design, marketing and promotion, and logistics and distribution are where the real value is created. This is increasingly true of almost any physical product we buy. When you pay several dollars a tablet for your heart medicine or Viagra, the value resides not in the cost of producing the pill itself, which in most cases amounts to fractions of a cent, but in the billions of dollars spent on research and development and testing: the intellectual value. Even if pharmaceutical companies are often guilty of inventing cures for conditions no one knew existed until they saw the TV commercials, the intrinsic value of much of what they produce is incalculable, and has little to do with the hourly wages of workers on the assembly line. Kay also cites the example of book publishing, in which “the books that Britain exports have, for as long as I can remember, been made from trees grown abroad; but then globalization meant the paper was also made abroad, and increasingly the printing took place overseas. Soon shipments will be entirely electronic; selling a book will involve no physical objects.”

Lately I have been working on development of industrial parks in Haiti, in which international garment manufacturers, attracted by cheap labor, special trade preferences, and proximity to the U.S. market, will set up factories.

This is unpopular in many quarters. Anti-globalists point to the exploitation of poor Haitians. A Haitian garment worker can expect to make less than six percent of the earnings of an American on minimum wage. Working and living conditions will be poor, and a worker might spend a quarter of his daily earnings for transport to and from work. Though the factories for the most part are clean and well-lighted and ventilated, it is not an easy life. Many also decry the shipment of American jobs overseas, as if employing Americans as minimum-wage sewing machine operators were vital to our national interest.

Most of the garment manufacturers likely to invest in Haiti’s industrial parks are Korean companies. Once Korea itself was a huge manufacturer and exporter of clothing, but as Korea grew richer it could no longer compete with lower-wage countries. But the Korean companies that had formerly made garments in Korean factories using Korean workers did not quit the business. Instead, they began setting up factories in places like Vietnam and Cambodia and Honduras and Nicaragua, which, with Korean experience and know-how, became some of the most efficient manufacturing operations in the world. The Korean companies integrated these factories into their global supply chains, becoming suppliers of choice to U.S. clothing companies and retailers like Levi Strauss, Wal-Mart, Nike, and Gap.

When you buy a pair of Levi’s made in Haiti, what is the source of value in the product? Is it the product design, distribution, quality control, and marketing provided by Levi Strauss? Is it the factory design and construction, production engineering and management, fabric sourcing, and logistics provided by the Korean manufacturer? Or is it the Haitian sewing machine operator? Obviously, all participants in this complex supply chain play an essential role, but you’d have to be a devout Marxist to argue that the product’s value resides exclusively or mainly in the direct manufacturing labor. That may have been the case in the 19th century, but certainly is not in the 21st. What differentiates one product from another, except perhaps for hand-made watches costing $100,000 and up, is not the skill and hard work of the laborer but the design, engineering, production management, logistics, distribution, and marketing that transform an idea into a tangible item.

It goes even further. The end product needn’t even be tangible, as John Kay points out in his example of book publishing. To put it another way, why do most of us instinctively feel that manufacturing a TV set is somehow a more worthy activity than producing a TV show?

Our entire way of looking at the economy is conditioned by this bias. We talk about our balance of trade, but although statisticians and econometricians do their best to quantify trade in services, such data are much harder to capture than information on trade in physical goods. When a software package is exported or an engineering firm designs and manages construction of a new road in another country, those transactions show up in the balance of trade of both the exporting and the importing country. But it gets far more complex when we consider all the trade in non-tangible items and services that take place within a single company or supply chain. When Gap sends its new T-shirt design to a manufacturer in Haiti it is effectively exporting its intellectual property to the manufacturer. When an engineer flies from Korea to Haiti to oversee the retooling of the manufacturing line for the new product, his employer in Korea is exporting his know-how. But it’s unlikely that either of these transactions shows up in official trade statistics. So, to complement our manufacturing bias, we have a system of recording data that fails to capture much of the value of non-physical trade and thus devalues that trade in the estimation of both the public and the policy markers who rely on those data.

It gets worse. Engineering is still considered a noble endeavor, but mainly because it remains directly linked to the production of something physical, be it a toaster, a bridge, or a pair of pantyhose. But a designer? Someone who slaps his initials on a T-shirt so as to sell it for ten times the price of the equivalent generic product. Where’s the value in that? And what about the marketers, the shippers, the wholesalers, the retailers, and the advertisers, not to mention the customer support staff? Useless parasites all of them, in the popular view, selling us stuff we don’t need and adding layer upon layer of profit to make everything more expensive than it should be. A moment’s reflection should dispel that belief, but it doesn’t. So Wal-Mart, which has outsourced much of its manufacturing to China, is considered a villain for shipping American jobs overseas, even though it has devised one of the most sophisticated systems of distribution, logistics and inventory management on the planet, which employs 2.1 million people worldwide, 1.4 million of them in the U.S.

The garment industry is an especially pertinent example, because it employs so many people and, in many poor countries, is the first step on the path to industrialization and greater prosperity. It is also one of the first industries to leave a place when the cost of production rises, usually as a function of rising wages. It happened in the U.S. right after WWII, when New England textile mills moved to the Carolinas, attracted by lower wages, less powerful unions, and cheaper electricity. It has happened again as textile and garment companies moved their factories to Mexico and El Salvador and Lesotho and China, and now Vietnam, Cambodia, and Haiti. Each time this happens there are recriminations and self-criticism. We are losing the manufacturing base that makes us strong. Our leaders should have done more to keep the jobs here. Those underhanded foreigners are grabbing “our” jobs.

If this were actually true, and if the migration of low-skill, low-paid jobs to poorer countries were such a threat, unemployment in the U.S. would be much higher than it is, whereas, until the current recession hit, we had one of the lowest unemployment rates of any advanced country. Some proportion of the U.S. labor force does work slinging burgers, greeting shoppers at Wal-Mart, and calling you at dinnertime to sell you a new cable TV service, but that’s only a fraction of the total. In Massachusetts, where I live, many of the textile jobs that went south and then overseas were replaced by higher-skilled and better-paid jobs in information technology, telecommunications, biotechnology, and finance. If our government had tried to resist the economic tide and preserve those textile jobs, these new industries might never have emerged. We should rejoice at these trends instead of seeing them as emblematic of the failure of our system of economic governance.

In John Kay’s words, “The productivity of modern economies is based on the division of labor. If everyone grows their own food, and gathers their own fuel, it takes them most of the day. There is little time or energy left for conversation, entertainment, trading derivatives or inventing new goods… specialization of tasks gave opportunities to achieve economies of scale and to focus on tasks at which individuals or companies were, or became, particularly skilled. Less time had to be devoted to toolmaking, hunting and foraging, and more was available for chatting, playing music, hairdressing, insurance broking and discovering how the world worked. Some new activities required rarer skills and were consequently well rewarded…the division of labor becomes ever finer and generally increases the wealth of all involved in the production process. Perhaps it is time for manufacturing fetishists to move beyond categories set by Stone Age man’s requirements for food and shelter.”

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My most recent blog post, discussing whether Barack Obama is good or bad for business, attracted more, and more vociferous, comments than anything else I have ever posted, apart from one article I wrote expressing mild skepticism about the utility of Apple’s new iPad (lesson: don’t criticize cultish dogma of any kind). Most of those who commented, some of them using noms de blog like “John Galt,” attacked me for peddling “pure propaganda” in favor of the President’s policies, while others, also missing the point, congratulated me for standing up in favor of the President. My point, however, was neither to praise the President nor to attack him, but to point out how much he resembles his predecessors as President and other senior elected officials, regardless of party affiliation. He and they are keen to show their pro-business bona fides by granting subsidies and protection to corporations, some of which may – directly or via their industry lobbies – contribute to their campaigns. At the same time, the President and Members of Congress are not at all eager to prune back the thicket of regulation that makes it increasingly difficult for many American companies, especially small businesses, to prosper and grow. The people who govern us act favorably towards specific companies and industries, but show little fondness for free markets, which favor all comers equally.

Though many companies benefit from government largesse, none has mastered the game of turning government policy to its advantage better than Archer Daniels Midland, the world’s largest corn processor based in Decatur, Illinois. ADM, with $69 billion in 2009 revenue, ranks 27th in the Fortune 500 and is the second largest U.S. agro-processing firm after Cargill, the privately owned Minneapolis company, which pulled in an estimated $110 billion in 2009 revenue.

ADM has exerted a strong influence on U.S. agricultural policy for at least 40 years. In  1973 Earl Butz, President Nixon’s Agriculture Secretary, engineered a shift away from the New Deal policies of farm price supports, which included limiting production of corn and other major commodities, to encouraging farmers to produce as much as they could, regardless of price. The government henceforth would pay direct subsidies to farmers to make up the difference between the market price and what it considered an appropriate floor price. Naturally, this sharply drove down the price of corn, providing a windfall to major corn processors. Michael Pollan describes this phenomenon in detail in his excellent book, The Omnivore’s Dilemma.

Except it wasn’t precisely a windfall, since ADM had done a great deal to engineer this outcome. During the Watergate investigation, Special Prosecutor Archibald Cox indicted then-ADM CEO Dwayne Andreas for giving $100,000 in illegal contributions to Hubert Humphrey’s 1968 Presidential campaign. But Andreas was nothing if not bipartisan. Richard Nixon’s secretary Rose Mary Woods, testified that during Nixon’s 1972 campaign Andreas handed her an envelope containing $100,000 in $100 bills. Between 1975 and 1977 Andreas gave $72,000 in ADM stock to the children of David Gartner, senator Humphrey’s chief of staff at the time, whom President Jimmy Carter in 1977 named to head the Commodity Futures Trading Commission (he was later forced to resign when the details of the ADM gift came to light).

ADM continues to lavish huge sums on candidates for high office. During the 1996 Presidential campaign ADM gave $100,000 to Bob Dole’s Better America Foundation, provided numerous free rides on ADM’s corporate jets to Senator and Mrs. Dole, and gave over $1.5m in soft money to the Republican National Committee. Though Bob Dole lost his Presidential race he remained highly influential as a Senator and helped arrange the 54-cent per gallon ethanol tax credit of which ADM, producer of more than 60% of America’s corn-based ethanol, is the main beneficiary. ADM also contributed to Clinton’s and George W. Bush’s campaigns. Although Barack Obama apparently has received no direct campaign contributions from ADM – ADM was, however, a major sponsor of the 2008 Democratic National Convention – as a Senator from ADM’s home state of Illinois Mr. Obama was one of several farm-state Senators who staunchly opposed a Bush Administration proposal to lower the prohibitively high import duties on Brazilian ethanol made from sugar cane. During his Presidential campaign Mr. Obama vigorously defended the corn ethanol subsidy, and as President he has kept the policy firmly in place.

ADM’s own corporate website has this to say about its political contributions:

“As a global agricultural leader, Archer Daniels Midland Company connects the harvest to the home and serves growing global demand for food and energy.   Our ability to fulfill this vital purpose is enhanced when government policies impacting our operations promote growth — growth that facilitates job creation as well as ongoing investment in our business, our employees and the communities where we live and work.

“For this reason, ADM and ADMPAC, our political action committee, support candidates for political office and organizations that share our pro-growth vision, our aspirations for the future of global agriculture, and our commitment to the people who depend on it for their lives and livelihoods.  All ADM and ADMPAC political contributions are made in strict accordance with applicable federal, state and local laws.”

In 2009, not an election year, ADM gave $197,575 in political contributions while its political action committee, ADMPAC, gave another $134,500.

If rigging U.S. agriculture, trade, and energy policies to its advantage weren’t enough, ADM has also conspired with other agro-processing giants such as Cargill and Ajinomoto to fix prices for lysine, citric acid, and corn syrup. It paid a $100m fine in 1996 for lysine price-fixing in a plea bargain that led to two-year prison sentences and $350,000 fines for Michael Andreas, Dwayne’s son and heir apparent, and Terence Watson, another ADM executive. At around the same time, ADM, Cargill, and the British sugar company Tate & Lyle were indicted by the U.S. government for  conspiring to fix the price of high-fructose corn syrup. Though they were cleared of criminal charges in 1999, they subsequently settled a lawsuit brought by U.S. food and beverage manufacturers, Cargill paying $24m, Tate & Lyle $100m, and ADM $400m.

According to a 1995 article by James Bovard of the Cato Institute, ADM heavily bankrolled the American Sugar Alliance, which successfully lobbied for high tariffs and quantitative restrictions on sugar imports, raising the domestic sugar price to a substantial multiple of the world market price and ensuring that ADM could profitably produce high fructose corn syrup at a substantial discount to the cost of sugar. According to Bovard’s article, “At least 43 percent of ADM’s annual profits are from products heavily subsidized or protected by the American government. Moreover, every $1 of profits earned by ADM’s corn sweetener operation costs consumers $10, and every $1 of profits earned by its ethanol operation costs taxpayers $30.” The numbers have no doubt changed over the past 15 years, but the underlying practice has not.

The funneling of taxpayer dollars into ADM’s bottom line continues unabated. The Des Moines Register reports today that the EPA is about to issue an approval for 15% ethanol blends to be sold as automotive fuel (the current standard is 10%), almost certain to be a bullish indicator for ethanol futures prices.

Apart from the obvious cost to taxpayers, what are the wider effects of the subsidies and other market distortions that favor ADM?

The current controversy over New York City Mayor Michael Bloomberg’s proposal to ban the use of food stamps for purchases of soft drinks on the grounds that such products contribute to obesity is a case in point. I am not going to wade into the debate over the health effects of high fructose corn syrup (HFCS), except to note that the Corn Refiners Association (principal members ADM, Cargill, and Tate & Lyle) have recently launched a huge campaign to rebrand HFCS as “corn sugar” and to convince consumers that “sugar is sugar,” whatever its source. Even if the association’s claim is true, HCFS has had a hugely adverse effect on public health, mainly because it is so cheap. It has become almost impossible to find a 12-ounce bottle of Coke or Pepsi anymore. Go into any convenience store and the minimum size is now 20 oz., while two-liter bottles, which cost only pennies more than their smaller cousins, appear to dominate the market. As one of the cheapest items on supermarket shelves, soft drinks laden with HFCS are a popular choice for people whose grocery budgets don’t stretch very far, and if you can get two liters for only slightly more than the price of one, why wouldn’t you?

Rather than robbing food stamp recipients of their dignity by telling them what they can and can’t buy, I’d rather see comprehensive reform of our agricultural policies, which would include abolishing food stamps, another form of agricultural subsidy, in favor of cash grants.

Then there is the effect of ethanol subsidies on world hunger. You may remember the commodities price boom in the first half of 2008, before the housing market crash, when the oil price hit $147 a barrel, the corn price went to $7.65 a bushel, and more than 30 countries, including Bangladesh, Cameroon, Egypt, Haiti, India, Indonesia, Mozambique, and Senegal, suffered widespread and deadly food riots. The spike in the corn price was caused largely by the diversion of roughly a third of America’s corn crop to ethanol production. This had a knock-on effect on wheat and rice prices. Numerous grain exporting countries, including Argentina, India, Vietnam, and Russia, imposed export bans, which contributed to shortages and price rises in countries dependent on food imports

The same phenomenon may be about to repeat itself. On Monday, corn prices gained 8.5% on the Chicago Board of Trade, the biggest rise since 1973, and it followed a substantial gain on Friday, both resulting from Friday’s release of a U.S. Department of Agriculture report, which sharply cut the outlook for U.S. corn yields. These developments had a knock-on effect on wheat prices, which rose 2.8% before falling back, and soybean prices, which gained 1.5%. Cotton futures hit a 15-year high on the New York market. Russia, suffering its hottest-ever summer, in August imposed a ban on wheat exports, which it subsequently extended to the 2011 harvest as well.

A lot of things contributed to the 2008 panic and are contributing to the current panic in the making. People in places like China are growing wealthier and want to consume more meat, which increases the demand for grain. Rapid urbanization, especially in China, is forcing the conversion of farmland to industrial, commercial and residential use. Higher oil prices raise the cost of fertilizer, which in turn causes food prices to rise. The planet’s population continues to grow, with much of the growth coming in countries that can’t grow enough food to feed themselves.

You can’t blame ADM for hot weather in Russia. But if you had to identify one principal cause of what seem to be recurring food shortages and price shocks, you’d have to look at U.S. agricultural policy, and if you look at U.S. agricultural policy you have to look at ADM. Ethanol subsidies and tariff protection divert cropland from food production to energy production. It’s as if you cut down a corn field to put in a power plant, except a power plant has a much smaller footprint than the thousands of acres of corn fields needed to produce an equivalent amount of energy. The competition for cropland intensifies, food prices shoot up, and the world becomes much less stable. Starvation abroad and obesity at home, ADM is one corporation with a lot to answer for.

Back to my original point, then. Barack Obama, like all of his predecessors for at least the past 40 years and like most of his former Congressional colleagues, Democrats and Republicans alike, is quite happy to grant hugely expensive favors to ADM and to scores of other big companies. In this he, and they, can be considered highly business-friendly. But this doesn’t translate into enthusiastic support for free markets. Quite the opposite, in fact. It might be appropriate to leave the last word to former ADM Chairman Dwayne Andreas, who told a reporter, “There isn’t one grain of anything in the world that is sold in a free market. Not one! The only place you see a free market is in the speeches of politicians. People who are not in the Midwest do not understand that this is a socialist country.” Even though they would never admit it publicly, a majority of our elected officials – and that includes Presidents Obama and Bush and a majority of senators and representatives from both parties – agree. You can quibble about the details, but President Obama is firmly in the political mainstream: friendly to big companies but distrustful of free markets.

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The media have been full in recent weeks of articles and commentary about Barack Obama’s view of business. Is the President pro- or anti-business? Have his actions improved or worsened conditions for American businesses? The Economist 10 days ago ran a cover story on the topic – “No love lost: Corporate America’s complaints about the president keep getting louder” – and also just concluded one of its online debates on the motion “This house believes that the Obama administration has been good for business.” The pro side won, 59% to 41%. [click to continue…]

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