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Why Employers want to Outsource Manufacturing Production
An Illustration of the Financial Impact

 Let’s say that Product X, whose manufacturing process is labor intensive, was produced in the United States paying production workers an average of $12.00 an hour. Management decides to outsource production to Asia using a subcontractor. This firm pays its production workers an average of $.60 per hour converted into U.S. currency. We look at financial impact as expressed in percentages of sales dollar for various categories of cost and profit.

(1) Hypothetically, Product X had the following cost structure when it was manufactured in the United States:

 

cost category percent of total
   
production labor
40%
materials
25%
transportation of finished goods
5%
executive compensation
3%
other labor costs
15%
other costs
12%
profit
5%
total percent of sales dollar
100%


(2) After production is outsourced to a low-wage country in Asia, the cost of production labor drops dramatically. However, there is an increase in the cost of transporting the finished product to market and in other management costs (which now include management and profits of the subcontractor). The new cost structure is as follows:

 

cost category percent of total
   
production labor
2%
materials
25%
transportation of finished goods
10%
executive compensation
3%
other labor costs
20%
other costs
12%
profit
28%
total percent of sales dollar
100%



(3) Let’s say that management decides to redistribute the 28% profit in two ways: (a) It doubles its own compensation as a reward for having performed well in producing increased profits for shareholders. (b) It reduces the price of Product X equivalent to 10% of the original sales dollar. The cost structure after these changes is as follows:

 

cost category percent of total
   
production labor
2%
materials
25%
transportation of finished goods
10%
executive compensation
6%
other labor costs
20%
other costs
12%
profit
15%
total percent of sales dollar
90%



Expressed in terms of the new sales dollar it is:

 

cost category percent of total
   
production labor
2.22%
materials
27.78%
transportation of finished goods
11.11%
executive compensation
6.66%
other labor costs
22.24%
other costs
13.33%
profit
16.66%
total percent of sales dollar
100%

 

In cutting prices as the price of its competitors’ products stays the same, management is able to boost Product X’s share of the market, resulting in increased sales and profits. The bottom line from management’s standpoint is that company profits and executive compensation have increased substantially. Management’s direct compensation in this example has more than doubled. If the firm’s top managers receive stock options, management stands to benefit further from the company’s rising stock value. In short, outsourced production has proved to be a real bonanza for the company’s top management.

Normally improved management performance is thought to reflect such things as improved product design, improved production methods, better marketing, etc. In this example, however, we assumed that nothing was changed except that production was moved to a country where labor was cheaper. Management did not improve its performance at all. The firm’s increased profitability came straight out of the hides of U.S. workers who were laid off when factories were closed in the United States and production was shifted abroad.

U.S. corporate executives are adamant in their support of free trade - a system which allows outsourced production of goods which will later be sold in the United States without being burdened by tariffs. These top executives are able to control their firms’ policies with respect to lobbying, political contributions, and support for or opposition to particular legislation. John MacArthur, publisher of Harpers, has said that Bill Clinton’s support of free trade - NAFTA in particular - meant that the Democrats gained significant financial support from the corporate world, almost on a par with support given to the Republicans.

Free trade involving imports from low-wage countries is good for corporate profitability and good from the standpoint of compensation given to corporate managers, especially CEOs. It is also good for consumers, who benefit from low prices. However, it is bad for U.S. workers who once had high-paying factory jobs. As such jobs are lost, the government loses revenues from the income tax and FICA tax and the U.S. consumer market is weakened by loss of purchasing power. The decline of the U.S. job base leads to a host of other problems including increased crime and declining affordability of housing.

U.S. government officials have a duty to protect the interests of their constituents, the American people. While they will give lip service to those ideals, their personal interest lies in getting reelected with the help of financial contributions and support from the corporate world and in finding lucrative corporate jobs after they have left politics. In effect, they have been bribed to betray their constituents’ interest; or, at least, they pursue short-term interests that conflict with their duty to constituents.

Boosting short-term profits and management compensation is increasingly important in the corporate world. The top-level corporate executives have no inherent loyalty to their employees or to their country. Some have frankly admitted to this. (An official of Gulf & Western Industries said, for instance: “All such allegiances are expendable under the new rules. You cannot be emotionally bound to any particular asset.) Once they have grabbed the ripe financial plum of excessive compensation given to them as corporate managers, they can convert their winnings into assets in another currency and retire comfortably to such places as the Caribbean islands, Europe, or central America. They are in business to make money, not protect the interests of the American people.

The problem therefore lies with U.S. politicians and with the shills for free trade in academia and the news media. They have a duty to balance the interests of workers and consumers. If they took the long view of things, they would realize, as Henry Ford did, that those two groups are one and the same. He once said: “The people who consume the bulk of goods are the (same) people who make them. That is a fact we must never forget - that is the secret of our prosperity.” If you cut out the worker, you eventually destroy the consumer as well.

Under the current system of free trade, people produce goods in low-wage countries such as China or Vietnam while consumers of those goods live in high-wage countries such as the United States. We receive their goods in exchange for our assets and debt certificates. Is that really “trade” as the term is commonly understood? I think not. We are trading away our future prosperity for the sake of present consumption or, in fact, to advance the short-term interests of our elected officials and business leaders. This is characteristic of a society in decline.

 

 

 

 



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