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From Stanford Business  magazine

STANFORD GRADUATE SCHOOL OF BUSINESS - As Intel Corp.’s former longtime chief executive, Andy Grove rarely pulled punches. His opening lecture last fall at a Graduate School of Business seminar taught with Professor Robert Burgelman was no exception. The seminar, Strategic Thinking in Action — In Business and Beyond, looked at Silicon Valley’s role in the computer, semiconductor, and automotive industries, with Grove in particular examining the region’s role in U.S. employment. But it became immediately apparent he had even bigger concerns.

In quick succession, he showed slides of unemployment rates matched to graphic depictions of massive worker protests in France in 1848, Russia in 1917, and the United States in 1932. For that last example, he “scared everybody,” says Burgelman, by playing a video clip of tanks and armed soldiers repelling jobless veterans rallying on Pennsylvania Avenue in Washington, D.C. “It was a little sobering to start a class like that,” says Joe Bingold, MBA Class of ’11.

Grove’s point couldn’t have been clearer: Unless the country wakes up to the real challenge of creating jobs and starts to chip away at stubbornly high unemployment, it could face social unrest it has not seen in generations. The only hope, he contends, is to restore a manufacturing base in the United States. Traditionally, manufacturing was responsible for producing millions of middle-class jobs as companies scaled up to produce successive waves of new products. According to market researchers IHS Global Insight and Moody’s Analytics, manufacturing jobs on average pay $22 an hour, nearly double the average for service jobs. Today’s nearly 9% unemployment rate pales next to the 38% rate in 1932, but manufacturing workers are faring far worse. Their jobs decreased by nearly 21% from 2001 to 2009, or about 290,000 jobs a year, according to the U.S. Bureau of Labor Statistics.

Many economists believe that it doesn’t much matter to U.S. prosperity where manufacturing is located as long as the domestic economy can keep generating new innovations and the highly paid design, programming, and other knowledge-based jobs that go along with them. Grove rejects that view. “What kind of a society are we going to have,” he asked last year in a controversial Bloomberg Businessweek cover essay titled “How America Can Create Jobs,” “if it consists of highly paid people doing high-value-added work — and masses of unemployed?”

He suggests, for one, that corporations and their investors must look beyond the next few quarters of profits. Individual companies pursuing their own agendas leads to offshoring manufacturing and even research and development to save money, he says, but the result is a gradual loss of the expertise and knowledge needed to create and scale up manufacturing for the next great industries, such as batteries and solar panels for clean energy. “Without scaling, we don’t just lose jobs. We lose our hold on new technologies,” he contends. “Abandoning today’s ‘commodity’ manufacturing can lock you out of tomorrow’s emerging industry.”

Grove also says government must take a more active role in spurring new industries. In particular, he calls for extra U.S. taxes on goods produced by overseas labor, with the proceeds to be invested in what he calls a “Scaling Bank of the U.S.” That fund would dole out dollars to companies that grow manufacturing operations here instead. “If the result is a trade war,” he added in his essay, “treat it like other wars — fight to win.” Separately, he also has called for a new immigration policy giving foreign graduates of U.S. institutions green cards so they can work or start companies here instead of overseas.

Both Grove’s apocalyptic vision of the future and some of his proposed remedies sound over the top to many, including some of his students, economists, and businesspeople. But he has reignited a longstanding debate about the impacts of globalization, giving voice to some who believe the free market can’t solve every problem. Grove has gained at least one very high-profile supporter: President Obama. During a Feb. 18 tour of an Intel plant in Oregon, the president praised Intel’s commitment to U.S. manufacturing, citing Grove’s belief that corporate leaders have dual obligations. “One obligation is to your shareholders,” Obama said. “But the other obligation is to America, because a lot of what Intel has achieved has been made possible, in Andy’s words, ‘by a climate of democracy, an economic climate, and investment climate provided by our domicile, the United States.’”

The plight of U.S. manufacturing reflects economic incentives that favor careers in finance, says serial entrepreneur Judith Estrin, MS Electrical Engineering ’77, author of the 2008 book Closing the Innovation Gap and member of the advisory councils of Stanford’s School of Engineering and Bio-X Initiative. “For the last couple of decades, we have been training people to be investment bankers,” she says. “The people who make the most money — such as hedge fund managers — take away jobs. Our economy went on a diet of empty calories.”

Grove can’t be easily dismissed, least of all by the business community. One of the most revered industrial figures of the past few decades, he helped build a company that remains a shining example that domestic manufacturing can make economic sense. Although it has many manufacturing operations overseas, Intel still builds multibillion-dollar semiconductor plants in the United States. It has maintained a global dominance in microprocessor chips used in most personal computers — making three-quarters of those chips in the United States, even though three-quarters of them are sold elsewhere. Intel employs 44,000 people in the United States, more than half its overall workforce of 84,000.

On one central point, Grove has found wide agreement among businesspeople, academics, and the government: The United States needs at least a basic expertise in manufacturing for a healthy economy. “When you lose manufacturing, you lose the ability to do everything up to and including services,” says Kevin Surace, CEO of Serious Materials, a Sunnyvale, Calif., company that makes highly insulated windows and drywall in six North American plants and offers energy management services. Kathryn Shaw, the Ernest C. Arbuckle Professor of Economics at the Graduate School of Business, says manufacturing knowledge is also key to high-end jobs such as design. “A product needs to be designed for optimal manufacturing, and you need to manufacture to know how to do that,” she says.

Burgelman, the Edmund W. Littlefield Professor of Management and director of the Stanford Executive Program, says Grove also has opened people’s eyes to a key dynamic of a successful industrial base: Only the knowledge gained by manufacturing today’s products can provide the insight needed to create the industries of the future. By making batteries and solar panels outsourced by U.S. companies, for instance, China has positioned itself to dominate huge future markets for electric cars, mobile devices, and green energy. “If you let go of manufacturing, eventually you will miss the learning feedback loop that leads to innovation — and others like China will do it instead,” Burgelman says.

The key point of debate is how much the government should get involved. Grove says it should help set investment priorities and provide incentives to enforce them at least in strategically important industries. “While free markets beat planned economies, there may be room for a modification that is even better,” he says. Burgelman suggests that China and other Asian nations such as Taiwan and Singapore may represent a new kind of economic player and require different strategies to compete against them.

In contrast to “entrepreneurial market states” such as the United States and “managerial market states” such as Germany, Burgelman says, China and its neighbors are what he calls “mercantile market states,” which promote exports through tariffs, currency manipulation, and other means and use the export capital gained to buy foreign assets, from bonds to real estate. “We do not fully understand the rules of this game yet,” he says. But the upshot, explicit in Grove’s call for action, is that competing with China successfully may require more government participation than we’re accustomed to.

The idea of explicitly targeting industries for government help, often called industrial policy, has been anathema, especially among free-market economists and businesspeople who don’t believe governments can successfully pick winning companies or industries. But the recent rise of China, whose government has invested billions in certain industries such as electronics manufacturing, has some experts taking a new look at how industrial policy might be employed more effectively. There have been some U.S. successes too. SEMATECH, a consortium of chipmakers, got $500 million in federal funding starting in 1988 to improve manufacturing processes to compete better with Japan, by most accounts achieving that goal before phasing out government funding in 1996. “The big step is to get over the ‘bureaucrats can’t pick winners’ type of knee-jerk rejection,” says Robert Wade, professor of political economy and development at the London School of Economics.

Still, some of Grove’s thinking remains outside the business mainstream. TechAmerica, an advocacy organization with 1,200 technology company members, recently came out against “piecemeal proposals” to increase taxes on U.S.-based firms that do business overseas. Estrin says she opposes taxes on overseas labor but thinks economic stimulus money or R&D tax credits could be given to companies that hire and spend in the United States.

Grove has come in for more direct criticism as well. Some people perceived his essay as an attack on foreign workers. That’s not what he intended, says Grove, a Hungarian immigrant whose company has employed many Indian and Chinese workers; in fact, much of his criticism was aimed at what he views as short-sighted American attitudes toward the importance of manufacturing. But his focus on jobs for Americans “sounded xenophobic” to Vivek Wadhwa, visiting scholar at the University of California, Berkeley’s School of Information, who wrote a dissenting commentary in Businessweek, “Why Andy Grove Is Wrong About Job Growth.”

Wadhwa and others also say Grove’s contention that most jobs are produced by established companies scaling up manufacturing is mistaken. Most jobs are created by startups, not larger companies such as Intel, he says. He cites the Kauffman Foundation’s findings that from 1977 to 2005, existing companies lost a total of 1 million jobs per year, while new companies in their first year added about 3 million jobs annually in aggregate. Besides, Wadhwa contends, U.S. workers don’t want jobs like those at China’s Foxconn, where 17 suicides have raised concerns about working conditions at the giant contract manufacturer for Apple and other tech companies.

“They used to,” Grove retorts, when those jobs were still available in the United States. He agrees that startups can be valuable job creators. But he says persistent high unemployment today, even during a time when some highly successful new startups such as daily-deal service Groupon have grown quickly into sizable companies, proves they are not enough. To restore the American job machine, he says, startups need the incentives to scale up manufacturing in the United States so they can hire thousands of Americans.

The problem, says Kevin Fong, MBA ’82, special advisor to China-focused venture capital firm GSR Ventures, is that many kinds of manufacturing tasks, such as semiconductor assembly, are simply cheaper to do in China. “For Intel, it makes a lot of sense to manufacture in the U.S. — they’re really pushing the edge of technology,” he says. But for others, using Chinese manufacturers is the only way to be cost competitive. “VCs prefer investments very close to them,” he notes. “So if we’re going to China, it’s because the economics demand it.” Grove doesn’t dispute the current economics China offers. But he contends that those economics can and should be changed with government carrots and sticks.

Carrots for reducing pollution offered by the European Union and China led Mike Biddle, Sloan ’91, to open factories overseas rather than in the United States. He is cofounder of MBA Polymers, a Richmond, Calif.-based company that developed processes for retrieving plastics from junked computers, appliances, and cars, and turning them into pellets that are reused. “I employ 25 people in California and 250 overseas,” he told the New York Times last year, shortly after he won the Economist magazine’s 2010 Innovation Award for energy/environment. The reason his factories aren’t in the United States is that the country does not have producer-responsibility laws requiring the collecting and recycling of anything with a cord or battery. Those laws elsewhere not only reduce pollution but produce economies of scale for him.

However, offshore manufacturing isn’t the main culprit in job losses, many economists say. Instead, it’s automation: the use of computers, often powered, ironically, by Intel’s microprocessors, to replace work once done by people. According to the Palo Alto-based Center for Continuing Study of the California Economy, industrial production increased by 2.5% a year between 1990 and 2008, but productivity growth increased much more, 3.8% a year, requiring 24% fewer manufacturing workers. “The great destroyer of man-ufacturing jobs is productivity, not outsourcing or offshoring,”says Stephen Levy, MA Economics ’67, the center’s director and senior economist.

Moreover, it can be tough for the government to figure out the most promising technologies and, especially, companies. In spring 2010, President Obama visited Fremont, Calif.-based solar-panel manufacturer Solyndra and announced that the federal government would lend it $535 million to finance an expanded factory that would employ 1,000 additional workers. But in November, the company abandoned the expansion plans and even laid off at least 155 workers. The reason: intensifying competition from both Chinese and U.S. rivals.

All that leads some economists to doubt there is a politically palatable solution. “I wish we could get those jobs back,” says Shaw, who has studied the steel industry in depth. “But I don’t see a policy mechanism to make that happen.”

In the GSB seminar, Grove didn’t offer his team of five 2011 MBA candidates an option to give up. He asked the team — Joe Bingold, Nick Halla, Lonny Olinick, Ian Tien, and Jim Wilson — to come up with potential fixes that were politically plausible, promised results in three to four years, and required no additional government funding. “It’s not as simple as ‘We want jobs,’” Bingold says. “We need jobs that support our standard of living.”

Mainly, the team said the United States could learn a lot from Germany, which produces more high-end goods, in industries from autos to renewable energy, than China and other low-cost manufacturing countries. How? For one, management and labor have a more cooperative relationship, emphasizing on-the-job training and wage freezes or temporary short work weeks instead of layoffs. German research and development also is focused more on improving manufacturing technologies than R&D in the United States. And the government uses various incentives such as renewable-energy targets to encourage faster progress in new technologies. Grove said Germany deserves more study as a potential guide for what the United States should do.

The student team also suggested three long-term strategies that would help: One is to reform immigration to encourage U.S.-educated foreigners to start U.S. companies; foreign graduates of top universities in manufacturing-related fields who raise at least $500,000 in funding could be granted permanent residency status so they could start U.S. companies. The team also called for education reform to emphasize math and science, where the United States has fallen behind. Finally, the report suggested revising the World Trade Organization to force more favorable trade terms and currency exchange rates that currently make Chinese manufacturing appear artificially inexpensive.

All of those, however, require political and even cultural changes, and in some cases government funding, taxes, or tax breaks to implement. So while Grove supports them, they won’t happen quickly, if at all. As the students’ report concluded, “There is no silver bullet to stem the loss of U.S. manufacturing jobs.” That was a disappointment to Grove, who says he had hoped for more actionable recommendations.

He finds some encouragement, however, in recent moves by President Obama, who set a goal last year to double exports by 2014. Because 70% of exports are manufactured goods, says Ro Khanna, deputy assistant secretary for domestic operations for the Commerce Department’s U.S. and Commercial Service, “there’s a real drive in the administration to make America more competitive in manufacturing.” As though to underscore the point, Intel announced during Obama’s February visit that it will start building a new $5 billion chip plant in Arizona later this year. Ultimately, Grove says, it’s up to U.S. businesses to “plug away and create enough successes” like that to prove the skeptics of domestic manufacturing wrong.

Former BusinessWeek Silicon Valley bureau chief Robert D. Hof is a writer in Palo Alto.

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