By Ajay Shah
- Shipping costs to the US go down when goods are made closer to the US. Today the supply chain is: Global raw materials -> China -> US. Instead it can be Global raw materials -> US.
- The skills required to run a robot-intensive factory are greater than the skills required to do low-end manufacturing using humans.
- Hence, a lot of robotic manufacturing will return to the US.
I agree with this. Similar things are going on with services production also, as improvements in artificial intelligence take work away from the cheap Indian BPO. There are three more perspectives that should be brought into this line of thought.
Robot-intensive manufacturing Ideal for Developed Economies
1 Safety of expensive physical assets: A person who places vast physical assets into a certain location worries about expropriation risk. The investment in a factory can go bad owing to regime change, outbreaks of anarchy, unfair changes in taxation, imposition of capital controls, etc. China is a greater risk. Placing manufacturing in developed countries is safer. I am reminded of the vast Reliance facility in Jamnagar, which is partly about going as close to the crude oil of the Middle East as possible, but avoiding the political risk of the Middle East.
2 Cost of capital: When manufacturing becomes highly capital-intensive, the cost of equity and debt becomes more important. Developed countries have mature financial systems where the cost of capital is low. Right now, the cost of capital is extremely low in developed countries as the policy rate is near zero. It is attractive to finance yourself in USD, manufacture in Oregon, and earn cashflow in dollars. Conversely, countries with capital account restrictions, such as China or India, will find it more difficult to attract investment as the cost of capital in these places is higher.
3 Cost of electricity: Firms like Google and Apple have placed data centres near hydro power in Oregon. Data centres, which consume a lot of electricity and require very few workers, are perhaps at the forefront of what robot-intensive manufacturing will be. There are many places in developed countries where there is reliable and cheap access to renewable energy. These would be ideal locations to place large-scale robot-heavy factories. (They would need good infrastructure of transportation and communication also).
By this logic, there are five reasons why robot-intensive manufacturing will be attracted to developed economies instead of a place like China: (1) Reduced costs of transportation; (2) Skill intensity which requires a superior workforce; (3) Expropriation risk for a big block of capital ; (4) Cost of capital on a big block of capital ; (5) Cheap renewable energy.
I’m reminded of an earlier article on the economics of cloud computing from an Indian perspective, and the developments in that industry give us some insight into the new world of robot-intensive manufacturing.
Implications for China and India
These developments induce depreciation in the existing Chinese capital stock. There is a lot of capital in China which is oriented around the old ways of manufacturing. The market value of that capital will go down. This is similar to the diminution of the capital stock of a country which comes about when trade liberalisation takes place, and a lot of the old factories are now worth less.
In China and in India, there is a low-skill middle class that got jobs in manufacturing or in BPO. These two kinds of jobs are threatened by improvements in artificial intelligence and robots. Millions of people who have got this prosperity for the first time will be unhappy. In both cases, their unhappiness could be exploited by messages of nationalism and religion.
How should a country like India compete in this world? Let’s think about each of the five channels of influence:
- Reduced costs of transportation to consumers in developed markets
- Skill intensity which requires a superior workforce
- Expropriation risk for a big block of Capital
- Cost of capital on a big block of Capital
- Cheap renewable energy
We should respond to #1 by improving the infrastructure of transportation, and we should note that a lot of Indian firms will do outbound FDI to stay competitive in this landscape.
We should respond to #2 by building higher education.
We should respond to #3 by strengthening our foundations of liberal democracy and rule of law, with sophisticated institutional arrangements on issues like capital controls and taxation.
We should respond to #4 by doing inflation targeting, removing capital controls and ending financial repression.
We should respond to #5 by undertaking reforms which improve the working of the electricity sector.
Other interesting implications
When raw materials → China → DM is replaced by raw materials → DM, this will not be good for demand for shipping.
Economists think in terms of the HMY model where a firm faces fixed costs of setting up operations near the customer, and after that it saves money on transactions costs of shipping. Under the HMY model, more efficient firms export and the most efficient firms do outbound FDI. In a world of robotised manufacturing the tension will be between placing manufacturing close to a customer (thus minimising the cost of getting goods to the customer) versus economies of scale. If there were no economies of scale, we can think of a small 3D printer facility being placed near every Amazon warehouse. The right scale of manufacturing will depend on the extent to which even with modern manufacturing, there will be powerful economies of scale.
Middle and top management in the operations of global firms is about managing the complexities of manufacturing in China. In the new world, it will be about getting raw materials to DM factories, and the construction+management of robot-heavy manufacturing. There will be reduced demand for `China hands’ who know how to build production systems involving China, or `India hands’ who know how to build low-end services production in India.
Ajay Shah is a professor at National Institute for Public Finance and Policy, New Delhi.
This article was originally published on Ajay Shah’s Blog.
Featured Image: Pixabay