Megatrends: Where Are We Going?

June 30, 2005
Yogi Berra, the erstwhile N.Y. Yankee catcher, is reputed to have said, "the future ain't what it used to be." Sure, we laughed, but deep down inside we knew what he meant. He was talking about changes. Certainly in the last five years, our industry has b

Yogi Berra, the erstwhile N.Y. Yankee catcher, is reputed to have said, "the future ain't what it used to be." Sure, we laughed, but deep down inside we knew what he meant. He was talking about changes. Certainly in the last five years, our industry has been all about changes.

In the run-up years preceding this millennium, the electronics industry was on fire. Executives, managers, and engineers received signing bonuses for taking new jobs. There were five job listings for every available candidate. Electronics industry stocks were all rising with no end in sight. IPOs made paper millionaires out of kids just a few years removed from college. Then, the dot-com bubble burst.

Within months, the same high-flying companies were racing to shed costs faster than their dwindling revenues. In the process, the U.S. private sector cut more than 2.7 million jobs—many of them in our industry. All of the electronic systems that were pouring off the assembly lines in response to bubble-fueled demand slowed to a trickle. And, people with experience in electronics marketing couldn't buy themselves a job.

So, here we are. It's June 2005. We read how our industry is recovering. Demand is up, production is rising, and profits have returned. Yet, empty commercial real estate in Silicon Valley is plentiful. Hiring, if at all, is still very conservative. Plus, budgets for marketing and advertising are only slowly creeping up. Welcome to the new reality.

COST CONTROL, OUTSOURCING GO HAND-IN-GLOVE In the early part of the previous economic expansion, most companies paid lots of attention to cost control. It was part of what was known as re-engineering. But in the frenzy of the bubble, with demand skyrocketing and price-resistance evaporating, the focus shifted to increasing production and overall corporate growth. We're now back to cost control with a vengeance and a renewed focus on bottom-line, rather than top-line, results.

The battle cry is once again "lean and mean." And, that means offshore outsourcing (Fig. 1). This isn't a new concept. So-called "fabless" semiconductor companies have offshore outsourced for decades.

Offshore outsourcing is not to be confused with offshore manufacturing. In the former case, companies contract out the manufacturing to someone else who owns the capital equipment and labor pool. In the latter case, the company owns the means of production and the labor pool. There are economies of scale from captive offshore manufacturing—so long as the demand is steady or rising. Offshore outsourcing provides a hedge against a downturn because its costs go down with reduced requests for production. That's what we're seeing these days in Silicon Valley.

The differences in labor rates can be very compelling. For example, the average hourly wage in China is just $0.59. This compares very favorably with Mexico ($2.27), Taiwan ($6.13), and the U.S. ($20.32) (Fig. 2). But these are average numbers. They suggest a 40-fold advantage to hiring Chinese rather than U.S. labor, but engineering is a highly skilled profession. Here, a U.S company only gets as much as a tenfold advantage by shifting design work to China.

The difference has been noted, too. Major U.S. and European electronics companies are building R&D facilities in China and India but not staffing them with engineers from the U.S. or Europe. There's plenty of engineering talent in China and India, and, as noted later, it's a much faster growing pool than that in North America and Europe.

CHINA AND INDIA—IS THIS THEIR CENTURY? In April, on a four-day official tour of India, China's premier Wen Jiabao said the combination of India's software skills and China's hardware expertise can propel both countries to a leadership position in worldwide information technology (IT). Was it simply political rhetoric, or prophesy?

There's a tendency to lump both countries together when talking about offshore outsourcing and global competition, so why shouldn't China's premier do the same? China's economy has been growing impressively at a sustained rate of close to 10% over the last five years, while India has averaged between 6% and 8% growth during that same period.

According to the U.S.'s National Intelligence Council (NIC), a center of strategic thinking that reports to the Central Intelligence Agency (CIA), China and India are expected to become global economy leaders and major participants in "the next revolution in high technology involving the convergence of nano-, bio-, information, and materials technology."

China's gross domestic product of $1.4 trillion, coupled with conservative estimates of future growth, led the NIC to conclude that China could become larger than any other industrialized country except for the U.S. by 2020. The NIC also said India has the potential of overtaking some European economies. Its current GDP of about $675 billion is nearly twice that of Russia.

Both countries are benefiting from foreign direct investments in addition to U.S. and European outsourcing. In fact, in 2003, China surpassed the U.S. in foreign investment. Virtually every large U.S. and European electronics company has invested, or is investing, in Chinese manufacturing. And India, although famous for its software and call-center outsource operations, is planning to move up the food chain by offering outsource electronic-design services.

But this silver lining has its dark cloud. In China, most of the foreign direct investment and domestic government spending has been focused on coastal, industrial enclaves. The rest of the country lags far behind in road, power, and communications infrastructures. And, the disproportion in wealth between China's emerging middle class and the much larger, rural poor is growing even faster than its GDP.

One very serious fallout from China's economic boom is pollution (Fig. 3). Some lakes in China are so polluted that just getting the water on one's skin is enough to cause serious illness. And in a country where authoritarian government keeps a tight rein on protest, thousands of villagers in southeastern China actually protested factory pollution. (It eventually deteriorated into a riot.) Huaxi Village in Zhejiang Province, home to Zhuxi Industrial Function Zone and 13 chemical factories, was the scene of overturned police cars and numerous broken windows. Just last year, tens of thousands of protesters in western Sichuan Province confronted police over a long-disputed dam project.

"The financing system that supports China's economic growth is very fragile," said Sun Lijian, professor at Fudan University in Shanghai. "People are often impressed by the look of cities like Beijing and Shanghai, or with GDP growth every year. But without a strong financing system, China's economic growth is unhealthy."

Finally, China recognizes that the only way to solve its problems in agriculture and rural areas is to shift the farming population to the cities, according to a report developed by the Chinese Academy of Science. By mid-century, 10 million to 12 million farmers will be moving to its cities each year. The long-term estimate of its urbanization process is 15 trillion to 16 trillion yuan (about $2 trillion). That's twice the country's entire GDP in 2000. Roughly, China's annual urbanization cost over the next 50 years will be as high as $60 billion, according to the report.

India shares the problem of rural poverty with China. It, too, must fund a major, long-term urbanization program. More than half a billion of its citizens are mired in poverty. The NIC sees the rapid growth of India's poorer northern states as a continuous drain on subsidies and social-welfare benefits. Failure of India's government to implement reforms that attack these problems will prevent it from achieving sustained growth.

A SHIFTING CENTER OF GRAVITY The U.S.'s electronics industry and its engineers have all benefited from public and private investment in basic and applied research from 1945 through 1975. Post-war computer projects, Bell Labs' transistor (1947), Fairchild's and Texas Instruments' applied research leading to the first integrated circuits (1959), and Intel's first microprocessor (1972) all paved the way for PCs and modern electronic systems. The U.S. government's DARPA "network" project gave birth to Ethernet and today's Internet.

Because the U.S. has invested in creating such intellectual property, its electronic industry often earns a proportionately higher share of the wealth created by the new systems and new industries spawned by these developments. The U.S.'s top-notch engineering schools, such as Berkeley, MIT, Purdue, and Stanford, were magnets for the best and brightest. This is where the action was, and these schools attracted a fair share of the best and brightest from other countries, too.

The U.S. doesn't lack in imaginative future technologies. Those most directly related to electronics include high-power energy packages, such as highly advanced batteries, inexpensive fuel cells, and microscopically small electric generators. Green Integrated Technology (GrinTech) envisions the marriage of advanced sensors, new materials, computer systems, energy systems, and manufacturing technologies to eliminate rather than just reduce waste. Super Senses, blending electronic and genetic technology, may offer our aging "baby boomers" renewed hearing and vision and provide others with sensory enhancements at any age.

The missing ingredient in all this is focused government and private-industry investment. After the USSR launched Sputnik in 1957, U.S. government, industry, and education came together to transform their processes. Today's older engineers are a product of that educational transformation. In the absence of immediate geopolitical life-threatening factors, such as global Fascism or Communism, the U.S. seems at a loss. It can't generate the focused investment and coordinated efforts that underpinned the Manhattan Project during World War II or the Space Race during the Cold War. Simply imagining new technologies won't make them happen.

Barring such a U.S. focused quest, the electrical engineering center of gravity appears to be shifting. According to the U.S. Department of Commerce, in 2002, 42% of all college degrees awarded in China involved engineering and the physical sciences (Fig. 4). That same year in the U.S., only 17% of degrees were in these fields. Nearly 40% of all Chinese college graduates were engineering majors (219,600). The U.S. had 59,500 engineering graduates, who made up only about 5% of all graduates.

For many years, foreign graduate students were the majority of those earning engineering master's and PhD degrees at U.S. colleges and universities. So, U.S. industry still got the benefit of that knowledge and experience in research and through employment. But since the attacks of September 11, 2001, U.S. immigration policies have become much more stringent and procedures more cumbersome. The net effect has been a marked decrease in foreign students going to U.S. universities—not just in engineering, but in all fields of study.

In the immediate future, the effects of these changing demographics may not be apparent. But in the next decade or two, without a national technology imperative, U.S. engineering aspirants may be going to China or India to study, because that's where the action will be. The U.S. needs to focus on education and research to support emerging, strategic technologies. Without that investment, and with offshore outsourcing moving further up the food chain, U.S. electronics companies may become shells of their former selves. Instead of designing systems, U.S. engineers may be managing design teams in Asia. By 2020—if not before—some of us may be tempted to say, "the future ain't what it used to be."

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