Its Called Scare Marketing and Adam Smith Knew Why

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Paul Midler in Forbes.com writes (26 July):
“Dealing With China's 'Quality Fade'

“If Adam Smith were around today, he would have had to write a separate chapter on global outsourcing. Because it takes importers a long time to find suppliers and to get them up to speed, importers keep their suppliers a secret. The last thing that an importer wants to do is let his competitors know the source of any supply chain advantage he may have. Even when it is in their collective interest to share information, importers keep to themselves.

As a result, factories pay little, if any, reputational cost for production shenanigans. The invisible hand doesn't work well when the manufacturers themselves are unseen.”

[Paul is the founder and president of China Advantage, a services firm that provides outsourcing and supply chain management to U.S. and European companies. He has been involved with China for more than 15 years, and in the course of his manufacturing career, has had dealings with thousands of Chinese factories.]

Comment
As expected an article in Forbes is authoritative and worth reading. And this one is no exception. It is about the perils for US businesses which source off-shore in China. Problems of quality are among the topics and the usual effect of growing trade on improving quality does not work quite like it should. Because US firms keep their import sources secret, a poor-to-bad quality Chinese supplier is not penalised by publicity; it just changes its customers and carries on producing shoddy goods.

US businesses in these conditions need reliable information about the quality standards of Chinese manufacturers, and the author of the article is in that business, running 'China Advantage’. Fine; that’s a useful service and deserves its market niche.

My problem is with the obligatory paragraphs on Adam Smith. That aims to hit the readers'‘recognition’ buttons, fair enough, but happens to be unwarranted. Would Adam Smith need “to write a separate chapter on global outsourcing. Because it takes importers a long time to find suppliers and to get them up to speed…”?

If you think about it, Wealth Of Nations would have to contain a lot of new chapters because the world has moved on through European imperialism, the industrial revolution, the communist failed experiments, and such like. But even in outsourcing, why would it need a new chapter?

Trade over large distances – and trade within Britain in mid-18th century was truly 'distant' – it took three weeks to travel by ‘road’ from Edinburgh to London, which is as long as a factory-to-factory cargo from China to the mid-west or California.

Smith wrote about these and related problems and the perils of distant, including foreign, trade in Wealth Of Nations. If the author had read all of the chapter from which he borrows the metaphor of the ‘invisible hand’ (WN IV.ii. ‘Of Restraints upon the Importation from foreign Countries of such Goods as can be produced at Home’, pp 452-72), he would have found plenty of comments about the risks, perils and costs of what is called today ‘outsourcing’, a word invented and promoted by those who oppose foreign trade (also known as competition) among businesses, trade unions, tv demagogues and those who fear they are about to fail to be elected.

Hence, when the authorwrites: “The invisible hand doesn't work well when the manufacturers themselves are unseen…”, he misses the reason why domestic merchants prefer the home to foreign trade which was discussed by Adam Smith:

“In the home trade his capital is never so long out of his sight as it frequently is in the foreign trade of consumption [importing]. He can know better the character and situation of the persons whom he trusts, and if happens to be deceived, he knows better the laws of the country from which he must seek redress.” (WN IV.ii.6: p 454)

To which part of that sentence would the author add something different? Of course, he could expand it (as I could) but Wealth Of Nations does not need expanding!

A US manufacturer buying in Chinese manufactured parts (computer chips) and being sold duff products, will soon know if her computers don’t work, because her customers will tell her, the trade press will report her quality problems and her customers’ suppliers will cancel orders.

Secrecy about her Chinese supplier becomes irrelevant at the most important level; the US business woman’s loss of business, perhaps terminally. If her testing procedures were operating properly (‘what do you mean she hasn’t got any?) that batch of chips, or whatever else it consists of, would have been rejected.

Similarly if Chinese manufactured chairs collapse, or items do not survive their first wash, or customers suffer from toxic poisoning, or for that matter, US based suppliers act similarly selling down the road or across the states, the US manufacturer suffers legal redress from its customers, plus loss of business.

I think I shall put this author's article down to ‘scare marketing’ of his excellent services. US firms looking at foreign supply chains would do well to call on his services if they are embarking on outsourcing in China, or his equivalents in Indian or European outsourcings. They would be wise also to check carefully a local outsource supply across town. Its called ‘due diligence’ and you don’t need to read Wealth Of Nations to know this in business, though if you do, you’ll find references to it.

PS: There are no invisible hands in markets (see archives for plenty of explanation of Smith’s use of the metaphor).