The Hidden Flaw in Our Economy: Why Didn’t Our Economic Policies Work?

(repost from the Huffington Post, March 8, 2013)

by Luke Ho-Hyung Lee

Revitalizing the economy is now the most important national issue facing not only the United States, but all the G-20 nations, including Japan, Korea and many Euro zone countries.  Even though each country has tried almost every possible policy and investment to revitalize their respective economies, most of them have not been effective.     

Why have the existing policies not been effective?  Why did this situation happen in the first place?  Even though many experts are studying this issue, none have found clear answers, let alone a solution.  Could they be looking in the wrong place?  Or have they missed something crucial in their thinking about the economy?

By way of explanation, I would suggest considering the economic impact of newly developed virtual supply-chain systems in the last three decades of the Modern Information Age.

Conventional systems in the supply chain

Let’s think of the manufacturing and supply chain network – from product manufacturer to distributor to retailer and finally to the consumer.  There were the narrow and curved countryside roads to drive, the mountains to pass, and the rivers to cross between suppliers and customers.  As usual, to increase the delivery speed and efficiency, we have tried to construct highways for the countryside roads, tunnels for the mountains, and bridges for the rivers between them.

In this case, however, let’s imagine that the highways, tunnels, and bridges were all privately developed and owned (mostly, by big companies).  Moreover, the owners weren’t interested in opening these transportation facilities to the public – not even to collect tolls.  They simply wanted the highway-tunnel-bridge system for their own, private use because of its competitive advantage.

What would have happened next in our economy and society?

The most likely development would have been that, due to the superior position of big companies in efficiency, the businesses of small- and medium-size companies would have weakened and eventually been destroyed, and accordingly many jobs in these companies would also have disappeared.  Job creation in the market as a whole would have suffered as demand fell.  In addition, while the profitability of the general service industry fell precipitously, we would have experienced a vicious deflationary cycle with rapid reduction of total consumption.  Correspondingly, the expanding gap between poor and rich would have become inevitable.… Our society could have experienced increasing social and political unrest.… 

In this scenario, what actions would national governments have taken?  First of all, they would have adopted a series of powerful expansionary monetary and fiscal policies and stimulus plans aimed at preventing truly vicious deflation due to reduced total consumption, and activated deregulation to revive the overall market.  Moreover, in order to calm social unrest, the implementation of generous welfare policies would have been unavoidable.  As a result, many national fiscal statuses would have continued to worsen after a lag, pushing weaker national economies toward default.

This looks uncannily like the situation that the world economy including the US has experienced over the last several years.

Fortunately, however, rationally run countries actually have never allowed this hypothetical case to happen.  That is, they have developed many open transportation infrastructural facilities for the public.

But, unfortunately, such rational development has not been the mark of the Modern Information Age.

Newly developed virtual supply chain systems in the Modern Information Age

A business could also improve the efficiency and speed of delivery by using advanced networking, or virtual, systems.  No matter how great the distance nor how complex the connection, whoever is responsible for a function is always clear in a virtual system.  As a result, outsourcing became possible for numerous functions in a supply chain.

We have developed virtual logistics systems and other collaborative functions in the supply chain through the use of IT and advanced networking systems.  Moreover, many companies (mostly big companies) have developed virtual supply chain networks by vertically and horizontally integrating logistics and similar collaborative functions.  The aim was to reduce the number of transactions and functions in supply chains and to improve the efficiency of collaborative functions.

Zara’s case is an example.  Zara, the largest clothing company in the world, developed an information-based supply chain network by vertically and horizontally integrating its logistics and collaborative functions through the use of IT and networking technology and now needs just two weeks to develop a new product and get it to stores, compared with a six-month industry average .  This enables Zara to launch around 10,000 new designs each year, far outdistancing its competition.

But what happened to others in the industry?  Most of Zara’s collaborators--small designers, manufacturers, and stores--became much less competitive than Zara, which absorbed only a few of them.  As we have come to expect, the employment situation for middle- and lower-income workers in this industry relentlessly worsened.  Zara’s IT imitators are now legion all over the market.

A serious flaw in our economy

Without being aware of the larger economic implications, our rationally run countries have accepted privately owned information-based supply chain networks as an economic necessity without calculating the consequences of such a decision.  As a matter of course, most of these networks have been developed by large companies and are used only for their own benefit.  Moreover, even if it is hard to believe, no similar public infrastructure has emerged at all--not a single one in the whole world. This is just as if all physical transportation facilities were privately owned and used only for the owner’s profit!

I believe this has become the hidden driver of the current economic crisis.  It increases the barrier price of entry for new businesses, and it perpetrates bloated costs of doing business in distorted markets.  It also accounts for distortions in demand and in labor.

What should we do for our distorted economy?

We must first repair this flaw by constructing a new public information-based supply chain infrastructure for modern IT-based markets in tradeable goods and services. 

Unfair conditions for small- and medium-size companies and accordingly also for middle- and lower-income workers now permeate the markets that make up the economy as a whole.  Economic policies not taking modern supply chains into account will continue to fail, and will produce no full economic recovery, because enormous amounts of capital are required to feed the oligopolies that emerged from the electronic revolution in private supply chains.

I believe it possible to ensure fair conditions in the market and restore a rationally-run economy along the lines of absolute competition.  This alternative to our current distorted markets will be relatively painless to implement, and over time will eliminate the fruitless economic policies of the past by making them unnecessary.

Supply Chain Revolution: How a 3-D Supply Chain Could Create Many New Jobs and Revitalize the Economy

(repost from the Huffington Post, December 12, 2012)

By Luke Ho-Hyung Lee and Jess Parmer

Extreme risk aversion continues to oppress the economy, and recovery is very slow.  Perhaps it is time for a new take on what was wrong in the first place.  Maybe all this mayhem owed less to financial disruption than is widely believed.

Our 2-D Private Supply Chain Process Is a Nineteenth-Century Relic

Since linear supply systems were developed between suppliers and customers at the beginning of the Industrial Age, each supplier has had to construct its own supply chain network.  This established two-dimensionally networked (2-D) supply chains in the overall market–a framework which has not changed, even under the modern information revolution.  We call for an innovative approach, a supply system that possesses a third dimension, and is public as well.

The advent of advanced information technology forced suppliers in almost all industries to develop their own electronic supply chain networks, at great cost, significantly reducing the number of competitors in supply chains and increasing the efficiency of each function (for example, logistics or warehousing) through consolidation.  Because of the superior market position of big suppliers and service providers with their private supply chain networks and fast delivery speeds, businesses which couldn’t afford such networks have weakened and over time been destroyed, and this is how many jobs disappeared.  But the overall effect was that the 2-D supply chain in real markets became unstable, and this contributed to the decline of jobs in the market as a whole, unavoidably and continuously. 

In this situation, the mantra for suppliers and service providers became, increase efficiency or die.  So, they aggressively adopted IT progress, off-shored and outsourced to lower-cost countries, and broadly adopted automation in the form of robots.  Accordingly, large corporations became job-killing machines.  These developments have contributed to the weakness and near collapse of the general services industry (such as auto parts and paint sundries) and have aggravated unemployment.

The existing 2-D supply chain process, focused only on efficiency, ignores human intelligence and imagination, and treats ordinary workers like machine parts, easily removed and replaced.  As a result, many full-time jobs have morphed into part-time jobs, and lower- and middle-skill workers have faced job erosion.

What then has happened to our efforts to generate higher growth and demand – and create jobs over the last four years?  Unfortunately, with the efficiency-driven 2-D supply chain, the Information Age has emerged at the expense of employment, policies aimed at raising employment are treading water, and capitalism’s regenerative office has been slow in reviving.  Abnormal economic phenomena--astronomical government budget deficits and extreme risk avoidance—have become salient.  It seems we have staved off financial collapse by creating more if not worse problems.  This is the capitalism of competition by size, and history has proven that it cannot solve its problems on its own.

Why Not Try a 3-D Supply Chain Process?

In limited ways, the electronic economy is doing just this:  the Internet serves as a 3-D hub or platform between multiple information sources and recipients.  But why haven’t we developed any such 3-D systems in U. S. supply chains, with strong operational feedback modules like Toyota’s?  Real markets in tradeable goods offer little prospect of righting themselves anytime soon.  This means that the disconnect between business needs and labor markets will continue without a lasting solution.

The authors have discovered the fact that our economy has erred in developing sophisticated technology-based transaction systems for supply chains over the last 30 years.  Oddly, the processes of real-world markets have not been considered at all in developing private systems, and constructing a fair rule and standard for the public has escaped attention.  Information technology has been misused from the start in developing such 2-D transaction board games.

The Supply Chain Revolution Is a 3-D Public Supply Chain System

We believe a new 3-D supply chain system could easily be developed with largely off-the-shelf technology to overcome restrictions of time and space in commerce by improving major real-world business processes in transaction systems.  A networked public supply chain infrastructure, bundled with third-party infrastructure for communication and peripheral networks, could quickly become available to all members of markets in tradeable goods. 

Under this new 3-D supply chain system, each business will have a competitive relationship with like businesses under fair conditions, and not simply by size.  In other words, a cooperative relationship will arise between a business and its nearby competitors.  This is far different from what we see today.  With these competitive-cooperative relationships, each business will be able to significantly increase its efficiency, productivity, and application capabilities—in a word, its overall market effectiveness.  3-D systems will be multiplicative, not merely additive, as with the 2-D supply chain model.  This will become a business revolution.

The 3-D supply chain system will arise with the voluntary participation of many SBEs and MBEs and their suppliers and service providers, with clarified responsibility lines, centralized volume, and mutually distributed expense.  Because this supply chain system connects the power of all participating members, each will benefit from the system’s size.  For example, competing convenience stores could insure themselves against theft, as opposed to paying some average price computed by an uncaring and locally unsophisticated insurance industry.  Numerous other applications could easily develop in real markets, based on imagination.  Human intelligence will re-emerge among the robots, as at Toyota, and the cascade of full-time jobs into part-time jobs will be reversed.  In effect, SBEs and MBEs will retake control of their own destinies.

Further, our proposed 3-D public supply chain system’s impact on SBE and MBE productivity, flexibility,  and delivery speed will draw operations of companies that have offshored and outsourced to lower labor cost countries back to the U.S. by lowering barriers to re-entry.  Accordingly, numerous new businesses and jobs will manifest in the market as a whole, and we can overcome American capitalism’s regeneration crisis and undertake economic revitalization on a realistic basis.    

Japan’s Lost Decades: Could They Happen in the U.S.?

(repost from the Huffington Post, Jan. 17, 2013)

By Luke Ho-Hyung Lee and Jess Parmer

When the Japanese economy prospered in the 1980s, every country in the world was envious.  But when Japan's Great Recession hit in 1990 with collapses in land and stock prices, people were surprised but immediately thought that it was just a correction in the regular economic cycle, and that Japan would resolve it soon.

The Japanese government and experts worldwide have tried to figure out the real cause for over 20 years, but to no avail.  Moreover, it seems the United States is following a similar path:  it doesn’t look as if it was only Japan’s problem any longer but every advanced economy’s problem.  What was wrong with Japan’s economy?  Why didn’t the remedies work?  Was the real cause of Japan’s Great Recession the same as that of the current world-wide economic crisis?  If this is so, why did Japan have it much earlier than elsewhere?

To answer these questions, let’s imagine a situation:  It is today well known that diabetic disease occurs either because the pancreas does not produce enough insulin, or because cells do not respond to the insulin that is produced, an overall body function failure.  Was there a market function failure something like diabetic disease in Japan’s economy?  That is, weren’t there several failed market functions, like a failing pancreas and failed cell functions?

I suggest you carefully examine Japan’s exclusive, privately owned supply chain networks.

These worked very well in the Industrial Age, with its limited number of products and services, by protecting Japan’s domestic industries, just as a healthy pancreas or robust body cells work well.  However, the market situation abruptly changed in the Modern information Age.  The number of products and services has increased explosively, and ways of doing business have become more complex.

Especially during the 1980s, Japan’s prosperous period, many Japanese companies developed new products and services and at the same time created supply chain networks for higher profit and greater efficiency.  That is, though more effectiveness-oriented activities (such as securing new customers) were required in its modern information-based market following the 1980s, only supply chain systems for efficiency-oriented activities developed and advanced in Japan.  So, its markets became much more efficiency-driven just at the moment when large efficiencies became hard to find.  And tooling up these electronic supply chains had cost a lot, while making lower prices and more jobs seem impossible, even silly, goals.

Due to this changed market environment, many Japanese companies off-shored or outsourced their manufacturing to lower labor-cost countries, mostly to China, and adopted full automation processes in their remaining domestic manufacturing.  The disease was to be cured by making all healthy customers go on a diet; easy money in the form of lower borrowing costs was to make this palatable.

In this situation, Japanese companies couldn’t expand their customer bases enough (or create enough jobs) to keep consumer spending at the desired level.  Profit maximization, rather than lower prices, was the irresistible reward; customer bases refused to grow.  That is, something like diabetic disease emerged in Japan’s economy.  Let’s call that something the Efficiency Disease. 

To keep the level of consumer spending up, Japan’s government adopted a series of excessive expansionary economic policies, and accordingly many abnormal phenomena were created and accumulated in the market -- and finally, the asset bubble burst in 1990.

Then, what caused the occurrence of the Efficiency Disease in Japan’s economy at that time?  Wasn’t it the failed function of Japan’s privately owned supply chain networks?  Clearly, they failed to effectively handle all market requirements in Japan’s changed economic situation in the Modern Information Age.  They were no longer suitable to Japan’s modern information-based market.

Nevertheless, strangely, Japan has never tried to treat its Efficiency Disease, that is, to fix its failed supply chain networks, over the last two decades of its Great Recession.  Many Japanese companies continue to develop advanced electronic supply networks.  It seems Japan has simply tried to solve its economic problems without knowing what was causing them, and has added to its problems with a series of ineffective economic policies and stimuli.

Ultimately, Japan is not an isolated case:  without being aware of the economic impacts, almost all Western countries, including the United States, have also developed massive private supply chain networks in their markets and have induced similar Efficiency Diseases in their economies.  At a minimum, a lost decade of growth will also be unavoidable in these countries.  

Strangely, even if it was possible with our advanced IT and networking capability, no open and public supply chain system as an electronic infrastructure has been developed at all--not a single one in the whole world!  This is the “tragic flaw” of the modern IT-based economy, and I strongly believe it is the real cause of Japan’s Great Recession -- and the current world-wide economic crisis as well.

Japan was like a rich man with a lot of savings, but it has spent too much over the last 20 years. The United States is still a reserve currency country, but its deficits pose a threat as the national debt becomes a serious issue for its economy.  

If this Great Recession persists for the next decade, what will happen to the U.S.?  The short answer:  “Catastrophe!”

Then, what should we do?

We should immediately replace our outdated, closed, and private supply chains with a new open and public electronic infrastructure that is better suited to modern IT-based markets.  I believe this is the most effective way to treat the Efficiency Disease in our markets and save our economy.

To suffer through a Lost Decade or to build effective economic revitalization – it depends on our choice.

After The Election: The Hidden Flaw Holding Back Full Recovery

By Luke Ho-Hyung Lee

Post-election America: it was a hard-fought campaign on both sides, but incumbent Pres. Barack Obama won with his message of “let's finish what we started.”

His next step domestically is tackling the "fiscal cliff" (with a compromise solution tied to a Grand Bargain... or not).

Moving ahead, new policies will be announced, and some cabinet changes made.  Obama's January inauguration will precede a measured economic recovery in 2013.

That’s the good news.

The bad news: this scenario might be as good as it gets.  The upcoming recovery won’t boost middle- and working-class households in a meaningful way.  It won't be a sustained, permanent fiscal recovery.

But this isn't necessarily the Obama administration’s fault.  Since the 2008 fiscal meltdown, government officials, policy experts, and financial gurus of all stripes and credibility levels have rolled out any number of ideas aimed at solving our continuing financial crisis and revitalizing the economy.

Little has worked so far.  The lack of significant job creation and its twin symptom of high unemployment, stagnant or dropping wages, stagnant or dropping worker productivity, decreased consumer spending and its twin symptom of increased household debt, and volatility in the housing market are all side effects of something much larger.

Policy makers are focused on the symptoms, not the problem.  The real problem is far more fundamental and systemic than a few leading economic indicators. 

And this fundamental problem is invisible to nearly everyone.

This unseen, and therefore unaddressed, problem means that an even bigger and longer-lasting crisis -- a true economic tsunami -- lies ahead for the world as a whole, not just the U. S.  Industries around the globe will continue to shed valued (and valuable) jobs, in turn harming consumer-driven economies and creating a self-sustaining downturn.

This downturn will continue until the world economy either "breaks" permanently -- or the fundamental problem is recognized and addressed.

At its heart, the flaw is our mistaking efficient markets as being effective markets and failing to recognize the significant and profound difference.

The solution starts with acknowledging that domestic manufacturing needs to be the backbone of any significant economic recovery. 

The "experts" will say, of course, that America doesn't "do" manufacturing anymore.  Our economy is all about service, finance, software, and entertainment. 

That's not strictly true, of course:  the auto industry is still a major player.  Just ask Ohio and Michigan. 

The fact manufacturing isn't considered a primary element of our economy is the big reveal of our fundamental problem.  We can encourage entrepreneurs, innovators, and inventors in any number of ways, but if the basic conversation assumes that new manufacturing at any significantly higher level would simply shift overseas -- we've been misled that job creation is and will be the primary direct benefit of American innovation and entrepreneurship.

"Job-Killing Machines" in the Modern Information Age

But this is the case now, and it's because over the last 20 to 30 years of the Information Age, we have shifted our “real market” process (basically, the physical supply chain process) to a more efficiency-oriented supply-side environment.

This shift essentially created numerous domestic "job-killing machines," as large firms focused on efficiency and profitability generated by information technology and advanced networking systems. This altered the whole economic environment, making the destruction of jobs a major result of this efficient, "intelligent" streamlined process.

Isn't efficiency good for the economy?  In a balance-sheet recession, no.

Here’s why:

Think of the manufacturing and supply chain network – from product manufacturer to distributor to retailer and finally to the consumer – as a long stretch of highway, leading from the countryside, through the mountains via tunnel, over a bridge spanning a river, and into a city.  The highway passes a variety of buildings, ultimately leading to a retail store. The companies in these buildings are members, whether they can afford it or not, of this highway "network."  The network is the connected supply chain.

The highway, tunnel, and bridge are all well designed and maintained. It's an example we can see over and over in the U. S. and other nations. 

In this specific case, however, imagine that the highway, tunnel, and bridge are privately owned.  The companies located along the highway are part of the same conglomerate.  Moreover, the owners aren’t AT ALL interested in opening this transportation system to the public – not even to collect tolls.  They simply want the highway-tunnel-bridge system for their own, private use because of its competitive advantage.

That’s a major problem, and unlikely to happen in any rationally run country. Right?

Wrong.  The same thing is happening throughout our economy, but in less obvious ways. 

Example: A Private Information-Based Supply Chain Network 

Let's look at just one example:  Zara, the world’s largest clothing retailer, has developed a private IT-based supply chain network that vertically integrates its logistics and collaborative functions.

The Arteixo, Spain-based firm’s network is so efficient it now needs just two weeks to develop a new product and get it onto its stores' shelves -- compared to a six-month industry average.

This competitive advantage lets Zara launch around 10,000 new designs each year, far more than its competition.  By one measure, Zara has been remarkably successful:  Bloomberg Markets named Chairman Amancio Ortega the third richest person in the world this year.

What happened to other players in the industry?  Most smaller designers, manufacturers, and retailers are far less competitive (or efficient) than Zara.  A few lucky groups (including suppliers, designers and distributors) were brought into Zara’s system. 

Because of the resources pulled into Zara's closed network, combined with the chain's cost efficiencies, the larger fashion retailing industry’s supply chain became seriously unstable.  Most other companies lost their businesses.

As a result, jobs for middle- and lower-income workers in this industry have continually and relentlessly decreased. 

And Zara is in no way an isolated case:  due to the superior position of large companies with their own private, highly efficient supply chain networks (think Wal-Mart), small- and medium-size companies worldwide have likewise seen their businesses weakened and often destroyed.

Jobs in those smaller companies also have been lost – and they haven’t been replaced in anything resembling equal numbers by the larger firms.

There are three primary reasons why jobs replacement isn’t happening: 

(1) the aggressive adoption of IT systems that can identify redundancies (eliminating similar positions within the domestic marketplace),  (2) off-shoring and outsourcing manufacturing to lower labor-cost countries (shifting jobs out of the domestic market), and  (3) broad adoption of robotic machines and automation processes (eliminating jobs from entire industries, period).

This is strongly correlated with the decline of the self-generation, or recovery/rebuilding, capability of the economy (and once again illustrating why Henry Ford paid premium wages to his workers: he wanted them as customers).  But the workers impoverished by Zara cannot afford even its cheaper goods. 

These private information-based supply chain networks have been the major job-killing machines in the modern Information Age.  This is competition by relative size.

Competition Through “Public” Supply Chain Networks

As to our current supply-chain networks, we can say that while these private networks are efficient, they aren’t -- in terms of larger economic priorities -- in any way effective. 

These winner-take-all closed, efficient systems harm larger economic goals and objectives because they eliminate jobs as part of their natural process.

An open, effective supply chain network would allow network members to take advantage of efficiencies of scale and information systems, while reducing the advantages of size alone.

An open, public supply-chain infrastructure would shift the emphasis from only cost-per-unit to competition by price, quality, and service, that is, absolute competition.

The existing efficiency-oriented mass production process and mass-market consumption model would be altered into a more effectiveness-oriented, diversified, or individualized production and consumption system. 

In our example of the private highway-tunnel-bridge system, the owners can keep their closed network. But we’re going to build a toll-based system nearby, open to whoever can pay the reasonable fee. 

This open, membership-based system means a broad range of businesses -- low-tech to high-tech and everything in between -- can benefit from shared, intelligent manufacturing and distribution networks. 

A public system will spark business growth and lower the cost of entry into any number of domestic markets. 

Owing to these changes, local employment conditions will improve considerably, and the business environment for middle- and small-sized companies and for the general service industry will ease significantly. 

Moreover, companies that off-shored and outsourced to lower labor-cost countries would come back to the domestic arena.

The (Open, Public, Membership-based) Road Ahead 

This synergy for employment would be a positive force for economic recovery and revitalization.  The improvement of the self-generation capability of the market could finally be transformed into a permanent structural force to steady, and then increase, the level of consumer spending. 

It's only when we're ready to discuss the realities of manufacturing's role in our domestic economic future -- and the advantages of an open system to foster innovation, production and distribution -- that we can also discuss the realities of a sustained, and sustainable, economic recovery.

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About the Author: 

Ho-Hyung (“Luke”) Lee (luke.h.lee@ubims.com) is the founder and CEO of UBIMS, Inc. ("Ubiquitous Market System") He's by training a lawyer, an international businessman and entrepreneur – and an inventor.  Lee has figured a clear way out of the current economic crisis and developed the modern world's first Public Information-Based Supply Chain Infrastructure - UBIMS Inc.