Outsourcing manufacturing, outsourcing risk

In October, with pricey gasoline pinching spending and Hurricane Katrina still a fresh memory, the Conference Board's Consumer Confidence Index slipped to its lowest level in two years. A recent article in the Wall Street Journal (access requires subscription) looks at whether the index has gained ground since then. Because, of course, if U.S. consumers cool their heels long enough, it would eventually stifle U.S. economic growth.

I am not so sure about this. The U.S. trade deficit with China this year through October amounted to $166.8 billion, up 27% from the same period last year. This reflects a quarter of the total trade deficit for the period. One of the objectives of outsourcing is to mitigate the risk of economic volatility. So, when U.S. firms outsource manufacturing to China, they also outsource the risk of industry and macro economic shifts. And the lack of sophisticated inventory management technology as well as time required to transfer finished goods from China to the U.S. only exacerbates the risk assumed by Chinese firms relative to their U.S. counterparts.

So, a slowdown in U.S. consumer spending may not impact U.S. firms directly. However, given the extent of business derived from the U.S., the Chinese manufacturers may well react by lowering prices even further and the Chinese government would turn even more resistant to depegging the Chinese currency and letting it appreciate against the greenback. This, in turn, could fuel more outsourcing to Chinese manufacturers and a further decline in U.S. manufacturing. Of course, this whole argument assumes that primary consumption happens in the U.S. That could change too. As Chinese disposable income increases, the U.S. firms may well find China the new cluster of prosumption, a low-cost producer and an eager consumer.

Heck, isn't that the path to development?