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APR 10

Where production goes R&D follows

There has been some talk recently about the off-shoring of production activity and how, provided the Research and Development (R&D) teams stay in New Zealand, this can be a viable option. Shamubeel Eaqub, principal economist for the NZIER promoted this view in a Herald article saying, “Just because the production process is moving overseas does not necessarily mean it’s a bad thing. What we do have in New Zealand, and in most advanced economies, is a very skilled labour force and that is where we are most suited - management and R&D and those more innovative processes.” While it is true that a skilled labour force provides New Zealand’s competitive advantage, moving production offshore removes some vital links between the engineers, designers and those dealing with the hands on production process. Experience has shown that a lowest cost solution requires co-location

This unfounded apathy to off-shoring was also evident from the previous Labour led Government which produced a Cabinet Paper in 2007 called ‘Advancing Economic Transformation’, where Paragraph 53 said:

The key challenges arising from international integration are for New Zealand to:

a. Position itself as an attractive location for investment and skills and for those parts of international supply chains that relate to high-value products and activities and that provide the greatest return (e.g. R&D and design). This includes an imperative to develop more and/or larger internationally successful New Zealand businesses, networks of businesses, and segments of the economy; and

b. Capture the best return through our businesses being part of international value chains offshore (return profits to New Zealand), through developing new business models of operating internationally (such as investing directly in offshore product and distribution chains), rather than transferring valuable activities offshore.
Ministry of Economic Development,

Again, the intentions of this document cannot be faulted but it ignores the influence of scale and interactions throughout the steps in the manufacturing process. As a trivial example, an engineer may realise, on visiting the factory floor or interacting with production staff, that a change in design could dramatically decrease the time taken to produce a product. This sort of interaction is lost if the different elements are separated.

The need to offshore is premised on the assumption that New Zealand cannot compete with lower wages overseas. In reality, wage costs are a fairly minor component of the overall cost and competitiveness of the manufacturing enterprise; often the cost of management of remote operations can more than consume the obvious savings. It is worth noting that a direct labour content of less than five percent of sales is not unusual in high technology products, and exchange rate fluctuations could have ten times the impact of the difference in labour rates.

We must look to keep as much activity, whether production or design, in New Zealand. End to end skills and capabilities embedded in an economy provide options and opportunities for that economy; gaps and shortcomings limit choices and opportunities. This means offering a stable exchange rate regime to stabilise returns for exporters in job number one. Offering R&D incentives to encourage firms to base themselves here and offering incentives to aid investment in new technology are also helpful. These initiatives would mitigate the significance of New Zealand’s higher wage rates and encourage manufacturers to integrate their supply chains here.

If we allow some bits of the supply chain to go offshore then more will follow, it is an insidious process of loss. While developing countries may not currently have the expertise to carry out design and engineering work, that capacity will soon develop if there is a significant presence in a particular industry. If there are better incentives for design and engineering work overseas the process of hollowing out skills and capability in our economy will be accelerated.

Our future must, in part, be based on sending more and more products to export markets holding more and more of the value chain to provide the jobs and the maximum economic benefit to the New Zealand economy.

tags: r&d, off-shoring, supply chains
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