Boeing Goes To Pieces

This article was first published in the January-February 2014 issue of The American Conservative.

At a welcoming banquet in Japan in the 1980s, Ford Motor chairman Philip Caldwell received a memorably double-edged compliment. “There is no secret about how we learned to do what we do, Mr. Caldwell,” said the head of Toyota Motor, Eiji Toyoda. “We learned it at the Rouge.”

Toyoda was referring to the Ford’s fabled River Rouge production complex in Dearborn, Michigan.

In the early days of Japan’s rise, the Detroit companies had been famously helpful to information-gathering Japanese auto engineers. Knowhow gleaned at the Rouge evidently proved particularly valuable.

Similar stories can be told about the preternatural complacency of other U.S. industries in the face of emerging Japanese competition. Where Japanese industrial “targeting” is concerned, America never seems to learn.

Now another industry is being targeted – this time America’s last remaining crown jewel, aerospace. The Boeing corporation in particular has long been in Japan’s crosshairs. Yet, although the scale of Japan’s agenda is well understood in the industry, American aerospace executives have chosen not to raise the alarm. In what amounts to one of the most outrageous sellouts in modern business history, the U.S. industry is consciously cooperating in its own demise. Swayed by stock options, top U.S. aerospace executives are increasingly prioritizing short-term profits and outright financial finagling over the long-term health of their industry.

Although the details of U.S.-Japan aerospace deals are rarely disclosed, it is clear that a key dynamic is that, in return for transfers of American technology and manufacturing knowhow, the Japanese low-ball their prices in supplying an ever widening and more sophisticated array of components and materials. In many cases, Japan’s state-controlled airlines further sweeten the pot by paying top dollar for U.S. airframes and jet engines. All this boosts the American industry’s short term profits. In the long term, of course, the current crop of top executives will have long retired – and in the meantime they are crying all the way to the bank.

For the Japanese the seemingly steep upfront costs are a steal given the enormous amount of learning-by-doing that would otherwise be required to reinvent American knowhow and production technology. As for the American national interest, the most obvious consequence is an endless stream of layoffs of American blue-collar workers. Less obviously but equally debilitating, the U.S. aerospace industry’s dependence on Japanese and other foreign suppliers has greatly exacerbated U.S. trade imbalances. By extension the U.S. Treasury has become ever more dependent on East Asia, not least Japan, to fund the trade deficits.

Already Japan’s successes reach into the industry’s every nook and cranny. Here are a few examples:

Jet engines. Both Pratt & Whitney and GE Aviation now rely heavily on Japan for engine components. A key supplier is Ishikawajima Harima Heavy Industries (IHI), a little-known Tokyo-based corporation that now ranks as one of the world’s most advanced aerospace players. (In common with several other leading Japanese aerospace companies, IHI got its start in ship-building. Hence the seemingly incongruous reference to “heavy industries” in its name.)

Avionics. This is the term of art for a huge array of sensors, controls, flight-deck instruments and displays, and communications equipment essential to modern aviation. The field used to be the preserve of U.S. companies like Honeywell, Hughes, and Raytheon, but increasingly the serious manufacturing is done in Japan by corporations like Panasonic, Sony, and Toshiba. The Japanese have also assumed leadership in critical avionics materials. An example is gallium arsenide, a superfast semiconducting material vital in advanced computer chips. The supply of gallium arsenide is dominated by Japanese companies like Hitachi Cable and Furukawa Electric.

Aircraft wings. Companies like Kawasaki Heavy Industries and Mitsubishi Heavy Industries are now world leaders in wing-making, a specialty long considered one of the aircraft industry’s greatest manufacturing challenges. In partnership with the world’s leading carbon fiber producer Tokyo-based Toray, Mitsubishi has pioneered the manufacture of carbon-fiber wings for passenger planes. Such wings are claimed to reduce fuel consumption by up to 20 percent per seat-mile.

To be sure, the Japanese have so far confined themselves almost entirely to components and materials, leaving Americans and Europeans proudly to affix their logos to completed engines and airframes. But past precedent suggests the Japanese may not be content to play second fiddle forever. In fact Mitsubishi is already working on a 90-seat regional jet scheduled to enter commercial service in 2017. Although this plane will not present much direct competition for the American airframe industry, it will stand in much the same position to that industry as, say, the Honda Accord did to the U.S. auto industry in the 1970s – the thin edge of a wedge.

Although global market share figures are hard to come by, Japan is arguably already the world’s largest aerospace player. Certainly it is the ultimate source of a vastly larger share of the industry’s most sophisticated value added than a reading of the English-language press would suggest. Boeing in particular is deeply hollowed out. Given that Boeing now subsumes most of the erstwhile independent companies that put Neil Armstrong on the moon, its eclipse constitutes a major part of a larger story of American decline.

As Robert Scott of the Washington-based Economic Policy Institute, points out, little more than a generation ago, Boeing planes were still almost entirely American-made. In the 1980s, however, Boeing came under increasing pressure to enter into “work-share” agreements with various technology-hungry foreign partners, most notably the Japanese.

The trend intensified as Boeing planned the 777, which entered service in 1995. On Boeing’s numbers, various Japanese companies took on in aggregate about 21 percent of the 777’s airframe, up from about 16 percent for the Boeing 767, which had been launched in 1982. Boeing allocated much of the 777’s fuselage to a government-led Japanese consortium.

Then came the 787, Boeing’s newest passenger plane which entered commercial service in 2011 in the livery of All Nippon Airways. For several reasons the 787 constitutes a watershed not only for Boeing but for the entire global aerospace industry. Otherwise known as the Dreamliner, it is the most technologically advanced passenger jet ever built. It is also the first progeny of a portentously redefined relationship between Boeing and Japan. On the company’s own figures, the Japanese account for a stunning 35 percent of the 787 – and that may be an underestimate. Much of the rest of the plane is also manufactured abroad, not least in Italy, Germany, South Korea, France, and the United Kingdom.

The 787 story began more than a decade ago when, in the manner of a man undergoing a mid-life crisis, Boeing suddenly embraced a New Age redefinition of itself: it aspired to be primarily a “systems integrator,” not a manufacturer. According to one online dictionary, the term systems integrator connotes “an individual or company that specializes in building complete computer systems by putting together components from different vendors.” As the commentator Mark Tatge has pointed out, the term suggests a largely service-oriented role similar to Dell Computer’s in the personal computer industry (Dell confines itself to the design and marketing of products assembled in East Asia from bought-in components).

Evidently wearying of trying to stay ahead of Airbus, already then in the passing lane, Boeing would henceforth delegate many of its most technologically challenging manufacturing tasks to a consortium of three Japanese “Heavies” – Mitsubishi Heavy Industries, Kawasaki Heavy Industries, and Fuji Heavy Industries. These rank first among equals as Boeing’s so-called Tier 1 suppliers and have been the recipients of much of Boeing’s most advanced knowhow.

Boeing’s retreat from manufacturing was powerfully symbolized also by its decision to move its headquarters from Seattle to Chicago. Executed in 2001, that decision seems to have been made during the wild stock bubble of the late 1990s. It is tempting to imagine that the directors of America’s most Olympian manufacturing company talked themselves into a shift to postindustrialism at the height of one of the most ludicrous outbreaks of crowd madness in American economic history.

What is clear is that Boeing’s changing view of itself nicely dovetailed with Tokyo’s agenda. For decades Japan had identified aerospace as one of the most crucial of all targeted industries. At a stroke Boeing’s transition to systems integration put the ultimate prize of global leadership in aerospace within Japan’s grasp.

Of course, on a superficial view, Boeing’s strategy seems like just any other case of outsourcing – and, to mainstream economists if not to blue-collar American workers, outsourcing is a good thing in that it helps nations allocate their capabilities more efficiently.

There is, however, another side to this story, as Ralph Gomory points out. A former director of research at IBM who is better known these days for his mathematical debunking of the traditional case for free trade, comments: “If the world economy were working in textbook fashion, Boeing’s technology transfer policy would not make sense. The Dreamliner story illustrates in high relief a fundamental, hitherto generally unnoticed, flaw in the theoretical case for globalism.”

For a start, in contrast to the standard case for outsourcing, Boeing’s increasing reliance on Japan can’t be explained as a search for cheap labor. The fact is that Japanese wages are notably high – probably, when all is said and done, higher than American levels. By the same token labor costs in several other nations where key Boeing suppliers hang their hats (Germany, France, and South Korea, for instance) are also high.

Even more anomalous is Boeing’s acquiescence in other nations’ requests for technology transfers. As Gomory points out, there is no place for such transfers in the standard case for free trade. After all if American corporations have a comparative advantage in plane-making, they should keep it. By transferring production knowhow to overseas partners, the American aerospace industry is cutting its own throat – and why would anyone do that?

As Dick Nolan, an emeritus professor of Harvard Business School, has pointed out, Boeing’s traditional policy had been to use foreign suppliers merely to do so-called “build-to-print.” The term signifies that they supplied components and subcomponents made to Boeing’s detailed specifications, an arrangement that enabled Boeing to keep to itself much, if not all, of its serious aeronautical and manufacturing knowhow.

Even before Boeing redefined itself as a systems integrator, keen observers had noticed a weakening in its resolve to resist Japanese pressure for technology transfers. As recorded by the British author Karl Sabbagh, already by the early 1990s Boeing’s willingness to reveal previously closely held manufacturing secrets to the Japanese became so notorious that Boeing employees vulgarly referred to it as the “open kimono” policy. The erstwhile Leviathan of the global aerospace industry was the one in the kimono.

As for the Dreamliner, not the least surprising aspect of its work-share arrangements is that the foreign-made sections arrive in Boeing’s final assembly plant in Seattle not only fully “stuffed” with systems and sub-components (a radical departure from previous arrangements) but already certified and tested. Certification and testing had previously been considered core functions that should never be delegated to foreign partners. Noting this in a Harvard Business Review blog, Dick Nolan has acerbically commented: “Boeing effectively gave Tier 1 suppliers a large part of its proprietary manual, How to Build a Commercial Airplane, a book that its aeronautical engineers have been writing over the last 50 years.”

Perhaps the single most controversial aspect of Boeing’s partnership with Japan is that the 787 flies on Mitsubishi wings. To add insult to injury these are no ordinary wings. They constitute the first extensive use of carbon fiber in the wings of a full-size passenger plane. In the view of many experts, in outsourcing the wings, Boeing has crossed a red line. For a start, as Stan Sorscher points out, the strategy has required the transfer to Mitsubishi of much of Boeing’s vaunted wing-making technology. Sorscher, a former physicist at Boeing and now an executive of Boeing’s main white-collar union, comments: “The value of the technology and knowhow transferred is probably around $500 million – that is what we call in the business a scientific wild-ass guess. Boeing built the tooling for a full-scale prototype of the 787 wings in Seattle and then gave all of that to Mitsubishi. It was a huge boost to Mitsubishi.”

He adds: “Boeing gave Mitsubishi the materials technology and the manufacturing processes – the layup processes, temperature and pressure conditions for the autoclaves, for instance. Boeing also transferred its tooling and assembly expertise and there is a lot of expertise in assembling a wing.”

Sorscher notes that previously Boeing had regarded wing-making as its ultimate core competency. By keeping the wings largely or totally in-house, Boeing minimized the risk that the Japanese consortium could ever become a viable future competitor. As recorded in the late 1980s by Louis Uchitelle of the New York Times, a security-conscious Boeing had previously gone to great lengths to keep Japanese visitors away from its wing-making operations.

The assumption in the industry is that carbon-fiber wings will become standard in future passenger jets. By engaging the Japanese to lead the move to carbon-fiber, Boeing may therefore be committing the industrial equivalent of assisted suicide. As Richard D’Aveni of the Tuck Management School points out, the risk is not only that Boeing will lose the ability to make state-of-the-art wings but that, as it loses touch with manufacturing, its ability even to conduct design and systems integration will gradually atrophy.

His concerns seem to be being belatedly heeded inside Boeing. In recent months, the company has indicated that it wants to bring more manufacturing back in-house. This is implied, for instance, in plans for the new so-called 777X, a stretched version of the 777 which is expected to enter service around 2020.

The question is whether Boeing is closing the barn-door after the horse has bolted. Certainly, as William Lazonick, head of the University of Massachusetts Center for Industrial Competitiveness, points out, the Japanese are looking increasingly formidable. He explains: “I don’t think Boeing will ever make a composite wing for a large passenger jet. Japan’s competitive advantage is its deep expertise in machining, its knowhow with advanced materials, and its capital goods. Where you are looking for very high-quality engineering, and labor that maintains its capabilities over long periods, the Japanese are superior.

“This sort of work has been abandoned in the United States because the Japanese are there to do it. They have tremendous expertise in precision engineering using complex materials – materials that have to be dealt with in a particular way such as getting the weight down to a minimum. They will low-ball their prices to get work because they know they will keep it.”

Going forward a major problem for a systems integrator is that technological progress is so rapid. Richard McCormack, editor of Manufacturing & Technology News, explains: “Once you fall behind in advanced manufacturing, the costs of catch-up are just too great, and a chief executive aiming to maintain quarterly earnings cannot afford to incur them. The story in advanced manufacturing is that once foreign suppliers gain a foothold, they rapidly descend the cost curve and can quote prices far lower than a U.S. corporation can match in-house.”

Why is wing-making so crucial? Wings must weigh next to nothing, yet withstand occasional extreme buffeting. They must respond instantly and smoothly as a plane takes off or lands. Imprecise machining means drag and, where components do not fit snugly, wear increases exponentially and, with it, the risk of catastrophic failure in flight.

Wings for large passenger jets pose unique challenges because the larger a part is the greater the difficulty in machining its surfaces to required tolerances. Given that some wing parts these days can be as long as 100 feet, only a few factories in the world have the massively expensive machinery and rich endowment of tacit knowledge to meet the challenge.

In the case of carbon fiber wings, the challenges are further compounded because carbon fiber is a notoriously fickle material. Extremely strong in normal aeronautical use, it can also be extremely brittle if mishandled. A few tiny cracks invisible to the naked eye can doom a plane.

In outsourcing so much of the Dreamliner, Boeing has flouted the opinion of its own top engineers. The company received a particularly well-argued caution at an in-house conference as far back as 2001. One of Boeing’s senior engineers, John Hart-Smith, delivered a paper on the dangers of excessive reliance on outside partners – a paper that subsequently went “viral.”

Referring to the American aerospace industry’s pattern of ever increasing outsourcing, Hart-Smith asked: “Is it really all that difficult to comprehend that, along with the work involved, the revenue and profit associated with it have also been outsourced?” He added: “One must be able to contribute in some way to products one sells to avoid becoming merely a retailer of other people’s products.”

Although Hart-Smith’s stand was widely applauded by his fellow engineers, a top Boeing executive immediately gave an unscheduled response in support of outsourcing.

Hart-Smith’s views were probably shaped in part by the fact that he had previously worked for McDonnell Douglas, a once brilliant company that flamed out after decades of increasing reliance on foreign partners. It eventually succumbed to a merger with Boeing in 1997. Hart-Smith had joined McDonnell Douglas at the height of its success in the 1960s, when in many ways it still overshadowed Boeing. He had subsequently watched its commercial aircraft business outsource itself to death. A key problem was that designers became so out of touch that they no longer understood basic manufacturing realities.

Hart-Smith’s message should have packed a special significance for one higher-up in particular: Boeing’s future chief executive Harry Stonecipher. A classic “numbers guy” who had come out of Jack Welch’s General Electric, Stonecipher had served as chairman of McDonnell Douglas and in that capacity had presided over a particularly toxic outsourcing fiasco involving technology transfer to China. By 2003 he was chairman of Boeing and oversaw the early stages of the 787’s development.

How does Boeing justify its retreat from manufacturing? The company is not saying and requests for interviews were refused. A spokesman said that all questions are answered at the company’s website. In reality the site is so difficult to navigate that it is virtually useless. Asked to comment on information gleaned from other sources, the spokesman declined, saying that he would not “fact-check” this article. Meanwhile independent sources who had been helpful for a previous article in 2005 inexplicably refused to cooperate this time. A pattern of self-censorship also seemed to extend to the U.S. Senate: one outspokenly pro-manufacturing Senator, a Democrat from the Mid-West, at first ignored this writer’s requests for comment and then, after repeated reminders, offered a few irrelevant platitudes that carefully avoided any criticism of Boeing.

All in all, as the prominent Washington-based aerospace analyst Richard Aboulafia has suggested, interpreting developments at Boeing these days “resembles Kremlinology.”

That said, Boeing does have some excuses, albeit weak ones. A key factor is so-called offsets, which are requirements by foreign air-forces and government-controlled foreign airlines to favor their nations’ manufacturers in outsourcing key aerospace contracts. No nation has benefited more from offsets than Japan, and the Tokyo government’s ability to manipulate the U.S. aerospace industry is legendary.

But this does not mean that Boeing had to roll over. The fact is that it has at all stages held the high ground. In buying full-size passenger jets, the Japanese have had only two choices, Boeing or Airbus, and Airbus, as a key manifestation of German-French industrial policy, has had no agenda to transfer either technology or jobs to Japan. Meanwhile, as Matthew Lynn, author of Birds of Prey, has pointed out, the Japanese have long been under a strong geopolitical obligation to buy Boeing to help reduce their nation’s chronically large bilateral surpluses with the United States.

In the circumstances it should have been easy for Boeing executives to hold the line. In reality there is no evidence that they even tried. Their failure seems all the more surprising for the fact that Japan’s work share in Boeing planes has long been far greater than the proportion of final sales accounted for by Japanese airlines.

As Barry Lynn, a senior fellow of the New America Foundation, points out, not the least controversial aspect of this story is that Boeing’s policies seem at odds with its communitarian obligations. On the one hand Boeing has received considerable government support over the years. Meanwhile though the company claims that nearly 500,000 workers worldwide participate in its programs, most of those jobs are outside the United States. Certainly jobs in the company’s civilian jet division have been cut by more than 20,000 in the last three decades.

Lynn comments: “Much of the technology that Boeing has transferred abroad was subsidized by the U.S. taxpayer and it was entrusted to Boeing to look after. Instead Boeing has sold it off. There has been a substantial amount of cashing out and top executives have treated themselves extremely well.”

On one estimate, in the three decades to the mid-1980s, more than 70 percent of the U.S. aircraft industry’s development funding came from Washington, D.C., mainly thanks to spinoffs from military and space projects. More recently Boeing benefited greatly from low-interest finance from the U.S. government. According to the industrial geographers David Pritchard and Alan MacPherson, Boeing received a $3.2 billion subsidy package from Washington State in support of the Dreamliner program. Earlier there had been a $1.8 billion hand-out from NASA earmarked to develop America’s industrial base in preparation for the so-called High Speed Civil Transport, a proposed American-made supersonic airliner. Although the plane was later cancelled, there seems to have been no record that Boeing returned any of the money.

Another factor often mentioned in mitigation of Boeing’s outsourcing is a perceived need to enlist financial partners who can help fund the development of new planes. In the case of the Dreamliner, the Japanese Heavies provided much of the funding. But did Boeing need such help? As William Lazonick points out, Boeing had plenty of in-house financial muscle. It chose instead to use its cash to reward shareholders via hefty dividend increases and, even more irresponsibly, huge buybacks of its own shares.

“Most of the buybacks came in two periods, first between 1998 and 2001, and then between 2004 and 2008,” says Lazonick. “Boeing’s buybacks cost more than $20 billion in total. And it is not as if they were not paying dividends. They were paying substantial dividends. I reckon between the beginning of 1996 and the end of 2007 their dividends totaled $8 billion. When you add it all up, buybacks plus dividend payments totaled $29 billion.”

He adds: “This is not atypical for major U.S. companies these days. They are looking for every way to cut what they spend on investment. Boeing could have done all the investment they wanted. Boeing’s buyback policy is a big difference with Japan. Companies there do very little buying back of their stock. They reinvest in their businesses.”

What is clear is that Boeing’s stock price has done well. Measured from end-1997 it is up more than 170 percent. Not bad compared to a cost of living increase of just 47 percent. The rising stock price has in turn powerfully boosted executive stock options. Hence in large measure the fact that Boeing’s current chairman Jim McNerney made $27.5 million in 2012. This compares with a total of $1,725,000 for then chairman Phil Condit in 1997 – and Condit’s package was probably rich by previous Boeing standards.

Let’s sum up. The Boeing story strongly suggests that America’s defense base has become dangerously eroded. In this sense it is further evidence of a trend identified in a little noticed report in 2005 by the Defense Science Board. The board’s focus was mainly on the electronics industry and it found that even among suppliers who served mainly or solely the U.S. defense industry, hollowing out had already then reached shocking levels. “There is no longer a diverse base of U. S. integrated circuit fabricators capable of meeting trusted and classified chip needs,” the report said. “From a U.S. national security view, the potential effects of this restructuring are so perverse and far reaching and have such opportunities for mischief that, had the United States not significantly contributed to this migration, it would have been considered a major triumph of an adversary nation’s strategy to undermine U.S. military capabilities.”

In discussions of the unintended consequences of globalism, the leakage abroad of valuable production technology is the elephant in the room. It is consistently ignored in all standard theoretical accounts of free trade. In an era when information can move around the world at light speed, this is an oversight of epochal importance. Almost everyone, it seems, assumes that no matter how fast American industrial knowhow leaks abroad, an abundance of new production methods and new industries will keep bubbling up to provide additional sources of prosperity. Not only do people not stop to consider whether this assumption is valid, they don’t even realize they are making an assumption. As Ralph Gomory points out, overconfidence about the U.S. economy’s capacity for economically valuable innovation is a major error, and it goes a long way towards explaining why, despite constant assurances from economic theoreticians that global free trade would boost American competitiveness, the opposite has consistently been the case.

Gomory notes that a fundamental problem is that many of America’s most sophisticated competitors do not run their trade policy on a free market basis. By intelligent use of trade barriers, among other things, they can hope to winkle advanced production technologies out of the United States. By the same token, employers in such nations are often under considerable pressure – political, economic, and societal – to keep their most advanced production technologies at home, and well away from the risk of theft by foreign rivals.

In short, a historic ratchet effect is at work. With high-value jobs disappearing never to return, America’s imports and current account deficits rise with each succeeding economic cycle. The deficits have to be financed – and this means ever greater reliance on major creditor nations, not least China and Japan, but also Saudi Arabia, Russia, and Germany. On present policies, the United States is destined to continue on a downward spiral of indebtedness similar to that of the late-era Ottoman empire.

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