Letting the world pick our pocket

By Jim Jubak

The developing world continues to clean the developed world's clock in the new global economy.

Lower overall costs and, most visibly, cheap labor drives companies trying to increase profit margins to export jobs to countries like China, India and Vietnam.

But developing countries aren't just waiting for free-market forces to deposit jobs on their doorsteps. They're aggressively using government-backed incentives of cheap land, lower taxes and low-cost capital to win jobs in cases where they don't have a compelling market advantage.

For example, the Saudis have emerged as the leading potential buyer in the April auction for General Electric's (GE, news, msgs) plastics division, and Intel (INTC, news, msgs) has just announced it will, for the first time, build a chip manufacturing plant in China.

And the response from the United States? Zippo.

Like most of the developed world, this country doesn't have either a plausible long-term strategy for capitalizing on its competitive strengths or a plan for countering the bidding muscle of the leading players in the developing world.

And that bodes ill for the developed world in a century where the scarcest resource is likely to be not energy or food but jobs.

The General Electric and Intel deals show how strongly free-market currents are running in the developing world's favor -- and how willing countries in the developing world are to help that current along.

After studying the margins in its plastics business, General Electric decided that it could get a better return on its capital by putting it to work in one of its other businesses. Higher prices for oil have pushed up the cost of making plastics. That wouldn't be so bad, except that intense global competition in the sector has made it impossible for General Electric to pass those costs through to its customers. In the fourth quarter of 2006, for example, while sales volumes in GE's plastics business moved up 3%, prices dropped 5%.

The results look even worse when compared with those from other General Electric divisions. Operating profit from the industrial segment was 8% in 2006 compared with a 19% operating profit for both the company's infrastructure and health-care divisions.

Not enough profit

It makes solid free-market sense then for General Electric to put its plastics business on the block so it can take the estimated $10 billion to $12 billion that would be generated by the sale and reinvest it in a business showing 19% operating profit rather than one generating just 8% profit.

Enter Saudi Basic Industries, the largest public company in the Middle East. The company, with 2006 revenues of more than $23 billion, has been buying chemical businesses even as U.S. companies shed these assets. For example, last year Saudi Basic Industries bought the European bulk chemicals operation of Utah company Huntsman (HUN, news, msgs). And now the company is reported to have hired Citigroup (C, news, msgs) to put in a bid for General Electric's plastics business.

Why does Saudi Basic Industry want a business that General Electric doesn't? Well, there are sound free-market reasons. Companies operating in the Middle East, with its abundant and relatively cheap supplies of oil and natural gas, have a huge cost advantage over U.S. and European companies. And with the growth of huge export markets in India and China, Middle Eastern plastics companies have an edge on transportation costs, too. Saudi Basic Industry wants to exploit those cost advantages by building up its operations. The company has announced it plans to double its plastics production to 100 million metric tons a year by 2015 through acquisition of European and U.S. companies and by building plants in China, India and Saudi Arabia.

But free-market economics isn't the only thing that counts in this deal -- at least from the Saudi side.

You see, Saudi Basic Industries is 70% owned by the Saudi government. Which, more or less -- and I'd say more -- makes the company a key component of the government's economic strategy:

• Move up from producer of raw materials such as oil and natural gas to producer of value-added petrochemical products such as plastics.
• Provide large numbers of jobs for the country's fast growing and very young population. More than 35% of Saudi Arabia's population is under 15 years old (compared with just over 20% in the United States), and the country's birthrate is about three times as high as that in the United States.

In the past, the Saudi government hasn't done an especially good job at running the economy to provide jobs for its growing population. Real economic growth from 1993 through 2002 averaged just 1.8% a year, while U.S. growth for the period was 3.3% annually. But the Saudis are determined to change that, and if that means investing some of the country's huge reserves of petrodollars in building a domestic plastics industry at a less-than-optimal return on invested capital, then so be it.

Saving a billion bucks

Intel's announcement that it would build a chip plant in China also makes perfect free-market sense from Intel's perspective. The $2.5 billion silicon wafer fabrication plant in Dalian in northeastern China would produce its first chips in 2010.

Why China for the company's first new site in 15 years? (Intel has built other new plants in the period but at existing sites.) Well, yes, it does put the company closer to one of its fastest-growing markets, which has business value. But the key is dollars and cents. Thanks to tax breaks, cheap land and access to cheap credit, it will cost about $1 billion less to build the plant in China than in the United States, Intel calculates. And even for a company with $35 billion in sales, saving $1 billion in costs can make a big difference on the bottom line. Intel's 12-month earnings on that $35 billion in sales came to $5 billion.

What do China's central planners get for their tax breaks, cheap land and cheap credit? Two things:

• First, jobs. About 1,500 of them. And these are exactly the kind of skilled, high-technology jobs that the Beijing government needs to address the huge unemployment and underemployment problem faced by graduates of China's universities and technical institutes. Beijing knows that if you put too many college grads out on the streets without jobs, you get demonstrations, riots and worse. No thanks. (Note that because chip manufacture is so highly automated and because labor costs make up a small percentage of the costs at these equipment-intensive factories, China's edge in wage rates wasn't a big factor, according to Intel.)
• Second, technology. Although Intel will start by building 90-nanometer chips at Dalian, there's a good chance that the company will upgrade to newer technology once the plant is open. Chips at the 90-nanometer scale will be old hat by the time the factory goes into production in 2010.

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