John Sewell on Import Substitution
Import Substitution is a concept that was popular in South America after the depression, where nations used it to wean themselves from dependence on foreign finance and imports. (read Wikipedia here) We were reminded of it reading Worldchanging about how in Brazil, use of ethanol as fuel had declined significantly. Of course it has- The Washington Consensus says that globalization is the key and import substitution is a drag on development.
In The Long Emergency there is discussion about how import substitution will become a reality when we can no longer afford the fuel to bring things from distant sources. When reading our post on community power,the big revelation was how much energy is saved by making it locally instead of suffering the transmission losses from distant generation. We read about poo power which is discussed in community power as a real method of import substitution.
Whether or not you believe that James Howard Kunstler is an Apocaphiliac or not, there are a thousand reasons why from a treehuggers point of view, import substitution makes sense. Globalism runs on cheap transport. The Shipping container revolution and cheap oil make it work. Take away the cheap oil and it falls apart.
When reading John Laumer's post on Chinese apples, This treehugger started thinking about when Import Substitution came on to our radar- 10 years ago, at a cocktail party, listening to the former Mayor of Toronto, John Sewell. He is one of the smartest guys we ever met, and tried to start a business promoting import substitution at the corporate level- big hospitals.
Listening to him then, we started drinking local apple cider from Collingwood instead of orange juice squeezed in Florida by Tropicana from oranges grown in Brazil and started practicing our own personal form of import substitution- not for the fuel it saved but for the jobs it created. Although it is over 10 years old, his argument is stronger than ever. We asked him if we could post an article he wrote to reignite a discussion about import substitution and its increasing importance.
We republish John Sewell's 1994 Report on Business article here, where he talks about Jane Jacobs, misguided bureaucrats and more.This is a report on work-in-progress, an account of a foray into a largely unknown world - for me - of buying and selling, of the nuts and bolts of making business work.
Much of my life has been spent in government, and worrying about public policy, but this new venture concerns the creation of jobs and wealth. Having concluded, like many others, that governments are excellent at expanding bureaucracies paid for by the public purse but are backward in attempts to create jobs or wealth, I set my task to discovering how those objectives might otherwise occur.
How did Canada create millions upon millions of jobs for our burgeoning population during the last several hundred years? Are there lessons to be learned from this history which can be used today to put people back to work? Is there a model or approach, a basic set of principles about job and wealth creation, to be applied today?
My inspiration came from Jane Jacobs, the clear-minded deductive thinker who has the useful habit of reaching conclusions after looking at things, rather than starting with a theory of how things work. Jacobs' discovered that jobs are created in cities when entrepreneurs decide to make locally products that were formerly imported. Some jobs come about when someone invents a new product which finds a market, but that event is much less frequent than someone deciding to try import replacement as a strategy to form a successful business operation. The merit of import replacement is that the market is already there: all that's needed is to make the product locally and supply it at a lower cost, which can often be done because of minimal transportation and handling costs.
Jacobs explored the role of import replacement in creating jobs and wealth in many cities in The Economy of Cities, published in 1968. `This process of replacing imports... is probably the chief means by which economic life expands,' she writes, `and by which national economies increase their total volumes of goods and services.'
Unfortunately, my experience was that no government in the job creation business seems to take the import replacement approach seriously. Municipalities, I know, concentrate their strategies on attracting companies from far way to locate within their jurisdictions. This has led to advertising wars between cities as they erect large billboards in foreign airports, touting their municipal wares, be they golf courses or universities or professional sports teams.
One municipality on the edge of Toronto went so far as to place in all Canadian consulates across the world a binder listing the 80 companies in the area which were interested in forming joint ventures or licensing arrangements with some foreign company. Needless to say, the grandiosity of that vision has managed to create jobs only in the preparation and distribution of the document. It's the paradigm of the successful government job-creation program: it creates precisely as many jobs as government is prepared to fund. No new wealth results. When the funding stops, the jobs disappear.
Other strategies have been used as well by cities, such as trying to attract tourists (always a good reason to spend public funds on a sports stadium or a convention centre expansion) or supporting export enterprises, which are fine ways for elected and unelected officials to travel to and become more educated about the rest of the world - which may not be a bad thing, but it has little to do with real job creation.
As one City of Toronto economic development official told me when I mentioned my little venture, `We're not into import replacement. We're into exports.'
I talked to provincial officials, and they gave the same story: the emphasis today in job creation is in creating a strong export market. The export craze may be a result of NAFTA and other trade arrangements, but its limited ability to create jobs is apparent by the extent of the public subsidies necessary to support it.
The conclusion I reached was pretty clear: if I wanted to create jobs through import replacement, there wouldn't be much support from governments. They were looking in another direction.
So I started off on my own, with six months part-time funding from a private source. Hospitals seemed like a good place to start - Ontario hospitals spend more than $1 billion annually on supplies, and that 80 per cent of those supplies are imported. The opportunities seemed immense.
My strategy was simple: I would ask hospitals if I could be a broker for them. They would identify imported products which they purchased, and I would attempt to find a local manufacturer which would supply the goods at a lower price. I would guarantee to the hospital that its identity would not be revealed, so that no one could claim existing supply contracts were being interfered with, and the hospital would be under no obligation to accept any bids I managed to secure. Since my brokerage services were being provided at no charge, it was an arrangement I thought the hospitals would have no trouble agreeing to.
Hospitals didn't jump at the opportunity as quickly as I expected. Senior staff at several hospitals simply refused to acknowledge my letters and phone calls asking for a meeting. Some showed a passive reluctance. (One purchasing agent told me all the suppliers to their health facility had Toronto offices. When I asked where the goods were made that they supplied, she said `We've never worried about that.') Some feared that by thinking about local suppliers they were really being asked to give preference to local goods - rather than simply not discriminating against them. But several hospitals took a more favourable approach, and I began to see the problems with the import strategy from the point of view of the hospital's purchasing staff. With recent staff cuts, those left are so rushed off their feet they can't even think of trying to locate new suppliers - they just want to deal with those they now have. The deeper problem is the anger of purchasing staff toward the product selection committee, which many feel has most of the purchasing power.
All hospitals have some committee to assess goods being purchased to ensure they meet the needs of doctors, nurses, and other staff. There's a sense these committees are controlled by doctors, and that decision-making is rather chaotic, following doctor preferences rather than reasonable rules about quality and price. Purchasing staff make it clear pretty early on in a discussion that it hardly matters what they say - the product selection committee will make its own decision in any case.
One Toronto supplier gave me his experience, which he said was typical. He had submitted a bid on the supply of certain materials, and learned to his dismay some weeks later that he was not successful. He asked the hospital's purchasing director what had happened, and was sent a package of information containing the minutes of the relevant hospital committee meetings. At the product selection committee, a doctor had said his product wasn't `flexible enough.' The committee agreed, without discussion, and the contract was awarded to the American supplier at 20 per cent more cost. The Toronto supplier was given no opportunity to prove his product was every bit as `flexible' as the more costly product. The doctor's word was taken as gospel, and no one seemed to worry about cost.
The hospitals which agreed to the experiment gave me samples of half a dozen or a dozen products made off-shore but purchased on a regular basis. Items included plastic bottles, jars and containers, as well as complete trays of disposable times needed for routine operations. The hospitals involved gave me annual quantities used and price per unit, which I agreed not to disclose - the latter necessary so the manufacturer had some idea of price range to operate within. One hospital balked at providing unit prices, and sent me a copy of the contract with their current supplier prohibiting disclosure to any third party - a most remarkable contract term for any hospital to agree to.
With these samples in hand, the task of sourcing these products from local firms revealed a different set of problems.
The first surprise was to find that no local manufacturer currently produced these items, even though none of the items required sophisticated techniques or patents or licenses. Current suppliers had so tied up hospital demand for the products I was trying to source that local manufacturers had abandoned the market. My job was not finding who made the products in question, but rather to track down a company that made a similar kind of product and to ask if it would consider expanding its product line.
After locating companies making the same kinds of products (the Yellow Pages was helpful, so was the Plastic Institute of Canada) my second surprise was to face the lack of interest shown by so many companies. I expected local companies to be eager for new work, but found that hardly the case. Of more than two dozen contacts, only three showed any interest in coming to look at samples in my office. Quite quickly I realized companies expected me to come to them, which I reluctantly did. And I met the usual array of promises which came to naught there or four weeks later, after much pushing on my part for performance. It was either a case of me being a novice in knowing how to deal with manufacturers, or a reticence on the part of companies to spend time looking at new opportunities.
But my first forays were successful. Without a dozen samples in hand, I was able to find local manufacturers for three items, offering prices 20 to 30 per cent below what the hospitals were currently paying. Prices are lower, apparently, for two reasons.
First, since products are made locally transportation costs are minimal, and without the mark-ups which accrue as goods are handled by different parties. (In looking for products to replace, I looked for those which are bulky or heavy, since they incur the greatest transportation costs.) Second, locally made goods don't involve all the problems of foreign exchange rates. Many medical products are manufactured in New England, New Jersey, and Illinois, areas where wages are about the same as Ontario, save that those companies are paying in American funds. These are two of the natural advantages of local manufacturing.
The bids, from three different companies, were not unconditional: the start-up costs of making plastic molds has pushed each manufacturer into requiring a larger volume than a single hospital can consume annually, although one hospital has undertaken to bring in others to take advantage of the favourable prices. At the time of writing, no formal contracts have been signed, but promise seems to be there.
Until contracts are signed, it's difficult to pin down the cost savings to the hospitals resulting from these there import replacements - they are probably in the order of $15,000 on $50,000 worth of supply. At the time of writing, offers are coming in on three further products, which would more than double those figures.
My hope was that this kind of business could survive off the commissions made from successfully concluded contracts, but that hope has some distance to go. This might be affected by my life experience, which clearly isn't in this field; and it might simply be the normal start-up period which always incurs high costs as the enterprise takes shape.
But the arrangement holds other promise. As one purchasing director noted enthusiastically, `With local suppliers we'll be able to sit down and work on how the product can be improved. We can't do that with a manufacturer who's a long way away.'
This is one of the advantages of import replacement which might far outweigh any price saving. Product innovation comes from a manufacturer wondering how the product can be improved, and that occurs by talking to the user. Product innovation leads to better products which other buyers then want - and local supply quickly turns into a useful export business as well, expanding the circle - until in some other city a local supplier decides to replace that import, and the process starts again.
Import replacement, or local or regional sourcing, looks like a good way of creating local jobs and wealth. It's not flashy or grand since it works in small increments, getting a small contract here, and another there. But it works within the market, providing a financial benefit to the purchaser (lower prices), while generating local jobs from the new work.
As I've learned in the hospital field, there are structural problems which stand in its way (product selection committees as currently structured, for one) and there are not a host of people eager to see it happen, but there are enough people interested that the process can occur. The hospital's incentive is that it saves money, and in the process may encourage the creation of better, more useful, and less expensive products. Local firms have more business, which in turn provides more jobs and creates more wealth. There's nothing special about the hospital sector, save that it has its own peculiar wrinkles: this model could be applied to other sectors as well. My original intention was to explore import replacement in the food industry, in the apparel industry, in bicycle parts - until I realized that I simply didn't have the energy to operate on so many fronts at one time.
Once in full operation, my hope is that this kind of brokerage operation should be able to support itself on commissions paid by the producer, levied on each successful match between hospitals and local manufacturers. With $800 million worth of business each year to replace, there should be no shortage of business. Assuming that occurs, then we'll have hit upon a self-funding market-oriented program to create jobs and wealth.
If this kind of a cycle can be up and running in all sectors, there's real hope for our ability to create the jobs and wealth our society needs.
This little foray, this work-in-progress, may prove useful after all. Maybe another six months will tell. ::john Sewell by [LA]