Silicon Valley, or the Valley, was not an overnight pop-up success.
The young tech kids in t-shirts have moved to the Valley for as long as anyone can remember.
Back in the late 1800s, San Francisco’s port created a hub for the telegraph and radio.
They helped advanced military and aerospace technologies. San José lays claim to the countries first radio stations.
Maybe the most notable addition was Hewlett Packard (HP) in 1939.
HP not only helped usher in the age of computing, they also developed the first radar detectors just in time for the Second World War.
Look at the Valley today. Not a whole lot has changed. It’s still fertile ground for the biggest names in tech.
Those companies have changed, though.
Today’s Valley giants are not like those of HP’s day.
Companies like Facebook, Google and Apple, are all dominant software businesses. It’s software, the intangible stuff, that drives all three companies above (Apple to a lesser extent).
Back in HP’s day, all the tech companies were high-end manufacturers. Rather than producing code, these old timey tech firms were producing physical goods, microchips and all.
Maybe this is a model French President, Emmanuel Macron wants to follow.
First the high-end manufacturers, then the software titans…?
But I doubt it.
Can you make manufacturing sexy?
France is trying to make manufacturing cool, according to Bloomberg.
A regular site across the country is, what looks like, a Hollywood style movie bus with a blue rooster on the side.
It’s the new initiative to get kids interested in manufacturing.
Source: Bloomberg Businessweek
‘Each daylong stage [the plan is for 60 stages across France] of the so-called French Fab Tour includes workshops and games for school-children, conferences, aptitude tests, virtual reality experiences, and speed-dating style job interviews,’ Businessweek wrote.
‘President Emmanuel Macron’s government is hoping the campaign will encourage the French back onto the factory floor. “We’re in a sector that is very opposite of sexy,” says Julien Hue, chief executive officer of industrial oil manufacturer Hafa.’
Maybe this is the first steps to a Silicon Valley in Europe?
These are not just ordinary factory jobs, after all. One employer is Groupe Celec, who designs electronic sensors. Another is a robotics engineer.
These are skilled service jobs within the manufacturing industry. Jobs that cannot be easily shipped off to China.
And that’s how the Valley got its start.
But I don’t believe France is trying to recreate a similar tech hub…
History will tell you the French are manufactures, and they like it that way.
As a percentage of economic output (GDP), France has actually seen the influence of their exports increase overtime.
Source: The Global Economy
This is not uncommon among developed nations, mind you. The US has also seen exports make up a greater percentage of GDP overtime.
What’s surprising is how much exports contribute to GDP. More than 30% is massive. Exports in the US, for example, make up just ~12% of GDP.
Source: World Bank
To France’s credit, most of their exports happen to be higher value manufactured goods. Stuff like spacecrafts and pharmaceuticals. They’re not industries that can be easily shipped off to China.
But why funnel the youth into an industry that’ll die anyway?
The French kids are smart to aspire working for the software giants.
These companies, and software in general, are not going away. Neither is manufacturing for that matter, but human labour is fast disappearing from factory floors.
The euro is evil!
If you read last week’s Money Morning piece, then a lot of this will make sense.
Productivity lifted us up off the farms and into the factories. It’ll also push us out of the factories and into the service industry.
This shift is already happening all over the world. Productivity, while slow at the moment, continues to push employment to services…
Source: Bloomberg Businessweek
Why try to fight what’ll occur naturally? Why push kids into factories, when automation and robotics will just push them back out?
Oh, I know why!
Because France and Germany dominate the European Union (EU). They grow fat, while others suffer. It has a lot to do with manufacturing coupled with the euro.
Consider a country like Italy. Much of their output includes machinery and autos, two industries that face intense competition from low wage countries.
While Italy’s total value of exports exceeds that of France, though not Germany, it is extremely difficult for them to move up the manufacturing value chain, which would improve wages and living stands for workers.
Places like Germany and France are far more competitive than Italy when it comes to producing higher value goods like spacecrafts.
Ordinarily, countries in this kind of situation could help themselves with a bit of currency manipulation. But Italy is locked into the euro.
They cannot devaluate their currency to make their goods more competitive than France or Germany.
That means they’ll likely be doomed to play in the low wage manufacturing sandpit.
Consider what Columbia Business School professor Bruce Greenwald said about Italy’s future in 2012…
‘What’s the future for Italy? If you can’t control your exchange rate, you can’t protect yourself against the competitiveness of Germany because they can keep their Deutche Mark from appreciating, so you’re going to have this chronic deflationary problem.
‘You can either adjust to it by changing the competitiveness of Italian business and getting productivity growth to be higher than it is in Germany…Or you can lower real wages in Italy, and that’s not going to be a pleasant process.’
So, locked away in what’s now called the Eurozone, countries like France and Germany produce high valued goods, en masse, at the expense of their fellow Europeans.
But EU or not, France and Germany cannot depend on their manufacturing industries forever.
Productivity has alrfeady pushed out many of France’s auto workers.
Just consider the following example cited by the Telegraph:
‘Outside the car parts factory, a group of burly petanque players laughed and joked as their metal boules clinked in the late afternoon sunshine. It would have been a pleasantly tranquil French scene – except for the improvised bomb that stood ready behind them.
‘Constructed by the players from a row of gas canisters connected together by electric cable, and positioned on top of a high voltage transformer to create maximum effect, the bomb is designed to blow up the long, white building where the men had worked for years – along with millions of euros worth of parts and equipment.
‘It is ready and waiting for the end of the month, they say, if their demand for redundancy money is not met before then.’
Sooner or later productivity will push out the more specialised workers, too. Then, France and Germany will face competition on all sides. And it will be the young bucks who just jumped into the industry that suffer.
If their jobs are not shipped somewhere where wages are lower, robotics and automation will fill the role.
For some reason or another, the French, the Germans, even the Japanese cannot imagine a world where people don’t make stuff. It’s why they continue to funnel their youth into a dead-end industry.
In fact, Germany has been doing this for years…
‘[Manufacturers] also blame strategic decisions made decades ago that encouraged French youth to pursue academic studies,’ Businessweek writes. ‘[W]hile in Germany the government chose to support and promote apprenticeships and professional training.’
Of course, there’s no problem with encouraging trades and technical workers. But imagine if Australia had aggressively incentivised factory workers, particularly auto factory workers a decade ago…
I think you can guess what would have happened.
‘Forty years ago, manual work was something natural and industry was everywhere,’ a disgruntled manufacturing boss told Businessweek. ‘But, bit by bit, people wanted their children to do better than them.’
And what’s wrong with that?
Surely, it’s obvious that moving out of factories, like we moved off the farms, is one of the greatest side effects to productivity.
In recent history, we’ve seen leaps in living standards and a shift from rural to urban areas.
Source: Bloomberg Businessweek
Productivity not only helps us produce more stuff and do it cheaply, generations today can create, follow their dreams and start new businesses because they’re not locked to a factory floor.
And those newly created businesses (predominately service businesses) generate jobs, add value to customers and grow income for workers.
No? We don’t want any of this? Life is better in the factories?
Macron seems to think so.
Putting it all together…
What does this — a shift to local services and production — mean for investors?
I’ll reiterate what I wrote last week…
‘Look for locally dominant companies that are immune to automation and global competition. That’ll narrow down the list a little (autos: out, apparel: out, home appliances: out).
‘You also want to look for locally dominant companies that have wonderful management in place. That’s because productivity is largely a managerial choice, rather than something that happens organically.
‘Chances are, though, if you find a locally dominant company, they’ll already have a great group of managers, hence their locally dominant position.
‘Lastly, you want to look at locally dominant companies with great management that you think are fairly priced.
‘This last one is probably the hardest one to stick to. It’s easy to get exciting and overoptimistic, especially when you find a great business with good management.
‘It’s also worth pointing out that a ‘fair price’ doesn’t necessarily mean a low PE. It means a price which is sensible for the level of growth you believe the company can sustain.’
And clearly, as growth investors, you want as many kids out of factories as possible.
That way you have more service and software opportunities to choose from, whether that’s here, in France or wherever.
Editor, Money Morning
PS: This push to a slow grinding industry also has some wider economic implications. Why is it that Japan, Germany and France struggle to grow?
Source: Trading Economics
All three can barely keep economic growth at 1%, hence why all three have extremely low interest rates.
Central banks are trying to ignite growth, yet interest rate cuts (lowering the price of money) won’t do it, because its not the price of money that’s the problem.
The problem is a lack of productivity, and a focus on an industry which needs less human labour each year.
This could all mean wonderful things for a shiny yellow metal, which is climbing in price as you read this.
My colleague, Greg Canavan has a few more insights on this angle. You can check out his research, here.