On wealth, wealth creation and Steve Jobs

   By the time Steve Jobs died at the age of 56, after a career spanning more than three decades, he had made Apple into one of the two most valuable companies in the world with a market value of about $350 billion. How much is $350 billion? Think of all the treasures brought to light recently at the Sree Padmanabhaswamy temple in Thiruvananthapuram and multiply it by 17 times!

Steve Jobs was exceptionally talented with many achievements to his credit. A tribute in the Wall Street Journal noted that “a nearly unbroken string of successful products like the iPod, iPhone and iPad changed the PC, electronics and digital-media industries” and went on to add: “Mr. Jobs turned Apple into the largest retailer of music and helped popularize computer-animated films as the financier and CEO of Pixar Animation Studios, which he later sold to Walt Disney Co. He was a key figure in changing the way people used the Internet and how they listened to music, watched TV shows and movies, and read books, disrupting industries in the process.” In short, Steve Jobs was a genius and a revolutionary. But, in contrast to most revolutionaries of the political variety, he actually changed our lives for the better.

Shrouded in these splendid accomplishments is also the fact that Steve Jobs was an outstanding wealth creator. In the fiscal year ending September 2010, Apple reported a top line of $65 billion and a net income of nearly $15 billion after paying $4.5 billion as income tax. This year, the top line is likely to nudge $100 billion even as profits exceed $23 billion. And to think that it all began in a garage!

Not surprisingly then, the Apple story offers critical insight into how wealth is created and what drives creators of wealth. Wealth creation is essentially a function of two factors, infrastructure and incentives. The role of infrastructure, both physical and human, is fairly well understood. Unfortunately, due importance is not given to the part played by incentives. Here’s why it should not be ignored.

The evidence of recent years shows that wealth creation is largely a private sector activity. Governments have a crucial role to play in providing the infrastructure but in terms of its own capacity to create wealth, governments all over the world have been a failure. Indeed, the reality is that excessive government involvement and interference tends to destroy, rather than create, wealth. Once we acknowledge that only the private sector creates wealth on a sustainable basis, we have to put in place adequate incentives for them to do so. This process necessarily begins with greater economic freedom, with respect for the rights of the entrepreneurial class to conduct their enterprise in ways which allow them to pursue efficiency and thereby maximise returns on their investment.

Steve Jobs was hailed around the world as a hero. And yet, look closely at the Apple model and it is crystal clear that without the benefits of outsourced manufacturing, Apple could not have succeeded in delivering its outstandingly innovative products at such value-for-money prices. According to unofficial estimates, Apple currently employs about 27,000 people in America. In contrast, it’s been pointed out that Foxconn (a company that does contract manufacturing for Apple) employs about 400,000 people at a single factory in Shenzhen dedicated exclusively to Apple’s products.

Isn’t that four hundred thousand jobs shipped to China? Isn’t it all a colossal loss to America?

Actually, the math is a little more complicated. To begin with, the jobs that do get shipped out are mostly the low-paying ones. A 2006 study commissioned by the US International Trade Commission estimates that Apples iPod supported twice as many offshore jobs as compared to the US. However, the total wages paid in the US were twice those paid abroad.

And then, in simple terms, how much labour you employ depends on demand for your products and the productivity of labour. Demand, in turn, is always sensitive to price. Thanks to gains from lower manufacturing cost, Apple is able to price its products competitively and offer better value to customers. A lot more people around the world find it worthwhile to buy these products; we know there’s a stampede every time a new Apple product is launched. In contrast, if Apple had remained in America on considerations of patriotism, its products would have cost more, fewer people would have bought it, and the company would have ended up employing far fewer to cater to the much lower demand. Apple, then, would have become yet another niche player, surviving on high margins and resigned to low volumes. (Here’s an interesting sidelight: China has now emerged as the second largest market for Apple after the US).

Remarkably, Apple was free to stick to its strategy even as unemployment levels in the US soared to historic highs in recent times. Indeed, the Apple story could only have happened in America because this is one country where economic freedom is still zealously protected and where businessmen can relentlessly pursue efficiency even in the face of short term conflicts with national objectives. Of course, over the longer term, the country gains far more than what it loses initially—from all the wealth created, the taxes paid, the quality employment created, the impetus given to higher skills—as the example of Apple proves so conclusively.

Interestingly, the economic argument in favour of outsourcing is identical to the logic that propelled the use of machines around the time of the industrial revolution. When machines were first introduced, the immediate impact was social disruption. But over a few short decades, it transformed a small country like Britain into the leading world superpower. More recently, it is this same logic that’s been driving computerisation. Once again, there was initial displacement of labour, but within a short span, the resultant efficiency gains have far outweighed the costs.

In these simple thoughts lie a hint why the US continues to be the most advanced and prosperous country in the world. In countries less committed to free enterprise, governments have a tendency to err on the side of caution. They use their discretionary powers to arrest the tide of new ideas, advanced technologies, or more efficient processes, all because they are deemed to be socially disruptive. They end up slowing down the march of progress.

Finally, one of the more eloquent tributes to Steve Jobs came from President Barack Obama. A statement released by the White House said, “…he transformed our lives, redefined entire industries, and achieved one of the rarest feats in human history: he changed the way each of us sees the world.” The irony in these words went largely unnoticed. In truth, President Obama has consistently opposed outsourcing as being inimical to the interests of the American people. From the evidence, it’s clear he’s got his facts wrong.

By V.P. Nandakumar, Chairman, Manappuram Group