Friday, November 30, 2012

'Fiscal Cliff' and what it would mean to the United States and the economy

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Mr. China Comes to America


For decades, every trend in manufacturing favored the developing world and worked against the United States. But new tools that greatly speed up development from idea to finished product encourage start-up companies to locate here, not in Asia. Could global trade winds finally be blowing toward America again?


David Høgsholt

Near the end of this year’s second presidential debate, Candy Crowley of CNN pointed out that iPads, iPhones, and other globally sought-after Apple products are all made in China. What would it take, she asked both Mitt Romney and Barack Obama, to “convince a great American company to bring that manufacturing back here?

I listened to this question with special interest, since I was following the debate, via hotel-room TV, from the Shenzhen manufacturing zone of southern China, where many of those same iPads and iPhones are made. For the few days before the debate, I’d been revisiting PCH International, an outsourcing company I’d first written about for this magazine in 2007, in “China Makes, the World Takes.” The company’s revenues have increased more than sevenfold since then and its workforce has grown almost as fast, despite the years of global recession. This is testament both to its own success and to the nonstop surge of outsourcing contracts to China.

The day after the debate, I walked through the famous Foxconn complex in the Longhua district of Shenzhen, where some 230,000 Chinese workers, mainly between the ages of 18 and 25, turn out products sold under international brand names, from Apple and Dell to Nintendo and Sony. Another Foxconn facility not far away employs another 200,000 people; throughout China the company’s workforce numbers 1.3 million. On previous attempts to get in over the years, I had never made it past Foxconn’s front gate—not surprising given the company’s policy of stiff-arming most foreign and domestic reporters. But a new PR team at Foxconn had apparently decided that closed-door secretiveness was making the company look even worse than it otherwise would. (If only this team were in charge of Chinese government policy—regarding the press, the Internet, letting people into and out of the country, and so much more.) Immediately after hearing the allusion to Chinese-made products on TV, I e-mailed an official at Foxconn and said that so prominent a mention in American politics would be a great news peg for a visit. I was fully expecting another turndown, but to my surprise, the company agreed. The next morning, I went to the factory and was told I could roam around and take pictures of anything I wanted, as long as I did not show or mention any of the brand-name products coming off its assembly lines.

What I saw at these Chinese sites was surprisingly different from what I’d seen on previous factory tours, reflecting the political, economic, technological, and especially social pressures that are roiling China now. In conjunction with significant changes in the American business and technological landscape that I recently saw in San Francisco, these changes portend better possibilities for American manufacturers and American job growth than at any other time since Rust Belt desolation and the hollowing-out of the American working class came to seem the grim inevitabilities of the globalized industrial age.

For the first time in memory, I’ve heard “product people” sound optimistic about hardware projects they want to launch and facilities they want to build not just in Asia but also in the United States. When I visited factories in the upper Midwest for magazine stories in the early 1980s, “manufacturing in America” was already becoming synonymous with “Rust Belt” and “sunset industry.” Ambitious, well-educated people who had a choice were already headed for cleaner, faster-growing possibilities—in consulting, finance, software, biotech, anything but things. At the start of the ’80s, about one American worker in five had a job in the manufacturing sector. Now it’s about one in 10.

Many factory managers say openly that they prefer women: women, they say, learn new jobs faster, handle high-precision work better, and pose fewer disciplinary challenges.

Whether you call the business history of the past 15 years the age of hedge funds, the age of Google (or its rival Facebook, or its other rival Amazon, or its other rival Apple), the age of Walmart, or even the cautionary age of Lehman Brothers and Countrywide, in no case would you call it the age of American manufacturing. Manufacturing’s share of the total American economy has fallen by about the same amount as its workforce share: it went from about 20 percent in the early 1980s to just over 10 percent now. For comparison, manufacturing accounts for some 30 percent of China’s total economy. Still, the U.S. economy is so much larger that our manufacturing sector, even in its battered condition, remains the largest in the world.

I’m used to hearing excitement from people at American infotech companies—or from biotech innovators, or people in other enterprises who believe the future is on their side. I’m used to hearing it in China. I’ve gravitated to tech topics and to fast-growing parts of the world because I like hearing from people with big plans and dreams. And this year, for the first time in decades, I have been hearing upbeat accounts from business officials and entrepreneurs engaged in American manufacturing.

The heart of their argument is this: Through most of post–World War II history, the forces of globalization have made it harder and harder to keep manufacturing jobs in the United States. But the latest wave of technological innovation, communications systems, and production tools may now make it easier—especially to bring new products to market faster than the competition by designing, refining, and making them in the United States. At just the same time, social and economic changes in China are making the outsourcing business ever costlier and trickier for all but the most experienced firms.

For Americans, the most important factor is the emergence of new tools that address an old problem. The old problem is the cost, delay, and inefficiency of converting an idea into a product. Say you have an idea for—anything. (For me, the list would start with silent leaf blowers, which I’d give to all my neighbors as gifts.) Before you can earn the first dollar from the first customer, you have to decide whether the product can be built, at what cost, and how fast, so you can beat anyone else with the same idea.
For the first time in memory, I’ve heard “product people” sound optimistic about hardware projects they want to launch and facilities they want to build not just in Asia but also in the United States.

The need to reduce costs has driven much of this work outside the United States. The possibility of saving time may bring some of it back. For instance, at Lime Lab, a small industrial-design firm in San Francisco, a design engineer named Adam Mack told me that technologies including 3‑D printing were revolutionizing the process of deciding what to build and where. Three-dimensional printing refers to computerized molding or related systems that can produce tangible objects in a matter of minutes or a few hours, on the basis of designs created on a screen. This dramatically speeds up the process of creating a prototype and then trying out variations and working out flaws.

“Before, you could sit around and talk about something you wanted to make,” Mack said. “Now you can have a prototype of an injection-molded part in your hand the next day, and confer with factory managers about how much it would cost to build.” By making manufacturing generally more attractive and feasible, new tools will—so I heard many times—lead to more good jobs in America than we would have thought possible only a few years ago.

“A revolution is coming to the creation of things, comparable to the Internet’s effect on the creation and dissemination of ideas,” Linus Chung told me at Lime Lab, in San Francisco. (Chris Anderson, formerly of Wired, has recently advanced a similar case in his book Makers.) Chung is an American-born, Stanford-trained manager who now works for PCH International and is based in Shenzhen. This past June, PCH bought Lime Lab as part of an expansion into America to encourage more start-ups and manufacturing work here. “There is a whole new interest in hardware in Silicon Valley,” said Phil Baker, a product-development expert who has worked with Apple and other companies since the 1970s. “I’ve never seen a more exciting time in the hardware business.”

Why “exciting”? Let’s consider the changes affecting China, and America, and manufacturers everywhere.

The Big Picture

For the past 30 years, all of the largest forces have pushed in favor of China’s manufacturing expansion, from very low labor costs and a deliberate policy of welcoming foreign investment, to ever faster and cheaper global cargo-shipment networks, to a deliberately undervalued Chinese currency. Within the past two years, nearly all of those advantages have become more complicated. (In his accompanying article for this issue, Charles Fishman explains some of the large forces pushing in favor of America’s manufacturing renewal.) In China, wages are rising, workers are becoming choosier, public resistance to environmental devastation is growing, and the Chinese “investment led” model is showing strain.

That model has involved a kind of hyper-Keynesianism far beyond what the United States experienced even during the most government-run periods of the New Deal. China has created jobs by building factories, highways, railroads, and dams—and airports where there are no cities, and cities where there are no people. “Americans are used to thinking of ‘savings’ and ‘investment’ as absolute goods, because we’ve done too little” of both, Michael Pettis, of the Guanghua School of Business in Beijing, told me. “But there is such a thing as too much savings and investment and infrastructure, and too little consumption, all of which we see in China.” If the American public challenge is “reinvestment” of all varieties—in education, in infrastructure, in a sense of community, in everything but houses—the Chinese counterpart is a need for a comprehensive rebalancing. Indeed, Pettis’s forthcoming book on the Chinese economy is called The Great Rebalancing. Reliance on exports needs to come into better balance with domestic consumption; economic growth with environmental sustainability; political liberties with the new level of economic prosperity; and on down a long list.

Some observers inside and outside China think that the strains are too great and the system too rigid to allow the necessary rebalancing in time for the party to maintain political control. For instance, Minxin Pei, a native of Shanghai who now teaches at Claremont McKenna College in California, has been warning for more than a decade that the economic, social, and political imbalances of the Chinese system would reach a breaking point just about now—and that Communist rule would have to give way to a multiparty system. Many others contend that, on the contrary, the Communist leaders will manage somehow to address each of today’s problems just before any one becomes an outright emergency, as they have done time and again for 30 years. Whichever view proves correct, the relevant point for Americans is a convergence of trends that make operations here more attractive and feasible, just as the cost and friction of operating in China are increasing.

The Factory-Level View, From the World’s Biggest Factory

I had a more vivid sense of some of these challenges after this latest look at Chinese factories—especially at Foxconn, the world’s largest electronics maker. You learn a lot about China from its factories, of which I have now visited nearly 200—just as you would have learned a lot about the England of Charles Dickens and Friedrich Engels by seeing its factories, and the America of Theodore Dreiser and Upton Sinclair. Factories are not the only arenas for high-speed social transformation in China: its farms, from which working-age people are fleeing, and its cities, to which millions of people migrate each year, are also the settings for individual dramas and collective adjustment at a rate and on a scale that the world has never previously seen. But on this trip I spent time in factories. And what I saw underscored the ways in which the tumultuous transformation of China is complicating life for its outsourcers and exporters.

At the Foxconn plant I visited, I know firsthand only about conditions I could observe in four hours of walking around the more than one-mile-square “campus” and being taken into selected dormitories, cafeterias, training rooms, and assembly-line areas by members of the newly accommodating Foxconn PR team. One part of the visit had the unmistakable note of the staged: In the sole dormitory we entered, whose occupants were all on their shifts at work, every towel and pillow in the four-bunk room I saw was perfectly aligned. The clothes were on hangers in precise order, and there was not a scrap of extra paper or debris on desks, dressers, the floor, or anywhere else. I could only assume that this room had been specially cleaned up; other parts of the campus resembled most other parts of China in being much more casually groomed. I’m acutely aware of all the things I did not see: conditions at night, the dorms where not four but six or eight workers live in each room, assembly lines where hazardous materials might be used or where the pace is exceptionally fast. Still, what I was allowed to see was more than a tiny keyhole glimpse—and my movement around the campus was less rather than more controlled than I’d been accustomed to on other factory visits. The scale of buzz and activity was so vast—cafeterias with thousands of people getting lunch, bus and shuttle stops with hundreds of workers waiting for a ride, coffee shops and convenience stores crowded with Foxconn patrons—that I doubted that every detail could have been orchestrated overnight. Plus, there were products to ship.

At most other big Chinese factories I’d seen, people walked around all day in uniforms—usually gray or blue coveralls for men, light-colored smocks for women. At Foxconn, people wore anti-static jackets and caps when at work on the assembly lines and shirts or vests with the Foxconn logo when in offices. But when walking to the cafeteria, going to the shops, or commuting to normal off-site apartments, where three-quarters of the workforce lives, people were dressed in the blue jeans or cargo shorts and fake Polo or NBA shirts of a normal Chinese crowd. On the lines I did see, where printed circuit boards and other electronic components were being put together in a process that combined the use of large, fancy, expensive machinery with detailed handwork, the pace and supervision seemed no looser or tighter than I’d seen at comparable sites elsewhere in China. If you are looking for the most-gruesome factory conditions in China, you don’t go to a multinational giant like Foxconn, which has to deal with Western customers and pay at least some attention to appearances and laws. You go instead to the small, ramshackle, often unregulated workshops, often away from the big cities, where conditions are as inefficient and sometimes as unsafe as they were when China was just beginning to industrialize.

Although I had heard about the Foxconn “suicide nets,” I was still taken aback to see them. Most dormitories and factory buildings on the site are five or six stories tall. Outside every upper-story window, open balcony, and other spot from which someone might plunge, the company has installed netting about 20 feet above ground level. The founder and CEO, Terry Gou, ordered the nets installed after a spate of jumping suicides in 2010; many of the upper windows also now have latches that keep them from opening fully, and some balconies have a fine mesh of jump-prevention wire. The idea, I was told by a Foxconn spokesman, was that while some suicide attempts reflect deep mental illness or depression, others are impulsive and half-thought-through, so anything that even slightly slows an attempt might deter a suicide altogether. (The peak suicide rate for Foxconn came in 2010, when it reported a total of 12 “completed” suicides at all its Chinese plants. On a per capita basis, this was below the suicide rate for China as a whole, but everyone at Foxconn recognized it as an emergency.)

But to me the most significant aspect of the visit—one my hosts were so inured to that they barely mentioned it—was the sight of the enormous throngs at Foxconn’s recruiting and new-worker training sites on campus. In a typical week, the Shenzhen Longhua facility will take on about 2,000 new employees for its own factories, and recruit and train many more for other Foxconn sites. It brings in so many people because so many keep heading out; the annual turnover rate at the plant is about 60 percent—high but not astounding by Chinese standards.
A convergence of trends make operations in America more attractive and feasible, just as the cost and friction of operating in China are increasing.
You can draw many conclusions from this rate of churn. Anita Chan, an expert on Chinese labor conditions at the University of Technology, Sydney, said the turnover indicated some brutal realities of Chinese factory life, in ways that reflected both well and poorly on Foxconn itself. “Why do workers still go to Foxconn despite its bad reputation?” she asked, in an interview with The China Story, an Australian online journal. “I believe that it is because they know that Foxconn pays wages on time. While this may appear to be a crude view, workers at Foxconn often come from smaller companies where they have been cheated, are underpaid, or even owed wages. In this context, they know that Foxconn is synonymous with an assured income.” But to earn more money—or even enough money to stay ahead of fast-rising food and housing costs—the workers find that they have to put in overtime. According to Chan, “They willingly comply until they get totally exhausted and cannot tolerate the long work hours anymore. Their solution then is to quit.” Some go back to Foxconn; some go, often with a group of friends, to another factory in hopes of a better deal; some find retail jobs; some move back home or to other parts of the country. All in all, they change the labor dynamics of China’s vast factory zone, steadily increasing the cost and reducing the predictability of doing business there.

I spoke about workforce churn with Foxconn’s Louis Woo, whom I had met years earlier in Shanghai. Woo and Terry Gou had become friends in the early 1990s, when Woo was the general manager of Apple Taiwan. Four years ago, Woo accepted Gou’s offer to be Foxconn’s chief spokesman, and moved to Shenzhen. Woo told me that Gou, who turned 62 on the day of my visit, was at this stage of life increasingly conscious of the social as well as the purely industrial legacy of his work.

Terry Gou has done as much as anyone since Deng Xiaoping to shape life in China, or at least in the factory-dense southern part of the country. Although Gou is Taiwanese and Foxconn’s headquarters are in Taiwan, the company is the largest private employer in mainland China. According to Louis Woo, Gou is aware of the example of Henry Ford. Not the Ford of the assembly line and the mass-marketed Model T, whose achievements Gou has already matched, nor the elderly Henry Ford of the anti-Semitic conspiracy theories. Rather, the “welfare capitalist” Ford, who in 1914 announced a new $5 daily wage, roughly double the prevailing rate. Ford did this to reduce then-extreme turnover on his assembly lines, which was even more rapid than Foxconn’s current level, and to hasten the creation of a middle class capable of buying his cars.

Foxconn has raised basic wages four times in the past three years, in some areas doubling the starting-level pay. A typical Foxconn assembly-line worker spends 50 hours a week on the job—40 hours at base rates, and 10 hours of overtime at a time-and-a-half rate. For that, a worker typically gets about $400 a month, or about $2 an hour. During production surges, workers may put in another 10 hours of weekend overtime, for which they get double-rate pay. Six years ago, typical monthly pay in Shenzhen factories I visited ranged from $115 to $155 (the difference partly reflects the higher value of the Chinese renminbi today). Woo said that he expected the trend of rising wages to continue, and that Gou was mindful of the centennial of Henry Ford’s $5‑wage announcement, in 2014. This would reflect a calculation of long-term self-interest comparable to Ford’s: if Gou can accelerate the growth of China’s middle class, a large company like his will share in the returns. “If we have a new-generation middle class, that will fuel the need for products like those we manufacture,” Woo said.

A living wage for the laboring class would be one more sign of progress for China, as it was for the America of Ford’s era. But it would also be part of the process that is reducing China’s advantage as a site of cheap labor—and a sign of other challenges facing Chinese employers.

Two more things about the Foxconn workers surprised me: that so many were male, and that nearly all were kids. By kids I don’t mean the 14-year-old “apprentices” a different Foxconn plant, in the northern city of Yantai, was found to have hired earlier this year. (The company apologized to the youths and their families and, according to Woo, fired one of the managers involved and disciplined a total of nine.) I mean that at factories I’d previously seen across China, the workers looked and acted like country people weathered by their rough upbringing. Most of the Foxconn employees looked like they could have come from a junior college.

“Even a few years ago, the typical worker was a farmer,” Louis Woo told me. “He or she already had a family back in the village. They came, they earned their money, and when they were able to buy some pigs or fix up their house, they went home.” The standard workers today, he said, are those people’s children. “They’ve never farmed. They don’t want to, and they don’t have to, thanks to the hard work of their parents, who were the first generation of migrant workers. They’re coming here as part of entering a bigger world.” Chinese factory bosses face the same challenge in dealing with them that Chinese political bosses face with a better-informed, more intellectually independent populace. The “shut up and look at your paycheck” approach that has worked for people who remember China’s backwardness may not work for their children.

Promising new tools are making it possible for American innovators to rapidly convert their ideas into products—and jobs.

I noted a parallel change at some PCH factories. On my previous visit, four years earlier, virtually all of the assembly-line workers had been female. This time, all but one of the PCH factories I visited was staffed predominantly by young men. I asked the supervisor of the one all-female line why there were no men on it. “These are the more responsible jobs,” she said. (The women were handling online orders from American customers for a famous electronics brand.) She was partly joking, but many factory managers say openly that they prefer women for any job not requiring unusual strength. The prevailing view is that women learn new jobs faster, handle high-precision work better, and pose fewer disciplinary challenges. (I am just telling you what they say.) But as the modernizing Chinese economy creates more options for women, fewer of them are choosing factory work. That leaves men.

Among the consequences is greater fractiousness in the typical Chinese factory force. In September, a Foxconn plant in Shanxi province was temporarily closed because of a late-night riot that eventually involved several thousand workers. According to Louis Woo, the riot was touched off not by worker-management tensions but by the Chinese equivalent of an ethnic-gang war in an American prison, as workers from one province took the side of a colleague who was fighting a worker from somewhere else. This is the sort of thing that happens more frequently with more men in the workforce.

Ten years ago, Chinese factory life stood comparison to the “dark Satanic Mills” of William Blake’s England in the early 1800s. Five years ago, I was struck by the parallels with accounts of Chicago packinghouse life in the 1890s. Now I see a counterpart to the American 1920s, with the first sizable generation of moderne post-rural life. In September, after turnover surged at many Chinese factories, PCH commissioned a nongovernmental organization to do a survey of worker attitudes. I sat in on a focus group from the factory discussing the findings. It’s not the long hours we mind, most of the workers said; according to the survey, fully 80 percent welcomed an average of two or three hours of overtime a day, because of the extra pay that meant. But we still want to “have a life,” they told the survey takers. The No. 1 item on their wish list was more organized social activities on the weekends, and singles nights and mixers for all the unaccompanied young men.

China’s economic and social maturing, tumultuous or smooth as it may turn out to be, will certainly affect the world division of labor. Some very low-skill jobs may move to very low-wage economies, such as Burma, India, and parts of Africa; some will move to inland China; some will be automated or done by robots; some will stay in China, but at higher costs. But some of the next round of jobs that might have moved to China will be more attractive for producers to keep in the United States.

The New Smiley Curve

Above: Woodworking and bookbinding equipment at the San Francisco factory of DODOcase, with founders Patrick Buckley and Craig Dalton pictured in the middle (David Høgsholt)

“Geography is history,” I was told in Shenzhen by Liam Casey, the Irish-born entrepreneur, now in his mid-40s, who founded PCH 16 years ago. (The name is a sentimental allusion to the Pacific Coast Highway in Southern California, where Casey had been living until his failure to get a green card forced him to leave. I’ll say it in every article: America’s greatest strategic advantage is its openness to an outsize share of the world’s talent, and one of its greatest self-inflicted weaknesses is needlessly turning that talent away.) Casey—whose company is headquartered in Ireland and employs some 4,000 people, mainly in China, and this year will handle electronic goods with a retail value of some $8 billion—still lives in the Sheraton Four Points Hotel in Shenzhen, as he did when I met him in 2006. Everywhere he goes, he takes three iPhones with him—one on a Chinese network, one Irish, one American—and I’ve seen him use all three at once. I am several inches taller than him, but I practically needed to run to keep up with his superfast walking pace. I took this as his way of reminding himself and everyone around him that modern business is all about speed.

Here is what Casey meant by “geography is history,” and how it affects the prospects for U.S. manufacturing:

For decades, the process of technology-enhanced globalization has been pushing manufacturing work steadily from richer countries to poorer ones. Casey has had a firsthand view of this transition. As he explained to me when I first met him, “supply chain” interactions like those between Apple and Foxconn, or other famous Western brand names and the tiny Chinese firms Casey lined up as subcontractors, brought benefits to all sides, but in a very particular way. Customers in rich countries got the benefit of cheaper products—an iPhone for $300, for instance, rather than $2,000 if it had been made at U.S. wages. Factory workers in China and elsewhere got their pay.

But the companies involved benefited very unevenly, according to what Casey has named the “smiley curve.” This idea has become so familiar in China that the government alludes to it in the current Five Year Plan. For anyone not familiar with it, the concept refers to the sequential stages in manufacturing a product, arrayed from left to right along a U‑shaped smile. They start on the left with the corporate brand (for instance, Apple), then the product idea (iPhone), then the industrial design, and on through the stages of manufacturing at the bottom of the curve—then shipment, retail, and service going up the other side. The profitability of each stage matches its elevation on the curve—which is why Chinese manufacturers, down at the bottom of the curve, get the smallest share. Globalization has thus far enriched Westerners on the high parts of the smiley curve—designers, shareholders, advertisers, other mainly white-collar professions—but has left out Western manufacturing workers.

A crucial and underappreciated step in this process, Casey and others explain, is the transition from the idea for a product to its physical incarnation, which can then be made and sold. There’s a direct analogy to the world of publishing. Even 10 years ago, having an idea for a book, a song, a political exposé or commentary, got you only so far. To spread your work or ideas beyond your immediate circle of friends required the involvement of a publishing organization. Unless you could persuade an editor, a broadcaster, or a publishing house to promulgate your views, few people would ever hear them. Writing was hard enough; “getting published” could be worse. But now, blogging software and social media of all sorts have eliminated that barrier. Publishing organizations can still provide authority and a megaphone. But more ideas from more people are now being heard by more people.

How does this apply to manufacturing? Blogging software and related technologies have made it easier for entrepreneurs in the realm of ideas to expose their products to a worldwide market test. Three-dimensional printing and related technologies are making it easier for entrepreneurs interested in making physical goods to expose their products to the worldwide market. America has more than its fair share of such potential innovators, thanks to immigration, our still-strong university and public research centers, and the financial and cultural underpinning of a start-up culture. The terrain is shifting in a way that should draw more entrepreneurs to manufacturing and let more of their ideas succeed. This should in turn foster more manufacturing work within the United States than was feasible a few years ago. Companies with the right connections to foreign suppliers and foreign markets will grow even faster.

But rather than simply shifting manufacturing work from rich countries to poorer ones, this latest technological wave should allow all regions to grow. “As business has become faster and more globally connected, that’s been good for American companies overall but bad for America’s low-skilled manufacturers,” Phil Baker, the designer for Apple and other companies, told me. “Now speed and connections allow start-ups to compete with much larger companies, and often beat them.”

Made in San Francisco

“I am betting heavily on San Francisco, for its energy and creativity,” Liam Casey told me in China. He didn’t quote Jane Jacobs, but he went on to present a theory that could have come from her book The Death and Life of Great American Cities: national economies are really a collection of vibrant city economies, and cities thrive when they foster a diverse ecosystem of small enterprises whose growth is mutually reinforcing. He felt that his adopted home of Shenzhen was the engine and the success model for China. “When I came here, Shenzhen was a place to make cheap products,” he said. “Then it became a place to make products cheaply. Now, for the work we do, it’s the only place to make certain products, because of the supply base, the logistics, and the workforce.” (He said that my article about his company, “China Makes, the World Takes,” could, five years later, be redone as “Shenzhen Makes, China Takes.”) San Francisco is his model for how the new manufacturing economy would spread in America. When we spoke, he had just leased a 30,000-square-foot building off I‑280, the former home of the San Francisco Bay Guardian, and announced plans to establish major PCH operations there. “We look forward to fostering the growing community of makers in the Bay Area who seek to have a massive impact on the world through their dedication to design, brand building, and consumer experiences,” he said in a statement announcing the deal.

To put his ambitions in context, let’s consider an existing effort to boost the “community of makers” in San Francisco, a coalition called SFMade. I use it as an example of undertakings on behalf of small manufacturing in several North American cities. This example is different from Casey’s plans in its scale and its level of technology. But it is similar in its emphasis on speed as the key to manufacturing success, and its ambition to help large enterprises grow from small start-up roots.

The Bay Area might seem to display all of America’s imbalances, intensified. Tech and venture-capital billionaires on the Peninsula, hipsters in the East Bay and the city, rich naturalists in Marin, and ordinary families priced out of anything not a distant commute away. Of course, this is a caricature, but it is one that matches the prevailing rest-of-the-world view of a hollowed-out and unequal modern United States.

Into the standard American urban mix—high-end tech and finance, low-end service or tourist work, the professional class from universities and hospital complexes—has come an unlikely renaissance of small-scale manufacturing in the past five years. There is no point in comparing it with anything in China. The 400 manufacturing firms that have factories in San Francisco and are part of the SFMade coalition employ a total of just over 3,000 people, equivalent to a busy week’s intake at Foxconn’s Longhua campus. Apart from the 100-employee LeeMAH electronics firm, founded by an immigrant from China, their products are mainly medium- and low-tech: apparel, high-end food and drink, bags and accessories. This pattern will be familiar to anyone who has followed the growth of light manufacturing in Brooklyn. In San Francisco, more than 120 of the firms were founded during the past three years of overall economic distress; their employment base grew by 10.5 percent last year and 12.5 percent this year; and they have applied in their modest way the principle of drawing on a local base of skilled workers for very fast response to global consumer demand.

“Most of the companies that are here would argue that, while they are not super-duper high-tech, they are all absolutely connected to the design prowess and skilled craftworks in the city,” Kate Sofis, the executive director of SFMade, told me. The most obvious example is apparel. Like New York, Chicago, Cleveland, and Los Angeles in their periods of fastest manufacturing expansion, San Francisco has attracted a large and diverse immigrant population. “The Latino and Asian communities have a high level of apparel skills,” Sofis said. “A young designer might have high design skills but not the technical ability to realize it.” Going to Asia for production would be too slow; finding the skills elsewhere in the U.S. would be too hard. Carrying out all operations locally has allowed many SFMade companies to offer quick “mass customization”: Rather than buying off the rack, a customer can choose personalized clothing, accessories, furnishings, or furniture, mainly online. Then small factories produce the goods locally, faster than they could come from overseas. I spoke with Sofis just before she headed to a conference of the Urban Manufacturing Alliance, which promotes manufacturing in 15 other cites, from Boston and New York to Detroit and Atlanta.

I first learned of SFMade two years ago, via DODOcase, a member that is one of the city’s start-up success stories. I had bought one of the company’s iPad covers as soon as it came onto the market, because I was drawn to its distinctive retro-futuristic design. Inside, the case contains an iPad or other electronic reader. Outside, it looks like an antique leather-bound book. A bamboo frame holds the electronic tablet in place and also strangely recalls the look of the page edges of a physical book.

“Back in 2010, we saw an opportunity present itself, if we could move quickly enough,” Craig Dalton, a veteran of tech start-ups who is now in his early 40s, told me in explaining the company’s history. I liked that he said “back in 2010” so matter-of-factly. The opportunity that 2010 brought was the launch of the first iPad. Liam Casey got his start making accessories for the popular electronic devices of 15 years ago. Dalton and his business partner, Patrick Buckley, did not know Casey’s story, but they saw a parallel chance.

To “design the product, and launch, and fulfill orders within one month—that meant that outsourcing to China was not ever a feasible option,” says Craig Dalton, a veteran of tech start-ups.
“The Kindle and other e-readers were already getting noticed,” Dalton told me. “The writing was on the wall, you could say, that there was going to be this shift from ink and paper to electronics as the way people consumed information. We felt there was an opportunity to connect people to the physical experience of picking up a book, and to the soon-to-be-dying craft of bookbinding.” Buckley, who is in his early 30s, had trained as a mechanical engineer at MIT and worked in laser physics at Lawrence Livermore National Laboratory, and had grown up with several relatives who worked in New York’s publishing industry.

He and Dalton felt they had to act fast, he told me, to get their product noticed in a field that was sure to fill up quickly. “We knew it was a very small window, and we needed to have a finished product quickly,” he said. “To figure out all the things we needed to do, and design the product, and launch, and fulfill orders within one month—that meant that outsourcing to China was not ever a feasible option.”

When he asked friends at Levi’s, Buckley said, they told him that nine months would be a reasonable timeline to take a product from concept to delivery. “We had to do it in a couple of weeks. Nimbleness like this would be impossible with a longer supply chain.” The partners drew on local woodworking and bookbinding talent. “The resources are still here, much atrophied, but in pockets,” Buckley said. San Francisco has a long tradition of fine printing. Dalton and Buckley bought large, heavy bindery machines from printing houses and brought them into their factory.

DODOcase is a niche success, to be sure. But it has grown to 30-plus employees in two years, with 30 percent of its sales outside the United States, and its founders have broad ambitions. “If you look at brands like Levi’s and Gap and North Face that had their beginnings here in S.F., you see that a small boutique idea can grow into a global brand,” Buckley said. “It is very hard to tell ahead of time which ones will make it, but we hope to become a lifestyle brand with the recognition and scale of a Gap.”

I have learned to imagine the possibility of rapid growth. I first interviewed the founders of Google when the company had 20 employees, versus today’s 30,000, and visited Apple three years after its founding, when it had a few hundred employees rather than today’s 60,000. Big things start small.

Mr. China Comes to America

The medium-tech start-ups of SFMade (and its counterparts) are working out a strategy that combines quick response, local skills, and a global marketplace to foster manufacturing in U.S. cities. Liam Casey’s new investments in the Bay Area are designed to apply a similar model for companies several steps up the technology ladder. The purchase of Lime Lab and the opening of what he sees as an academy of high-speed manufacturing in the city could combine to bring to U.S.-based entrepreneurs, inventors, designers, and smaller companies some of the advantages now unique to Apple and a handful of other globally integrated firms—and with a greater probability than Apple’s of creating jobs in the United States.

The heart of those advantages is, again, connecting the sequential stages of the manufacturing cycle as a whole. The process naturally starts with the idea for a product. Whether the idea is practical depends crucially on how it is realized in industrial design; whether that design makes for an efficient or impractical factory experience depends on how well it is matched to process-engineering on the shop floor. Even after production begins, the design is often refined and the manufacturing process rejiggered based on real-world experience.

The closer this linkage, the faster and more efficiently an idea can be converted to tangible, marketable reality. The more evolved and responsive the feedback loop, the more precisely an organization will be able to distinguish promising projects from impractical ones. Apple has this capacity; it has teams on more or less permanent assignment to southern China to match its designers’ goals to the realities of the shop floor. But for the first time in decades, new tools are making it possible to develop this capacity for U.S. manufacturing. This means greater prospects for American innovators to convert their ideas into products—and jobs. That is what’s new, and promising. As one entrepreneur told me, asking not to be named for fear of irritating the mighty Apple, “What Apple has, internally, will now be available to smaller companies.”

In specific terms, the service that Lime Lab and a growing number of design firms can offer is a “quick iteration” way of deciding which ideas will be most practical for manufacturing. “Over the past couple of years, people have gotten used to the idea of rapid iteration in social-media firms,” Linus Chung told me. “You iterate and adapt quickly based on consumer demand. You learn to ‘fail fast.’ We’re bringing that to the hardware space.” As an illustration, he mentioned a start-up called Lark, which makes electronic sleep- and fitness-monitoring devices that are part of the broader trend toward precise, individualized indicators of health that Mark Bowden discussed recently in “The Measured Man” (July/August 2012). Lark was founded two years ago, while the overall economy was still reeling, by a Stanford-trained entrepreneur named Julia Hu. Many of its products, the latest of which is a $149.99 wristband that monitors your sleep, exercise, calorie-burning, and even degree of hydration, are now carried at Apple stores and by Best Buy and Brookstone. The electronics in this wristband are assembled in China, as are nearly all of the world’s electronics. But more of the total job growth in the company’s rise, including engineering and design work, has been in the United States than would have been the case even way back in 2009. “They started with five people, and now they have 30,” Chung, who has worked with Lark, told me. “For a company their size, you’d expect they’d need half those people in China. Now that entire team is one office in the United States.”

Fifteen additional employees here, a new urban start-up there—these are obviously not the sole answers to America’s reindustrialization. The growth of this sort of activity depends on large-scale policies: continued national investment in high technology; education to train the next generation of engineers and craftsmen; negotiations to open up markets (and protect intellectual property) around the world. The politically controversial, but right, decision to keep General Motors operating saved hundreds of thousands of manufacturing jobs from being needlessly lost.

But developments like these are an important part of the solution. Any account of a region’s growth or decline at any stage of our economic history has indicated promise when the region is full of people optimistically starting small ventures, and decline when it is not. “The real key to long-term value creation is that ongoing string of new companies,” Liam Casey told me this year, in New York, after he had met with people considering start-ups there. “That’s where you create the next wave of value, and new jobs.” American culture has long been favorable to the start-up, and the United States has captured a disproportionate share of the profits from their innovations. Shifts in technology may soon allow us to capture more of the jobs.
James Fallows is an Atlantic national correspondent. His latest book, China Airborne, was published in May.

What's Going on With the Fiscal Cliff?

Why we're not really going to fall off a cliff on January 1 and everything else you need to know about the upcoming budget talks.

| Mon Nov. 12, 2012 3:08 AM PST
Where did this whole "fiscal cliff" metaphor come from, anyway?
It's the handiwork of Fed chairman Ben Bernanke, the same guy who warned us about a "global savings glut" in 2005. In testimony before Congress earlier this year, he said that although it was a good idea to get deficits under control in the long term, it would be a bad idea to raise taxes and slash spending right away:
You also have to protect the recovery in the near term. Under current law, on January 1, 2013, there's going to be a massive fiscal cliff of large spending cuts and tax increases. I hope that Congress will look at that and figure out ways to achieve the same long-run fiscal improvement without having it all happen at one date.
I didn't realize Bernanke was such a colorful phrasemaker. So what's the deal with January 1, 2013?
Remember the lame-duck session of Congress after the 2010 midterm elections? President Obama cut a deal with Congress that extended the Bush tax cuts, established several miscellaneous tax credits, put in place a payroll tax holiday, and extended unemployment benefits. However, all of these things expire on January 1, 2013.
But that's not all! Remember the debt ceiling fiasco in 2011? At the last second, President Obama cut a deal with Congress to raise the debt ceiling, but the price he paid was a big set of spending cuts that would automatically take effect unless Congress figured out a way to do something different. Congress failed, of course, which means all those spending cuts will happen on January 1, 2013. There are a few other items too, including some new Obamacare taxes that take effect, but this accounts for most of it.

So when you add it all up, what's the price tag for this stuff?
That's where things get a little tricky. The whole fiscal-cliff metaphor is specifically designed to sound super scary, but it's really kind of misleading. Here are two different ways of looking at it:
  • The fiscal-cliff way: On January 1, about $400 billion in tax increases and $200 billion in spending cuts will take effect. That's $600 billion, or 4 percent of GDP, and that would be a huge drag on the economy.
  • The fiscal-staircase way: On January 1, total spending cuts and tax increases of about $1.6 billion will take effect. On January 2, another $1.6 billion. On January 3, another $1.6 billion. Etc.
You see? We're not really going to fall off a cliff on January 1. The cumulative effect of all this stuff will be pretty small for the first few weeks. It's only if it drags on forever that we really feel the hit.

Okay, so suppose it drags on forever. What effect would that have on the economy?
Not a good one. The Congressional Budget Office estimates that instead of growing modestly, the economy would shrink 0.5 percent in 2013 and unemployment would rise significantly. Technically, that would mean we'd be in recession for at least a few months of the year.

That all sounds very Keynesian.
Yes, it does. Ironic, isn't it? Republicans try to avoid admitting this when they join in the doomsaying about the fiscal cliff, but the basic idea here is that a big drop in deficit spending would be bad for the economy while it's still performing below potential.

Which part has the worst effect: the spending cuts or the tax increases?
That's tricky! CBO estimates that the effect per dollar is greater for spending cuts than tax increases: roughly a dollar of GDP for every dollar of spending cuts versus about half a dollar of GDP per dollar of tax increases.
However, the absolute size of the tax increases is much larger than the absolute size of the spending cuts. Overall, CBO estimates that the spending cuts will reduce GDP by about 0.8 percentage points; the end of the payroll tax holiday will reduce GDP about 0.7 percent; and the expiration of the Bush tax cuts will reduce GDP by 1.4 percentage points.

But wait a second. There are two parts to the Bush tax cuts: the middle-class cuts and the cuts for the rich.
Right. And here's the thing: CBO figures that letting the middle-class tax cuts expire would shrink GDP about 1.3 percentage points.

But that's almost the entire effect of letting the Bush tax cuts expire.
Right. And everyone agrees we should extend the middle-class tax cuts. So if we did that, but let the tax cuts on the rich expire, it would have virtually no impact on growth.

So that would make a ton of sense. Are we going to do that?
Good question! Republicans are dead set against it, so it's going to be a big fight.

What about the payroll tax holiday?
Everyone seems willing to let that end, so that's not really very controversial.

Why is that? It has a pretty big effect.
Beats me. It would make a lot more sense to extend the payroll tax holiday than to extend the Bush tax cuts for the rich, but Republicans are opposed to the tax holiday and Democrats have already caved in on this. Mostly it's because they're worried that extending it would set a precedent for keeping payroll taxes lower forever, and that would hurt Social Security's finances.
Conversely, Republicans care a lot about tax cuts for the rich. At the moment, they claim they'll kill any deal to avoid the fiscal cliff unless they get to keep them.

Are they serious?
Yep. But they're going to have a tough time sticking to this. Right now, because the Bush tax cuts are still in effect, the conversation is about letting them expire and thereby raising taxes. But on January 1, the Bush tax cuts disappear and everyone's taxes automatically revert to the higher Clinton-era rates. At that point, the conversation changes: Suddenly we'll be talking about cutting taxes on the middle class and maintaining them where they are now on the rich. And Obama can basically go on TV every single day and say that he's ready to sign a middle-class tax cut any time, but Republicans are refusing to agree unless their rich pals also get a tax cut. Every poll ever taken shows that the public doesn't want to give the rich a tax cut, and they're going to be pretty pissed that the GOP is holding their tax cut hostage unless Donald Trump gets a tax cut too.

Is some kind of face-saving deal possible?
Oh, sure. Republicans want tax rates on the rich to stay at Bush levels, while Obama wants actual taxes paid by the rich to go up. It might be possible to square this circle by leaving rates at Bush levels but reducing deductions and closing loopholes on high earners. The math is a little tricky, but there might be a way to make a deal along these lines.

And what about the spending cuts?
There are two parts to this. Half the spending cuts are to defense and half are to domestic programs. Republicans don't like the defense cuts and Democrats don't like the domestic cuts. But there's no telling what will happen here. It would make sense just to eliminate them all for now, and negotiate a different set of spending cuts to be phased in later, when the economy has improved. The problem is that a deal like this would basically be a "grand bargain": a bunch of future spending cuts—including cuts to entitlement spending—plus some future tax increases, as a way of reining in the deficit. Obama tried to negotiate a deal like that back in 2011, but Republicans revolted because they refused to accept any future tax increases at all. This might change, but so far it's not looking very likely.

So give me the nickel summary.
You bet. Here it is:
  1. January 1 is not a drop dead date. Nothing much will happen unless all the spending cuts and tax increases drag on for weeks or months.
  2. If no deal is made, economic growth will slow down a lot and unemployment will increase a lot.
  3. Therefore, a deal will probably be made. On taxes, everyone wants to extend the Bush tax cuts for the middle class, and the only question is how long Republicans will refuse to extend them unless the Bush tax cuts for the rich are also extended. Probably not too long. Likewise, no one is really all that excited about the spending cuts either, so probably some kludge will be worked out that either eliminates or postpones most of them.
  4. It's possible that the whole thing will be solved with a grand bargain, which would produce trillions of dollars of deficit reduction via spending cuts and tax increases in the future. However, this will only happen if House Republicans are willing to accept tax increases. Right now, that doesn't seem likely.
Wait a second! Did you forget about the debt ceiling?
Of course not. The debt ceiling will need to be raised early next year, and Republicans are keen to play games with it, just like they did in 2011. However, an agreement to raise the debt ceiling will almost certainly be part of the negotiations surrounding the fiscal cliff. It adds a little frisson of danger to the whole thing, but not much else.

What going over the 'fiscal cliff' would mean . . .

The fiscal cliff is Washington shorthand for the blast of tax hikes and spending cuts set to take effect in January. 

Sources: Moody's Analytics, Tax Policy Center. By Bonnie Berokowitz, Karen Yourish and Laura Stanton - The Washington Post. Published on November 11, 2012, 5:24 p.m.

‘Fiscal cliff’: Consensus on increasing tax revenue, a wide gulf on how to do it 

By Lori Montgomery, Published: November 25

For the first time in decades, a bipartisan consensus has emerged in Washington to raise taxes. But negotiators working to avert the year-end “fiscal cliff” remain far apart on crucial details, including how taxes should go up and who should pay more.

Neither side gave ground in an opening round of staff-level talks last week at the Capitol. As President Obama and congressional leaders prepare for a second face-to-face meeting as soon as this week, the divide over taxes presents the biggest obstacle to replacing the heap of abrupt tax hikes and spending cuts, set to hit in January, with a less-traumatic debt-reduction plan.

People in both parties are exploring ideas for bridging the gap. Without a deal on taxes, there is not much hope for agreement on a broader strategy for restraining the national debt that also tackles the skyrocketing cost of federal retirement programs such as Social Security and Medicare.

But with tax rates set to rise automatically in January when the George W. Bush-era tax cuts expire, Democrats say they have little incentive before then to cut a deal that falls short of their revenue goals. That means going over the cliff, at least for a short time, remains a possibility, they say.

“The bottom line is we’re about to have a poker game and it’ll be hard to read” what each side is willing to do, said Kevin Hassett, a senior fellow at the American Enterprise Institute and a former adviser to Republican presidential candidate Mitt Romney.

For now, Democrats are seeking $1.6 trillion in new taxes over the next decade collected from about 3 million families at the pinnacle of the income spectrum — those earning more than $250,000 a year. The Democrats want to start by letting the top two tax rates return to 36 percent and 39.6 percent when the Bush tax cuts expire.

Republicans insist on maintaining the Bush rates, at 33 percent and 35 percent, through 2013. Instead, they want to raise cash by rewriting the tax code to eliminate individual loopholes and deductions, an approach House Speaker John A. Boehner (R-Ohio) argues would be less harmful to businesses and the economy.

It is also more popular, Republicans say. They pointed to a new poll by the Winston Group, a GOP research firm whose president, David Winston, is close to Boehner. Sixty-five percent of those surveyed preferred a deal that wipes out “special interest tax loopholes and deductions commonly used by the wealthy” over an approach that raises tax rates on “Americans earning more than $250,000” on Jan. 1.

GOP negotiators have declined to say how much they are willing to raise, according to people familiar with the talks. In the past, Boehner has proposed $800 billion. But who, in the Republicans’ view, should foot that bill is unclear.

Major deductions, such as breaks for mortgage interest and charitable contributions, disproportionately benefit the wealthy but also reach far into the middle class. Capping all itemized deductions at $17,000, an idea offered by Romney, would affect the wealthy but raise tax bills for nearly 15 percent of families making between $40,000 and $50,000 a year, according to the independent Tax Policy Center.

A proposal by Sen. Bob Corker (R-Tenn.) to cap deductions at $50,000 would come closer to focusing the impact on households earning more than $250,000, but it would also raise less money.

Some Republicans are willing to explicitly tax the rich, but only if the target group is smaller. For example, Sen. Susan Collins (R-Maine) has suggested a 2 percent surtax on millionaires, who make up just 0.3 percent of taxpayers — about 400,000 households. And Collins would exempt small-business owners whose profits are taxed on their personal returns.

“Multimillionaires and billionaires who are not running businesses could pay more of their income to help reduce the $16 trillion federal debt,” Collins said in a statement last week. “But I feel strongly that we must ensure that small-business owners . . . are protected.”

The continuing dispute over taxes contrasts with the bipartisan unity on display Nov. 16 at the White House, when Boehner and Senate Minority Leader Mitch McConnell (R-Ky.) met with Obama and Democrats Harry M. Reid (Nev.), the Senate majority leader, and Nancy Pelosi (Calif.), the House minority leader. Days after an election that returned Obama to the Oval Office and returned the GOP to power in the House, the leaders vowed to work together to avoid the dramatic year-end tax hikes and spending cuts, which threaten to spark a new recession, and adopt a more gradual debt-reduction plan.

Pelosi suggested a Christmas deadline, a sign of optimism that briefly buoyed financial markets. But except for agreeing to pursue a two-step legislative “framework,” the group hammered out no details. That was left to top aides who were instructed to develop an agenda for the leaders’ next meeting, which on Sunday had yet to be scheduled.

The framework calls for an immediate down payment, likely to include tax hikes and spending cuts, along with targets for further tax increases and entitlement cuts to be achieved through a broader debt-reduction effort next year.

Taxes are hardly the only point of contention. In exchange for raising additional revenue, Republicans want cuts to fast-growing federal retirement programs, projected to be the biggest driver of future borrowing. Their opening bid included a demand to apply a less-generous measure of inflation to Social Security, which would slow the rise of benefit payments.

Obama agreed to the idea in talks with Boehner during the summer of 2011. But since the election, liberal groups have mobilized against it and Reid has ruled it out. On Sunday, the No. 2 Senate Democrat, Sen. Richard J. Durbin (Ill.), appeared to endorse Reid’s position, though he argued that Democrats should ignore calls to take Medicare off the table.

“Social Security does not add one penny to our debt — not a penny. It’s a separate funded operation,” Durbin said on ABC’s “This Week with George Stephanopoulos.” “Medicare’s another story — only 12 years of solvency if we do nothing. So those who say, ‘Don’t touch it. Don’t change it,’ are ignoring the obvious.”

Durbin suggested higher payments for “high-income beneficiaries” but expressed concerns about another idea Obama has previously accepted — raising the Medicare eligibility age from 65 to 67.

Sen. Lindsey O. Graham (R-S.C) said on the same show that gradually raising the retirement age — for both Medicare and Social Security — is exactly the kind of “eminently reasonable” entitlement reform Republicans will demand.

“I don’t expect Democrats to go for premium support or a voucher plan,” Graham said, referring to a Medicare proposal championed by Rep. Paul Ryan (R-Wis.). “But I do expect them to adjust these entitlement programs before they bankrupt the country.”

The talks must also address other critical issues, including the federal debt limit, which is set by law at $16.4 trillion. The national debt is approaching $16.3 trillion, and Democrats are hoping Republicans will agree to an increase as part of a fiscal-cliff deal.

No such offer was forthcoming last week, but Republicans, too, are interested in getting the debt limit off their plate and avoiding a repeat of the damaging debt-ceiling standoff that sent congressional approval ratings plummeting in the summer of 2011.

Taxes, however, remain the key to a breakthrough, people in both parties say. Obama has left the door open to a compromise that would raise the top rate for 2013 to something less than 39.6 percent, a move Republicans took as an encouraging sign.

Democrats have continued to press for legislation that extends the Bush cuts for 98 percent of taxpayers and lets the top rates expire. Along with changes to the inheritance tax, the expiration of the Bush tax cuts would generate about $1 trillion over the next decade compared with current policy. The immediate question, in Democrat’s view, is the scope of entitlement cuts Republicans want in exchange for passing such legislation.

Republicans close to the talks say they will not extend the Bush rates only for some taxpayers. Instead, they have been scrambling to come up with alternatives for raising the same amount of money — around $50 billion in 2013 — from the same group of people.

Among the options floated by Republican tax aides is a “bubble tax,” which would eliminate the benefit of the lower tax brackets for taxpayers over a certain income level. (Currently, for instance, all taxpayers benefit from a 10 percent tax rate on the first $8,700 of income regardless of their total income.) In a recent report, the bipartisan Committee for a Responsible Federal Budget offered other ideas, including a $25,000 cap on itemized deductions for taxpayers who earn more than $250,000 a year.

Targeting deductions now, however, could limit the amount Democrats raise later through rewriting the tax code. Obama, after all, has proposed his own limit on itemized deductions, which would raise an additional $600 billion over the next decade on top of the money to be gained from increasing tax rates.

“A much wiser course would be to let the Bush tax cuts sunset,” said Chuck Marr, a tax expert at the left-leaning Center on Budget and Policy Priorities. “You’d be locking in nearly $1 trillion in 10-year savings. And then one can start talking about reforming” deductions.

Zachary A. Goldfarb contributed to this report.

More fiscal cliff coverage

The GOP’s claim on a tax hike

The GOP’s claim on a tax hike
FACT CHECKER | We look at the claim that raising rates on wealthy will pay for a week of spending.

The dangerous fiscal deadline isn't Dec. 31- it's February 2013

The dangerous fiscal deadline isn't Dec. 31- it's February 2013
That's the drop-date date for the government to raise the debt ceiling. And unless a significant deficit deal is achieved by then, Republicans could threaten another showdown.

Absolutely everything you could possibly need to know, in one FAQ

Absolutely everything you could possibly need to know, in one FAQ
Washington is engaged in an all-consuming debate about how to resolve the "fiscal cliff." But what is that, and why does it matter?

The ‘fiscal cliff’ showdown

The ‘fiscal cliff’ showdown
Here’s the complete coverage of the fiscal cliff negotiations among President Obama and lawmakers.
On edge of brutal ‘fiscal cliff,’ some see an opportunity to end debt paralysis

By Lori Montgomery, Published: November 11

Two years ago this month, the leaders of a presidential commission rolled out a startling plan to dig the nation out of debt. After decades of profligacy, they said, Washington must tell people to work longer, pay higher taxes and expect less in retirement.

Lawmakers recoiled from the blunt prescriptions of Democrat Erskine Bowles and Republican Alan K. Simpson. But their plan has since been heralded by both parties as a model of clear-eyed sacrifice, and policymakers say the moment has come to live up to its promise.

When Congress returns to Washington on Tuesday, the most urgent task facing President Obama and congressional leaders will be avoiding the year-end “fiscal cliff,” a towering accumulation of $500 billion in budget cuts and expiring tax breaks that would abruptly reduce government borrowing but could trigger a new recession.

In the past, policymakers have handled such moments by delaying the pain and giving themselves new deadlines for getting the budget under control. Now, however, the national debt is larger, as a percentage of the economy, than at any time in U.S. history except for the period after World War II — and it’s rising rapidly. Avoiding hard decisions could have grave consequences, analysts say, potentially undermining the U.S. economic recovery and the world’s confidence in American leadership.

“I think this is the magic moment,” said Bowles, a veteran negotiator who served as chief of staff in the Clinton White House. “They’ve got to compromise. And I think if you listen carefully to what all the politicians are saying, there’s room to get something done.”

Few expect Washington to replicate the scope of the Bowles-Simpson plan. Though it is widely praised, its $4 trillion in 10-year savings includes major changes to Social Security opposed by liberals and an aggressive new tax code that would generate far more revenue than most conservatives could stomach.

Last week, House Speaker John A. Boehner (R-Ohio) publicly urged Obama to return to a less ambitious framework drafted in secret during the summer of 2011, when the two men came tantalizingly close to compromise. That blueprint would save about $2 trillion, on top of $1.3 trillion in agency cuts already in force.

About half the new savings would come from reversing part of the massive tax cuts that, along with the collapse of tax collections during the recent recession, are a major cause of current budget problems. The rest would come from lower spending, including on Social Security and Medicare, forecast to be the biggest drivers of future borrowing.

The 2011 talks collapsed when Obama asked for more revenue and Boehner, facing a conservative insurrection over taxes, abruptly called the deal off. The obstacles are similar now: Republicans are still talking vaguely about raising money through economic growth rather than higher taxes, and key Democrats are arguing that Obama’s reelection victory entitles them to resist cuts to retirement benefits while demanding even more in new taxes.

Still, as they prepare to launch a fresh round of talks Friday at the White House, Boehner and Obama both have delivered nuanced public statements that seem to leave the door open to the historic “grand bargain” both men are said to desire.

Boehner’s offer last week to raise revenue through tax reform “was a positive sign,” Obama senior campaign adviser David Axelrod said Sunday on CBS’s “Face the Nation.”

While Obama is demanding higher taxes on the wealthy and Boehner is resisting an increase in the top tax rate, Axelrod said, “obviously, there’s money to be gained by closing some of these loopholes and applying them to deficit reduction. So I think there are a lot of ways to skin this cat so long as everybody comes with a positive, constructive attitude toward the task.”

Lawmakers streaming into town for the first time since September are nervously expectant. For two years, the debate over the debt has paralyzed the Capitol. Now policymakers face a particularly brutal decision point.

The fiscal cliff amounts to the largest one-year dose of government austerity since 1968, when Congress raised taxes and was blamed for triggering a recession. Without preventive action, the United States will go on a debt-fighting diet comparable to those recently undertaken in Spain, Italy and the United Kingdom. Simply delaying the pain is not an option, economists say.

“We would be stepping into an economic netherworld of slow growth and high unemployment that would leave us very vulnerable to anything else that goes wrong,” said Mark Zandi, chief economist at Moody’s Analytics. “The window is as far open as it’s ever going to be. It’s the president’s second term. He’s got to go through it.”

The cliff was not constructed intentionally, but it was no accident, either. For decades, Washington has been postponing tough decisions about taxes and spending. The result: dozens of temporary provisions that are forever expiring. This year, they all happen to come due Dec. 31.

Take the Medicare sustainable growth rate, or SGR. Enacted as part of the 1997 Balanced Budget Act, the SGR was designed to make sure payments to providers grew no faster than the overall economy. But doctors screamed when the formula required cuts in 2002, and Congress has since passed legislation, known as the “doc fix,” to temporarily override the SGR.

Because Congress has not changed the underlying formula, the payment cut gets bigger and the doc fix gets more expensive with each passing year. In January, Medicare providers face a payment cut of 27 percent unless lawmakers come up with $18 billion to override the formula for another year.

The cliff is packed with such quandaries. On the tax side, most date to the start of the George W. Bush administration, when the budget was in surplus and the nation was paying down its debt for the first time in a generation. Bush took office on a promise to return the surplus to the taxpayers.

The Bush tax cuts were so big and far-reaching their effects rippled through the code. Suddenly, millions of people’s tax bills were so low they were in danger of being forced into an expensive parallel system known as the alternative minimum tax, or AMT. So that had to be patched, too.

The latest AMT patch expired last December, and unless Congress acts, 26 million people will have an extra $3,700, on average, tacked onto their 2012 tax bills. The cost of patching the AMT for 2012: $92 billion.

The Bush tax cuts are also temporary. To avoid increasing deficits far into the future, lawmakers designed them to expire in 2010. Obama extended them for another two years, piling on a temporary payroll tax holiday to boost the sluggish recovery. That also expires in December.

All told, expiring tax breaks account for nearly four-fifths of the $500 billion the cliff is projected to suck out of the economy between January and September. Automatic budget cuts, known as the sequester, are almost an afterthought. According to the nonpartisan Congressional Budget Office, they amount to $65 billion in the fiscal year that ends in September, evenly split between the Pentagon and domestic programs.

Because Republicans have so far insisted on taming the debt through spending cuts rather than tax increases, the sequester was essential to winning GOP support for legislation to increase the nation’s debt limit after the Obama-Boehner talks broke down in 2011. The threat of across-the-board cuts was supposed to force a special congressional “supercommittee” to come up with a more reasonable way to save money. But the supercommittee disbanded in failure last November.

Many Republicans say Obama’s victory will serve to break the stalemate. With his post-election speech, Boehner essentially offered to reverse three decades of GOP orthodoxy on taxes.

“The movement on the part of the GOP to say that revenues are part of this mix is significant,” said Rep. Peter Roskam (R-Ill.), who as chief deputy whip will be responsible for rounding up votes. “Obama can take his victory lap on more revenue. Let’s give the GOP a victory lap on keeping rates low and call it a win.”

In return for their concession, however, Republicans say they will demand structural changes to retirement programs on the order of those Obama offered in 2011, including raising the eligibility age for Medicare from 65 to 67 and applying a stingier measure of inflation to Social Security.

Those ideas are “very constructive,” said Sen. Patrick J. Toomey (R-Pa.), an anti-tax conservative who served on the supercommittee. “The problem is big government programs are growing faster than the economy. It doesn’t matter what you do on the tax side if you have spending consuming ever more of our economy with no end in sight.”

Democrats oppose cutting benefits. But Senate Majority Leader Harry M. Reid (D-Nev.) and House Minority Leader Nancy Pelosi (D-Calif.) told Obama they would support the secret deal in 2011. If he leads them there now, they are likely to follow.

“We’ve been resisting the obvious for the past two years,” said Rep. Peter Welch (D-Vt.), a liberal who advocates compromise. “And the obvious is: There’s no grand bargain that will not cause political pain for all of us.”