U.S. Manufacturing: Reviving or Not?

Stephen DeAngelis

October 16, 2012

“The US is on course to regain its status as a global industrial powerhouse,” writes Peter Marsh. [“US set for industrial revival, says study,” Financial Times, 21 September 2012] At least that is what a recent study concludes. The study, written by the Boston Consulting Group, claims the rebound in manufacturing “is being driven by several factors including lower energy costs, higher labour expenses in competitors such as China and the potential to use idle US port capacity for pushing up exports.” Marsh continues:

“As a result the US has the potential to increase goods exports by up to $130bn by 2020, in the process adding 5m jobs to the US economy. The consultants estimate that because of the underlying shifts, the US will by 2015 have a cost advantage over manufactured goods exports of 5 to 25 per cent compared with countries such as Germany, Japan and the UK. In particular, the cost disadvantage the US suffers compared with China is starting to decrease. While in 2010, the cost of turning out a dollar’s worth of goods in a Chinese factory was on average 12 per cent less than the equivalent cost in the US; by 2015 the cost gap will be reduced to 7 per cent, the consultants say.”

Boston Consulting Group indicates “that the biggest U.S. export gains will be in machinery, transportation equipment, electrical equipment and appliances, and chemicals.” [“Could Rising U.S. Exports and Reshoring Help Create Up to 5 Million Jobs by 2020?,” SupplyChainBrain, 25 September 2012] Harold L. Sirkin, a BCG senior partner and coauthor of the research, states, “The export manufacturing sector has been the unsung hero of the U.S. economy for the past few years. But this is only the beginning. The U.S. is becoming one of the lowest-cost producers of the developed world, and companies in Europe and Japan are taking notice.” The new report increases BCG’s forecast of how many new jobs are likely to be created. The SCB article continues:

“Earlier this year, a BCG report titled ‘U.S. Manufacturing Nears the Tipping Point: Which Industries, Why, and How Much?’ predicted that the U.S. would gain 2 to 3 million jobs from higher exports and production work shifting from China to the U.S. Although the reshoring trend – also referred to as ‘insourcing’ and ‘onshoring’ – is still in its early stages, several large foreign manufacturers have already announced plans to use the U.S. as an export base for other markets. Toyota, for example, has announced that it will export Camry sedans assembled in Kentucky and Sienna minivans made in Indiana to South Korea, while Honda and Nissan both say that they expect to boost exports of vehicles made in their U.S. plants to the rest of the world. Siemens is building gas turbines in North Carolina to ship to Saudi Arabia for construction of a 4-gigawatt power plant. Rolls-Royce recently opened a new aircraft engine parts manufacturing facility in Virginia citing lower labor costs, productivity and dollarization (doing business in U.S. dollars to mitigate local currency risk).”

Michael Zinser, a BCG partner and co-author of the study, asserts that many more such announcements are likely to be made over the coming years. “Producing in the U.S. offers increasingly compelling cost advantages,” he states, “to supply not only North America but also some of the most important overseas markets.” The article continues:

“BCG estimates that average manufacturing costs in 2015 will be 8 percent lower in the U.S. than in the U.K., 15 percent lower than in both Germany and France, 21 percent lower than in Japan, and 23 percent lower than in Italy. Average manufacturing costs in China will still be 7 percent lower than those of the U.S. in 2015. But those costs do not include transportation, duties and other expenses. And it is less than half of the advantage that China enjoyed a decade ago.”

The previous BCG report noted that there are “many risks and hidden costs of managing extended global supply chains [that must be] taken into account” when considering overall supply chain costs. As a result, “it will be just as economical to manufacture many products in the U.S. if those goods are sold in the U.S.” As I’ve noted in previous posts on this subject, all things considered, it makes sense to move manufacturing closer to the geographical location in which products will be purchased and used. That means that, even if some manufacturing returns the U.S., a good deal of manufacturing will still be done overseas. The article continues:

“Labor and energy costs will be especially important sources of U.S. competitive advantage in manufacturing. Adjusted for differences in worker productivity, which is considerably higher in the U.S., average labor costs of the other large developed economies will be 20 to 45 percent higher than those of the U.S. Only a decade ago, the same U.S. worker cost only 12 percent less than the average factory worker in Europe.”

Boston Consulting Group isn’t the only organization that has reached the conclusion that U.S. manufacturing is likely to have a resurgence. “A new PwC US report, A Homecoming for U.S. Manufacturing?, reveals that while rising labor costs are part of the story, a range of factors—including transportation and energy costs and protecting the supply chain—could drive a sustained manufacturing renaissance in the U.S. beyond any cyclical recovery, potentially improving investment, employment, production output and research & development (R&D).” [“A Homecoming For U.S. Manufacturing? Manufacturing.Net, 21 September 2012] The article continues:

“PwC’s new report identifies seven factors—including transportation and energy costs; currency fluctuations; U.S. market demand; labor costs; U.S. talent; availability of capital; and the tax and regulatory climate—as the primary catalysts influencing manufacturers’ decisions to establish production facilities domestically and produce products closer to their major customer bases. PwC’s report also notes that localizing production can mitigate supply chain disruptions, which totaled $2.2 billion in financial impact for U.S. industrial products companies in 2011.”

The PwC report concludes, “Relocating manufacturing production in the U.S. generally holds greater advantages for some industries over others.” The PwC list of advantaged industries is very similar to the BCG list. It includes chemicals, primary metals, and heavy equipment manufacturing industries. In addition, “wood, plastic and rubber products companies could also benefit from changes in domestic costs, but lower net imports in these industries may limit the full economic benefits of on-shoring in the U.S.”

Not everyone is jumping on the U.S. manufacturing rebound wagon. Matthew Philips writes, “It’d be nice if it were true.” [“Here Comes the Big Manufacturing Slowdown,” Bloomberg BusinessWeek, 17 September 2012] He continues:

“[In early September,] the Fed reported a sharp contraction in the country’s industrial output, which showed that production from factories, mines, and utilities fell by 1.2 percent last month—the biggest drop since 2009 and also well below expectations. Slowing U.S. exports have pushed the monthly trade deficit in manufactured goods to a record $63.9 billion. After creating 500,000 jobs since 2010, factories are starting to cut workers. Manufacturing data tend to be a leading indicator for the rest of the economy. The recent weakness is more an indication of future conditions than present ones, meaning the U.S. manufacturing renaissance of the last two years may be about to take an extended breather.”

The real problem, Philips states, is uncertainty. The U.S. Government faces a “fiscal cliff” and European governments continue to wrestle with their own fiscal issues. U.S. consumers are over-leveraged even though recent reports indicate that they are starting to pay down their debts. If things looked brighter, Philips notes “that industry is primed for a big investment boom.” He explains:

“On the whole, manufacturers have high profits, relatively high utilization rates, and bunches of cash. They face ultra-low borrowing costs. Right now, the U.S. manufacturing sector is using 78 percent of its total capacity, compared to a low of 66 percent in June 2009. Even with low growth expected, companies aren’t that far from maxing out what they can produce at current capacity merely to meet a 2 percent increase in production. A lot have plenty of cash on their balance sheets, and with borrowing rates so low, it’s hard to think that the return on investment from a new project wouldn’t be higher than the cost of the money it takes to build it. ‘The hurdle rate is really low right now,’ says [MAPI chief economist Daniel] Meckstroth.”

Gary Pisano, a Harvard Business School professor, agrees with Philips. He told Peter Marsh, “I still don’t see the indications that the kind of sea change in [company] behaviour [that could bring about a prolonged manufacturing recovery] is really happening.” Another naysayer is Alan Tonelson, a research fellow at the US Business and Industry Council. He told Marsh that “BCG’s upbeat conclusions failed to take into account ‘higher incentives’ that competitor nations such as China were likely to provide their domestic companies to boost manufacturing.” On the other hand, George Magnus, an economic adviser to the UBS investment bank, told Marsh, “I’m quite persuaded by the substance of the [BCG] arguments that the pendulum is starting to swing back to the US [in manufacturing] and away from countries such as China.”

The PwC report also makes some pretty persuasive points. They list seven factors that are likely to persuade businesses to return manufacturing to America. They are: transportation and energy costs; currency fluctuations; U.S. market demand; U.S. talent; availability of capital; tax and regulatory climate; and U.S. labor costs. Robert J. Bowman, managing editor of SupplyChainBrain, offers “two observations about human nature: We move in herds. And we very quickly forget what the last pasture was like.” [“The ‘End’ of U.S. Manufacturing – Again,” 15 October 2012] He continues:

“Back in the late 1960s and early ‘70s, ‘Japan Inc.’ was poised to destroy American manufacturing. Flush with dollars amassed from churning out cheap goods for U.S. consumers, Japanese tycoons weren’t just financing our debt, they were buying up real estate – threatening, literally, to own the country. … But when Japan sank into decades of deflation, yet another crisis emerged, in the form of the Asian ‘tigers’ – Hong Kong, Singapore, Taiwan and South Korea. These aggressively developing economies became the go-to region for low-cost Western consumer goods … until they weren’t. They were followed, of course, by China, the latest challenge to American economic hegemony. … China’s inexhaustible labor force and huge investments in infrastructure looked certain to propel the nation to global dominance. Just two years ago, China passed Japan to become the world’s second-largest economy. The Middle Kingdom was on a roll. China remains a force to be reckoned with, but its economy has faltered over the past couple of years. Rising labor rates are making it a less attractive place for manufacturing, at least where exports to the West are concerned. Some of that activity is even returning to the U.S. A recent report by Acorn Systems, a vendor of cost-management software, found that 28 percent of its U.S. manufacturing customers had ‘reshored’ at least a portion of their sourcing, saving an average of $23m a year in the process. Yes, China took a huge bite out of the U.S. manufacturing base. And yes, it still makes most of the personal electronic devices that we treasure. But at least one analyst believes that China was never the threat to the American economy that it appeared to be, even back in 2001, when it joined the World Trade Organization and manufacturing wages were 58 cents an hour.”

I admit that it is difficult to look past near-term problems to see a brighter future; but, I believe that brighter future is coming. There are just too many good reasons to move manufacturing closer to consumers. The biggest bump to employment is likely to come from ancillary work associated with the supply chain and other services rather than from jobs on the factory floor.