Why U.S. Manufacturing Is Poised for a Comeback

Why U.S. Manufacturing Is Poised for a Comeback

     
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Why U.S. Manufacturing Is Poised for a Comeback

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  • Third-party presidential candidate H. Ross Perot coined one of politics’ most memorable sound bites in 1992 when he used the phrase “giant sucking sound” to describe the flight of U.S. manufacturing jobs to foreign shores.

    The trend had begun years earlier, as U.S. industrial firms—beset with high labor costs and inflexible work rules—sought competitive advantage by moving operations to low-cost countries, such as Mexico and China. And while Perot’s tunnel-vision analysis conveniently overlooked dramatic U.S. productivity gains that had enabled American factories to increase output while reducing payroll, the country’s manufacturing employment did take a nosedive in the years that followed. It plummeted from a peak of 19.6 million jobs in 1979 to 15.3 million in 2002, to 14 million in 2005, to roughly 12 million jobs today.

    That decline, however, appears to be coming to an end, and manufacturing employment may now be poised for a comeback. Last year, U.S. manufacturing jobs increased for the first time since 1997, rising approximately 1 percent. In the next five years, many more manufacturing jobs will likely return to U.S. shores, sparking a renaissance in certain production industries. The primary reason for this trend is that productivity-adjusted labor costs in China’s industrial heartland—the Yangtze River Delta region, which includes the provinces of Shanghai, Jiangsu, and Zhejiang—are rising fast and are expected to converge with those in the Sun Belt states of the U.S. by about 2015.

    When making investment decisions, business executives often make the mistake of comparing “average” labor costs for Chinese production workers with labor costs in the U.S. But averages can be deceiving. Though wages are much lower in China, they don’t reflect the full cost of doing business or the full range of decisions that companies have to make. Executives planning a new factory in China to make products for sale in the U.S. need to account for what such a facility may cost over its full life cycle. When they do that, they are likely to find that, for many goods, China’s cost advantage a few years from now may not be large enough to bother with—and that’s before taking into account the added expense, time, and complexity of long-distance management, logistics, and quality control.

    Wages are climbing in China at 15 to 20 percent per year because there is a mismatch between the supply of skilled labor and the demand for it. Looking ahead a few years, after adjusting for the significant productivity advantage of U.S. workers—who, in many cases, today produce three times the output of their Chinese counterparts—wage rates in Chinese cities such as Shanghai and Tianjin will be just 30 percent lower than in the lowest-cost U.S. states. And since wage rates typically account for up to 20 to 30 percent of a product’s total cost, this will make manufacturing in China just 10 to 15 percent cheaper than manufacturing in the U.S. The total cost advantage will drop to single digits after inventory and shipping costs are factored in.

    As a result, states such as Alabama, Louisiana, Mississippi, South Carolina, and Tennessee—with their competitive wages and flexible work rules—will be increasingly attractive as low-cost manufacturing hubs for the U.S. market, and they will become some of the cheapest locations in the developed world for manufacturing.

    When these nonwage factors are included in corporate decision-making, the math becomes fairly easy: products that require less labor and that are produced in modest volumes—especially heavy, bulk products that are costly to ship, such as autos, household appliances, and construction equipment—become strong candidates for U.S. production. Products that are labor intensive and produced in high volumes, such as textiles and apparel, will remain strong candidates for manufacturing overseas.

    For some companies, the economics have already reached the tipping point. Caterpillar, for example, announced last year that it planned to build a new 600,000 square foot hydraulic-excavator manufacturing facility in Victoria, Texas. When it becomes fully operational, the plant is expected to employ more than 500 people and to triple Caterpillar’s previous excavator capacity in the U.S. “Victoria’s proximity to our supply base, access to ports and other transportation, as well as the positive business climate in Texas made this the ideal site for this project,” said Caterpillar vice president Gary Stampanato. Similarly, NCR Corporation announced in late 2009 that it was bringing back production of its ATMs to Columbus, Georgia, in order to decrease the time to market, increase internal collaboration, and lower operating costs.

    The bottom line is clear. Given rapidly rising wages in China, combined with critical shortages of skilled workers in many of China’s lower-cost regions and the higher productivity of U.S. workers, many companies are finding that it makes sense to manufacture goods for the U.S. in the U.S.

    But while more goods sold in the U.S. will bear a Made in the USA label in the coming years, China—with a population more than four times that of the U.S—will certainly remain a top manufacturing location. There are at least three reasons for this. First, as the largest and fastest-growing developing economy in the world—with a rapidly growing middle class—China’s domestic market seems virtually insatiable. Second, in the absence of trade barriers that limit offshoring, Western Europe will continue to rely on China’s lower-cost labor, since the euro zone lacks the flexibility in wages and benefits that the U.S. enjoys. Third, even though other low-cost countries—such as Vietnam, Thailand, Cambodia, and Indonesia—will attract some manufacturing from companies seeking wage rates lower than China’s, these countries lack the supply base, infrastructure, and labor skills to absorb much of the manufacturing that would otherwise go to China.

    It’s important to herald the coming U.S. manufacturing renaissance, but it’s also important to note that the U.S. has never stopped being a manufacturing giant. Even last year, as the country crawled out of the Great Recession, U.S. exports increased more than 20 percent to nearly $1.3 trillion, the Census Bureau reports. Some 85 percent of those exports were manufactured goods.

    Those who have been writing U.S. manufacturing’s obituary, therefore, need to recall Mark Twain’s famous words: “The report of my death was an exaggeration.” Still, the news of a manufacturing renaissance is no exaggeration. It’s already on its way.

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