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The Economist: Manufacturing comes back to the United States




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Dr. M. Ray Perryman
September 26, 2013 | 1540 views | 1 comment

Some promising news for US manufacturing: there is reason to believe that the sector is set for a rebound after more than a decade of job losses and factory closures. Strength in basic industries such as manufacturing is important to long-term prosperity, and a shift in locations back to the United States could notably alter future performance.

Although the recent recession didn’t help matters, the steep slide in the numbers of jobs within the manufacturing sector has been going on for more than a decade. From the mid-1980s through 2000, manufacturing bounced around within a fairly narrow range between around 17 and 18 million jobs, fluctuating with business cycles. In 2001, the sector began to shed jobs at a rapid pace, falling by approximately 2 million positions in just 18 months. The trend leveled off through the middle of the decade, before falling again during the recession. In early 2010, national manufacturing employment bottomed out at about 11.5 million, and has recently increased to almost 12 million.

Why the big drop? One reason is increasing automation, with technology allowing for increasing production with fewer employees. In fact, domestic manufacturing wasn’t in a decline in terms of the amount produced, just the number of people working. Perhaps the most important development was the significant entrance of China (and, to a lesser degree, other emerging countries) into the global marketplace. China entered the World Trade Organization (WTO) in 2001, opening up the doors to greater exchange with that nation. Access to China’s incredibly cheap and huge pool of labor led companies to set up shop there in droves. In particular, industries where labor is a large component of the overall value of a product (think clothing or inexpensive consumer goods) benefit from locations there. In addition, certain electronics manufacturing is well suited to China.

The size of the wage differential is vast. While precise comparisons are complicated by data gaps, the US Bureau of Labor Statistics estimates that the hourly compensation costs for manufacturing jobs in China (and India) is less than $2. Compare that a US estimate of nearly $36 (including hourly wages and benefits). Clearly, for many companies, the only way to stay competitive is to tap into this cheap labor source. Although there have been factory closures and other negative fallout in America and elsewhere, consumers worldwide have benefitted from access to less expensive products.

Such re-allocations of scarce global resources have been going on for centuries. If there were no barriers (political, geographic, cultural, or otherwise), production would happen in the places where it was most efficient. (You may remember discussing or sleeping through “comparative advantage” in an economics class.) It only makes sense for things that require a lot of labor to be made in places with cheap labor. Of course, when you factor in painful job losses and erosion of this cornerstone industry within the United States, what is a logical concept becomes an unfortunate trend for many Americans.

However, the story doesn’t end there. Over time, the United States is becoming more competitive. We already have one of the highest rates of output per hour worked, and productivity is rising. We also have advantages in shipping and other logistics, and those expenses have been on the rise internationally. At the same time, wage rates in China are rising rapidly (double digits per year), eroding cost advantages. Productivity there is also rising, but not as fast as labor costs.

Moreover, building highly automated factories in China doesn’t make sense for many global firms in that it decreases reliance on the strongest reason to be there in the first place: cheap labor. The rapid rise in Chinese compensation is a natural outgrowth of development of the economy there, and increasing prosperity is good on a number of levels. Political stability in the United States and quality levels have also become more crucial in today's more skittish and risk averse economic environment.

When the game changed with China’s entrance into the WTO, it’s not surprising that there was an immediate flurry of relocations to take advantage of the situation. More recently, the pattern has leveled off and the situation is changing.

The Boston Consulting Group (BCG), a prominent global management consulting firm, has long studied the relative advantages of manufacturing in countries around the world. According to their analysis, over the next few years, the tide will begin to turn. BCG estimates that the US manufacturing sector could gain between 2.5 and 5 million jobs by the end of the decade. In addition to changes in relative labor costs, they cite low natural gas and electricity prices as major contributors to the changing cost picture. (Again we see the benefits of the surge in unconventional natural gas production.) BCG points to seven industry clusters that may be close to a “tipping point” where they begin to return to the United States (transportation goods, computers and electronics, fabricated metals, machinery, plastics and rubber, appliances and electrical equipment, and furniture).

The US share of manufacturing of certain labor-intensive products may never fully recover. However, a $2 wage is simply not a living wage here, and China and other low-wage areas will likely always have that advantage. For other products, higher productivity and logistics advantages in the United States are growing. In addition, even some of the low wage manufacturing segments are becoming increasingly automated and infused with new technology. When that phenomenon occurs, the advantage shifts back to the domestic market.

Dr. M. Ray Perryman is President and Chief Executive Officer of The Perryman Group (www.perrymangroup.com). He also serves as Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies.
 
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