Manufacturing In Our Favor

Jun 21, 2012

This article first appeared in Business Horizon Quarterly, a publication of the National Chamber Foundation.

There were three related and important manufacturing trends that emerged in 2011:

a)  American manufacturing remained at the forefront of the United States’ economic expansion for the second year in a row and re-established itself as one of the economy’s strongest sectors;

b)  An erosion of China’s manufacturing cost advantages, especially for wages, started to bring manufacturing production back to the United States from China and other low-wage countries, reversing a decade-long trend of outsourcing production overseas; and,

c)  An abundance of domestic shale-based natural gas brought gas prices to record low levels and sparked a new boom in the United States for energy-intensive manufacturing. 

As a result of these trends, American manufacturing in 2011 had its best year in at least a generation by all relevant measures of economic performance: profits, output growth, and employment gains. In fact, it’s possible that we will look back on 2011 as a watershed year that marked the beginning of a great manufacturing renaissance in America. 

Here’s a review of U.S. manufacturing’s strong economic performance in 2011:

1.  Employment - Following a gain of 109,000 jobs in 2010, manufacturing companies added another 233,000 jobs in 2011 and 83,000 more in the first two months of 2012, bringing the total increase in factory employment to 425,000 since the beginning of 2010. These job gains were notable because 2010 was the first year since 1997 that the manufacturing sector added jobs, and the back-to-back gains in 2010 and 2011 marked the first time since 1996 to 1997 that American manufacturing companies added jobs in two consecutive years.

2.  Output – Manufacturing output expanded 4.7 percent last year, which was almost three times the 1.7 percent growth rate of the overall U.S. economy. Industrial activity in 2011 was especially strong in the nation’s manufacturing heartland—Midwest manufacturing output increased by an impressive 8.4 percent, led by strong gains in regional automotive output of 14.8 percent and regional steel output of 14.6 percent.     

3.  Profits – Based on data through the third quarter of 2011, U.S. manufacturing companies are on track to have their most profitable year ever, with annual after-tax earnings estimated at a new record high of $600 billion. Manufacturing profits in 2011 increased by 25.6 percent from the previous record of $477 billion in 2010 and were above pre-recession 2007 profit levels by almost 36 percent. In contrast, annual profits for all U.S. corporations increased just 5 percent in 2011 and are above pre-recession levels by only 14 percent. 

Despite the frequent media reports about an industry in decline, the manufacturing sector was more profitable in 2010 and 2011 than in any two previous years in history. American manufacturing’s notable performance over the last two years is partly explained by the natural recovery of the U.S. economy from the effects of the 2007-to-2009 recession. All the same, there are several emerging trends starting to have a positive impact on domestic manufacturing. 

Reallocation of global manufacturing due to an erosion of China’s cost advantages

In 2010, the U.S. economy started benefitting from the initial effects of a reallocation of global manufacturing from overseas back to the United States. That global shift contributed to the manufacturing sector’s rebound in 2010 and 2011. Surveys of American companies confirm that manufacturing production has returned to the United States in recent years. A quarter of manufacturing companies responding in 2010 reported they returned some or all of their production back to North America from a low-cost country, and 22 percent of companies last year reported moving production home.

Looking ahead, one out of every three U.S. manufacturing companies reported they are planning to research bringing production back home from low-cost locations in 2012. With these plans underway, we can expect the return of manufacturing output and jobs to continue in future years. 

The recent global shift in manufacturing to the United States, also known as “reshoring,” reflects a number of favorable long-term factors that are expected to revitalize America’s manufacturing sector in the coming years. The emerging reshoring trend was recently summarized by the Boston Consulting Group (BCG) in its August 2011 report “Made in American, Again: Why Manufacturing Will Return to the U.S.”

“China’s overwhelming manufacturing cost  advantage over the U.S. is shrinking fast. Within five  years, rising Chinese wages, higher U.S. productivity,  a weaker dollar, and other factors will virtually close the cost gap between the U.S. and China for many goods consumed in North America. While China will remain an important manufacturing platform for Asia and Europe, the U.S. will become increasingly attractive for the production of many goods sold to consumers in North America. As long as it provides a favorable investment climate and flexible labor force, the U.S. can look forward to a manufacturing renaissance.” 

There’s mounting empirical evidence that the manufacturing renaissance predicted by BCG is already underway, based on the survey data reported above, and further supported by documented accounts of dozens of American companies that have re-located manufacturing production and employment back to the United States in the last two years. This emerging reshoring trend will certainly gain momentum over the next five years, but it’s important to recognize that the initial effects of the renaissance have already been felt and were partly responsible for the strong performance of the manufacturing sector in 2010 and 2011.      

 In addition to China’s shrinking manufacturing wage and cost advantages highlighted by BCG, there are additional factors contributing to the reshoring trend, including:

     •     Long delivery times and rising shipping costs
            for overseas production;

     •     Quality control issues;

     •     The physical separation of design and
            production personnel; and

     •     A lack of safeguards on intellectual property
            outside the United States. 

Moreover, crude oil prices have more than doubled over the last three years and are expected to remain at record-high levels in the future. This in turn translates into historically high delivery costs and makes overseas production much less competitive than in previous years. Meanwhile, natural gas prices are falling to historic low levels in the United States, reducing energy costs for domestic manufacturing in many industries. 

Based on the recent changes in global manufacturing costs, the “math of manufacturing” has shifted, and American factories have become increasingly cost competitive. The U.S. has gradually moved from being viewed just five years ago as a high-cost manufacturing country to boasting an industrial sector that can now compete very effectively globally on cost, productivity, quality, and delivery. These advantages have the greatest impact on products destined for sale in the U.S. market.

It’s this new increased competitiveness of U.S. manufacturing that primarily explains why dozens of U.S. companies have moved production and thousands of jobs from overseas back to America in just the last few years. Among these companies are the likes of Caterpillar, Sauder, National Cash Register, Wham-O, Otis Elevator, Outdoor Great Room Company, Buck Knives, Farouk Systems, Collegiate Bead, TapHandles, Calibowls, Sleek Audio Systems, and PRO Charging Systems, among many others.  

The factors that have motivated the initial wave of reshoring back to America will develop at an ever-faster pace in the future, especially the rising costs of labor, land, and materials in China. That acceleration will bring manufacturing production and jobs back home at increasing rates. According to projections by the BCG, the cost advantage of producing most manufactured goods in China will shrink to less than 10 percent by 2015, and that’s without even considering other factors like transportation costs, import duties, delivery delays, and quality issues. Therefore, within three years, and possibly even sooner, it will be cheaper for most U.S. companies to manufacture goods for the American market at home, compared to producing those same goods in China. As the overseas cost advantage disappears, the return of manufacturing production to the United States has the potential to create as many as 3 million new jobs over the next decade. These jobs will arise by reallocating existing production from China and other low-wage countries back to the United States and locating new manufacturing production facilities in America rather than overseas.

Energy-related manufacturing renaissance

In addition to the U.S. manufacturing boom that is being driven by a shrinking wage gap with China, there is another favorable cost-related factor that will contribute to increased manufacturing output and jobs in the United States—abundant and low-cost, domestic shale natural gas. Advanced drilling techniques have been perfected in recent years, unlocking vast supplies of natural gas in previously inaccessible deep shale rock in areas like the Marcellus region in Pennsylvania and surrounding states. Following decades of flat domestic natural gas production, the “shale revolution” has set new annual production records in every year since 2006. The new abundance of domestic natural gas—a 100-year supply by some estimates—has brought inflation-adjusted gas prices to their lowest levels since the late 1990s. 

The shale revolution of cheap natural gas in the United States has completely changed the world energy map and the U.S. manufacturing landscape. As recently as 2005, domestic natural gas prices were among the world’s highest and the United States was considered a high-cost location for energy-intensive manufacturing processes like petrochemicals and steel. Yet, in just the last five years, there has been a remarkable reversal in price thanks to cheap shale gas, and the United States has emerged as one of the world’s lowest-cost production locations for chemicals, nitrogen fertilizers, ethylene, steel, and iron. Consequently, the United States is in the early stages of what promises to be a long-term renaissance of energy-intensive manufacturing, much of it in America’s traditional, rust-belt industries that have been shedding jobs and shuttering factories for decades. In several early signs of a turnaround for energy-intensive industries, chemical manufacturing employment increased in 2011 for the first time since 1997 and primary metal manufacturing (iron and steel) employment increased in two consecutive years (2010 and 2011) for the first time since the mid-1990s.      

Those employment gains will continue because many energy-intensive manufacturing companies have recently announced investment plans to build or expand existing domestic facilities to take advantage of America’s low-cost natural gas. Those companies include:

     •     Dow Chemical (five new projects including
            three new petrochemical facilities and the
            revival of a closed plant);

     •     Royal Dutch Shell (a new $2 billion ethylene
            plant planned for the Midwest);

     •     Nucor Steel (currently building a $750
            million plant to make iron from natural gas
            in Louisiana);

     •     U.S. Steel (recently completed a new $95
            million plant in Ohio to make drilling rigs);

     •     Westlake Chemical (planned expansion of up
            to three existing ethylene plants); and

     •     Siemens AG ($350 million invested in a plant
            to build turbines for gas-powered electricity).
  

Looking forward, all of this construction and investment in domestic manufacturing bodes well for the outlook of America’s energy-intensive manufacturing and will translate into future increases in output, employment, and profitability. In a December 2011 report, “Shale Gas: A Renaissance in U.S. Manufacturing,” PriceWaterhouseCoopers (PwC) predicted that cheap natural gas will spark an energy-related manufacturing renaissance that has the potential to create one million new American manufacturing jobs by 2025. Further, PwC estimated that lower natural gas costs will generate cost savings of $11 billion annually for U.S. manufacturers, which will make them more competitive globally as well as contribute to greater profitability, increased investment in domestic production, and increased employment opportunities.   

This energy-related renaissance in American manufacturing predicted by PwC will complement the revival predicted by BCG resulting from the shrinking wage gap with China. Together, these two forces will serve to revitalize the American manufacturing sector in profound ways that nobody would have predicted even just a few years ago.     

Conclusion

The increased competitiveness of America’s industrial sector in recent years has brought manufacturing production and employment back to the United States and this reallocation of global production is expected to continue in the future. From two parallel boosts to the U.S. manufacturing sector—one wage-related and one energy-related—the reallocation of global manufacturing could possibly create 3 to 4 million new manufacturing jobs in the United States over the next decade. 

The possibility of as many as 4 million new factory jobs being created in the near future is certainly good news for the U.S. economy, and it will allow manufacturing to maintain its historical importance as one of America’s key industries for research, innovation, and high-paying jobs. To be realistic, however, we shouldn’t expect U.S. manufacturing employment to ever return to the levels of the past.

In the long run, going beyond a decade-long renaissance that might add millions of new factory jobs, the same labor-saving, productivity gains that reduced manufacturing employment in the past will once again dominate, as America’s factories innovate to produce an increasing amount of output with fewer workers. Nevertheless, that long-run reality shouldn’t minimize the fact that the U.S. economy will reap tremendous benefits from the twin renaissances now underway, revitalizing an industry that many once predicted would experience a perpetual state of decline. 

A significant benefit of the U.S. manufacturing renaissance is that it will help move America’s industrial sector forward in one area where it already has a strong global edge —technology-driven, modern, advanced manufacturing. As new manufacturing technologies emerge, like computationally engineered materials, 3-D printing, and direct-digital manufacturing, the highly paid, technically-trained workers available in America will be more important than cheap overseas labor for the technology-driven factory floor of the 21st century. With America’s rich history of innovation, research, education, and entrepreneurship, it has the key resources available to maintain its position as one of the world’s largest and most sophisticated manufacturing nations.  

In the coming age of advanced manufacturing, one challenge for America will be to train workers for the new high-wage, high-talent manufacturing environment. There is evidence that some manufacturing companies are currently experiencing shortages for skilled production workers and those shortages could create a drag on the manufacturing renaissance if they continue.  

For the U.S. manufacturing sector to continue its remarkable economic expansion of the last few years, take full advantage of the nascent twin renaissances, and move towards an advanced manufacturing future, it is critical that any shortages of skilled workers be addressed. Fortunately, the issue of training American workers for the new era of advanced manufacturing is getting some well-deserved attention from industry and educational institutions. Indeed, there are a number of training and certification programs being developed to meet U.S. manufacturers’ requirements for highly-trained workers.

Putting it all together, the U.S. manufacturing sector had one of its best years ever in 2011, reflecting a new manufacturing rebound that is now underway and is expected to accelerate in the years ahead. Flush with record-level profits, the manufacturing sector has never been financially healthier than it is today, and the future of American manufacturing has never looked brighter. After years of negative reports about the decline of American manufacturing, it’s now time to recognize and celebrate a great turning point, as America’s industrial sector moves in a new direction that many are now calling a “manufacturing renaissance.”  

NCF Fellow Mark J. Perry is the professor of Economics and Finance at the school of Management at the Flint campus of the University of Michigan. He is also a visiting scholar at The American Enterprise Institute in Washington, DC, where he has been a regular contributor to the Enterprise Blog and American.com. Perry is also the creator and editor of the popular economics blog Carpe Diem.

CASE STUDIES OF RESHORING

To understand the dynamics and decision-making process at the company-level that have resulted in the decision to bring manufacturing back to the United States, here are some case studies:

1. The Outdoor GreatRoom Company - When the Minnesota-based company started in 2003, it found that outsourcing the manufacturing of its outdoor products including fire pits, fireplaces, pergolas and outdoor kitchen equipment to China was more cost effective than manufacturing in the United States. Yet, in 2010, the company brought all of its production back to America. In making its decision, the company cited several key factors: growing frustration with long shipping delays and quality control issues; and greater efficiencies by having production and distribution centralized at company headquarters in Eagan, Minnesota. The company was also motivated to help the U.S. economy by bringing jobs to America that were previously held by Chinese workers. 

2. Buck Knives – The iconic American company has been making hunting knives in California and Idaho since 1902. Around 2000, however, under pressure from big-box retailers to lower its prices, the companystarted outsourcing half of its production to China to lower its labor costs. The company recently made the decision

to gradually move all China-based production back to the United States. Half of Buck Knives’ overseas production has already been moved back to Idaho, with the remainder to be “reshored” over the next few years. In explaining why the company brought production back to America, the company’s chairman reported that Buck Knives suffered from a loss of customer goodwill, and eventually sales, when its products started carrying a “Made in China” label. Now that the knives are “Made in the U.S.A,” customer goodwill and sales have improved dramatically. Other factors that contributed to the company’s reshoring decision were the long lag times for ordering products from China and the frequently changing market conditions by the time the orders arrived from overseas. With production now taking place in Idaho, the company has greater flexibility to adjust production levels quickly to meet fluctuations in customer demand.    

3. Sleek Audio is a Florida-based company that designs, produces and sells expensive, high-end earphones that retail for $250. In early 2010, it decided to move 100 percent of its production from China back to the United States after experiencing the common frustrations frequently cited about manufacturing in China: delivery delays; frequent problems with quality; long and costly trips to China to coordinate production; rising shipping costs; and large company cash investments in inventory that can take up to six months to produce, ship 8,000 miles, and clear customs. After moving production from low-wage China back to the United States, Sleek Audio compensated for the higher U.S. hourly labor costs by pursuing a common “reshoring” strategy: it redesigned its products with labor content in mind and an emphasis on minimizing actual assembly time. In other words, companies that reshore frequently “innovate around cheap labor” by finding less labor-intensive methods of production and instead using automation, robotics, and advanced technology to minimize labor costs.

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