Manufacturing- The American Prodigal Son?

Christopher Steele – President, CWS Consulting Group LLC , Chris.steele@cwsgrp.com and twitter at @cwsgroup

 

According to current common knowledge, the American manufacturing sector is dead. It all picked up wholesale and moved overseas some time ago due to cheap labor there and bad regulation here. Of course, just about all common knowledge is eventually proven to be false, and so it is with the assertion above. Nonetheless, the other great piece of foolishly optimistic common knowledge – that offshoring has been a failure and that all manufacturing is just about to return to the developed nations of the world – is just as wrong.

 

The fallacy does originate from a few interesting theories and hypotheses, all of which seem to take a grain of truth and stretch them to a rosy tomorrow. Here are a few of the major themes:

 

The Small World Proposition
When compared to the CPI or just about anything else in the economy, fuel costs grew at an extraordinary rate from 2003 to 2008. Just as the CPI grew about 25-30 % over this period, diesel fuel prices climbed over 3 times as fast. This divergent growth trend backed off slightly in 2009, but resumed again in 2010 when the economy showed just the slightest hint of a partial recovery.

 

From the data above, one can postulate that we are running out of cheap and easy fuel at exactly the moment that the developing world is experiencing a growth spurt, instantly pegging demand high. As a result, skyrocketing transportation costs will begin to offset any benefits of offshore cheap labor. Hence, we will need to once again produce goods closer to where they will be consumed, thereby resuscitating the manufacturing sector.

 

The Declining Labor Arbitrage Theorem
There was a time where the movement of an assembly job from North America to China meant a labor savings of about 80% or more. This more than offset any issues raised by the difficulty of managing a distant supply chain, running the risk of extended production timeframes, or indeed the inefficiencies of using labor that wasn’t as well trained or experienced.

 

However, just as pouring hot water into a glass of cold will raise the temperature, labor demand has resulted in double-digit wage inflation rates in China and India. The declining labor arbitrage theorem states that this wage escalation has begun to affect the overall cost to produce overseas and that manufacturing will balance back homeward.

 

The Demand Meets Supply Hypothesis
Still another school of thought says that as the Chinese, Indian, and Vietnamese people become more prosperous, they will develop the acquisitive tastes which have typified western economies for the past six or seven decades (or more). This simple uplift of the demand side of the equation will overwhelm the Asian production base and will force American and European factories to come out of mothballs or to be rebuilt anew to meet this titanic new market need. At the very least, Asian plants will need to be customized to Asian tastes, and there will no longer be capacity to produce for the western world.

 

However
But the funny thing is, we haven’t completely lost the manufacturing sector in the developed world, nor have we completely mothballed it. We have certainly lost ground due to all of the items listed above. The newer investments in capital and machinery overseas will also provide a temporary advantage.

 

However, manufacturing and production do and will continue to make up a significant part of local and regional economies of just about every developed country. To fully outsource this capability is not only foolish, it is probably completely impossible. Perishability, customization, prototyping, just in time and other requirements make local production capacity essential.

 

This much is true: The developed nations will no longer be the sole manufacturing powerhouse that they once were. Industrial capacity was once the key asset that concentrated wealth in selected parts of the world. We will no longer be this monolithic industrial supplier, but neither will we be completely without manufacturing. Now that global production is more broadly based however, we will need to better understand what capabilities we will need to retain, which can move, and how to wisely manage this balance.

 

Incentives (tax credits, grants, training, etc) are some of the most powerful tools governments can use to try to attract businesses. But, what really constitutes an incentive? Does it have to be financial? What is the best way of influencing a corporate decision? And when can it be good public policy?

 

Answers to these questions and more next month.