Tuesday, February 28, 2012

Manufacturing Renaissance

Politicians have been falling over themselves in recent months to come up schemes to lure manufacturing jobs back to the United States. They needn’t worry: Adam Smith’s invisible hand seems to be doing the work for them. BCG analysis shows that within the next five years the United States will undergo a “manufacturing renaissance.” How could this be? Well, there are a number of factors at play, but the main reason is rising wages in coastal China.

Since China joined the WTO in 2001, it has essentially been the default location for companies looking for cheap overseas workers. In addition to low labor costs, China also has a (relatively) fixed currency, a growing domestic market, good infrastructure, and access to critical Asian supply chains. Those elements will insure that China remains an economic juggernaut in the short-term. But for American companies looking to set up shop in China in order to export goods back to the North American market, the cost advantages are fading fast. Chinese wages, while still far below those paid to American workers, are rising at about 17 percent a year. Wages have skyrocketed so dramatically in eastern and southern China that many domestic manufacturing firms are relocating to inland parts of the country. The problem for those companies then involves attracting talented managers and engineers to run the plants. For American firms, relocating to other parts of China is not usually an option. Inland China has poor infrastructure (which means even longer lead times) and is culturally very different from the Westernized megacities of Shanghai and Shenzhen. Building a plant in China is a long-term project, and so for companies in the business of manufacturing goods where wages account for less than 30 percent of the total cost, such as appliances, construction equipment, computers and plastics, America looks like a good place to build future supply chains. After taking into account American productivity, wage rates in cities like Shanghai will only be about 30 percent lower than wages in low-cost states. Considering that wages only account for 20-30 percent of total costs for these products, China will hold a cost advantage of only 10-15 percent, BCG forecasting shows. After taking into account inventory and shipping costs, that advantage effectively disappears. The U.S. states that will benefit most are those with flexible work rules and low wages. BCG reports that Mississippi, Alabama, and South Carolina are some of the cheapest places in the developed world to do business.

With all this happening, it begs the question: what can U.S. politicians do, if anything, to nurture this process? BCG recommends implementing robust training programs, in areas like wielding, to ensure workers are ready for the jobs.

It is wise to point out that the cost gap between the U.S. and China is still large. BCG’s projections are based on historical trends. The fact that wages are rising at a rate of 17 percent this year does not necessarily mean that wages will rise at that rate over the next number of years. In addition, for labor intensive production goods, like shoes and clothing, the overall cost advantage will remain with China.

We’ll have to wait to see whether the jobs actually materialize.
- Read more about it here: BCG Perspectives