October 17, 2007    Volume 14, No. 18

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Is Manufacturing In The United States Toast?
Michigan Manufacturing Technology Center's Dan Luria Analyzes The Numbers


Since the 2000-2001 recession, manufacturing output has grown much more slowly than in any previous recovery, and even that growth might be over-estimated because government data do a poor job of capturing how much more foreign content there is in "American" products. If so, then U.S. output is barely higher than it was in 2000.

A recent study by the Kalamazoo, Mich.-based W.E. Upjohn Institute for Employment Research shows how output -- defined as value added, or sales minus the cost of purchased inputs -- could be overstated. A $10-million pump manufacturer that buys $5-million worth of shafts, seals and motors would have value-added of $5 million.

But what if some of those shafts, seals and motors get re-sourced from U.S. to offshore factories, and the same inputs now cost $4 million? Magically, the pumpmaker's value-added -- which is how government data measure output -- rises from $5 million to $6 million. In fact, the value of goods and services that the pumpmaker produced in the United States didn't change.

The Upjohn Institute study estimates that U.S. manufacturing output is probably growing 0.2 percent to 0.5 percent less per year than the government's statistics say it is. That's significant, because even those statistics show a pretty weak recovery: the Federal Reserve Board's index of U.S. industrial production in June was up just 13.4 percent from its 2002 level -- barely a 2.5 percent annual improvement after a plunge from 2000 to 2002.

If that 2.5 percent growth rate is really, say, 2.2 percent, then production in 2007 is up just 11.5 percent from 2002, and less than 6 percent from 2000.

In other words, over a period in which U.S. GDP has risen by nearly 25 percent, more than three-quarters of the increase in demand for manufactured goods would have had to have been satisfied by a rise in net imports.

Other pundits tell us that it's somehow inevitable that manufacturing employment must decline, thanks to a combination of rising productivity and the growing share of output made in low-wage nations. A new study by the International Labour Organization (ILO) compiles 1990 and 2005 manufacturing jobs data for every country. On a global scale, productivity is allowing output to grow by about 4 percent a year with no increase in jobs. Interestingly, most countries -- the rich ones through policy, the poorer ones through big additions to capacity -- have maintained or grown their factory job sector. A relative handful of countries -- led by the United States, Britain, Germany and Japan --have borne almost all of the losses. Between 1990 and 2005, Britain lost 43.5 percent of its manufacturing jobs (2.6 million); Germany lost 31 percent of its manufacturing jobs (3.6 million); the United States lost 24 percent (5.09 million); and Japan lost 22 percent of its manufacturing jobs (3.36 million).

The New York Times' Thomas Friedman's best-selling book "The World is Flat" describes globalization as a straight-up blessing, a rising tide that lifts all boats. Apparently not. Not only has the United States shed between four and five million manufacturing jobs (depending on the survey), but there are 35,000 fewer U.S. factories than there were eight years ago. This is not some slow, productivity-driven event like the 85 percent drop in farm jobs from 1900 to 2000, but a largely trade-driven impact. As we will see, only half the problem is that other nation's manufacturers are "beating" ours; the other half is that, in industry after industry, U.S.-based large-firm customers -- think GM, GE, Wal-Mart -- are telling their American suppliers to increase their "offshore footprint."

Reluctantly or not, many suppliers are listening and sourcing more work offshore. Since 2002 corporate profits have doubled, matching their highest share of GDP ever in 2006. Yet government data show domestic investment growing more slowly than in any previous postwar recovery. Corporations report an 18- to 20-percent annual increase in their total global investments. That means that companies are investing more outside the United States and less here at home. And that, in turn, helps to explain why more than 40 percent of the imports into the United States, which totaled $1.8 trillion (or 13 percent of GDP) in 2006, weren't from "foreign competitors," but from U.S.-based corporations' facilities and contractors offshore.

There are, and will always be, some products that need to be made close to where they are consumed because they are too bulky to ship, or because it is too risky to have long supply lines. Unfortunately, most of the products consumed in North America are easily shippable, and -- except for the largest items -- air freight is a viable option. Just look at UPS's and FedEx's exploding Asia business. A great July/August 2007 Atlantic Monthly article called "China Makes the World Takes" shows how laptops ordered online in the U.S. today will be assembled in China tomorrow and be FedEx'd to Long Beach the day after that. A lot is going to China and other low-wage countries.

Unless something is done about this situation, then onshore manufacturing is sure to shrink further -- perhaps quite soon and perhaps quite dramatically.

What can be done? One possibility is that many more U.S. manufacturers could contract out more of their work to low-wage country producers. But managing a far-flung supply chain is expensive, and hence probably not practical for smaller companies. Another possibility is for U.S. policy to change. The United States could get much more aggressive with respect to foreign subsidies, currency practices and labor standards, signaling that it will not continue forever to act as the buyer of last resort. The government could move toward more regulation of U.S.-based multinational corporations using the tax code to signal a preference for onshore production and onshore purchasing. These ideas, while still ridiculed as "protectionist" by most economists, have won new respectability in recent months through the work of the Horizon Project (see www.horizonproject.us).

But don't hold your breath.

There's still a strong bipartisan consensus in Washington that it's anti-business to get in the way of "free trade." This means that -- unless something drastic changes in American politics -- manufacturers are on their own.

Manufacturers have to figure out whether and how their companies can meet the low prices of low-wage offshore producers and, for products where they can't, decide whether to move the work offshore or exit the business.

Economists at the Michigan Manufacturing Technology Center (MMTC) believe that the data show that much of the work that manufacturers are tempted to move offshore can be performed profitably in the United States. But manufacturers facing this flat new world need to know what it will take to stay, fight and win. Manufacturers need to know:

1. By how much do prices (and therefore costs) have to come down to keep business?

2. Which actions will drive down costs the most to have a better shot at competing against low-wage competition?

Consulting firms report differences between on- and offshore parts ranging from 30 percent to as much as 50 percent. But at MMTC, we have concluded that the true landed cost advantage of a typical low-wage offshore producer is really more like 17 percent. The two charts on page nine show our analysis, comparing a $10-million U.S. facility to a $10-million low-wage-country (LWC) competitor. But those are just averages. The low-wage country landed cost advantage could be 17 percent, but it can also be 7 percent, 27 percent or 37 percent depending on the type of business.

Just as important: How much of the cost gap could be eliminated by increasing productivity? By reducing inventory? By redesigning products? By a further drop in the value of the U.S. dollar? What will it take to get costs down below the 100.00 index value of that typical low-wage-country producer?

Even though the average U.S. manufacturer's costs are about 17 percent higher than the average low-wage-country manufacturer's landed cost, 20 percent of U.S.-based manufacturers already have lower costs than their low-wage-country competitors (see below). In some industries, 35 percent of U.S. plants are lower-cost. Just as important, another 30 percent of U.S. manufacturers are within striking distance of LWC producers' average landed cost.

-- Daniel Luria is Research Director at the Michigan Manufacturing Technology Center

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