If I had told you in the summer of 2009 that America’s long-suffering manufacturing industries would lead the lackluster recovery from the Great Recession, you probably would have wondered what I was reading—or smoking.
I would have been correct, however. As a June 1 report from the Institute for Supply Management (ISM) noted, May 2011 marked the 22nd consecutive month in which U.S. manufacturing expanded. Exports have driven much of the growth. Last year, for example, U.S. exports increased more than 20 percent, according to the Census Bureau, and some 85 percent of those exports were manufactured goods.
It comes as no surprise that manufacturing employment also is on the rise, with related jobs increasing last year for the first time since 1997.
The good news about U.S. manufacturing is no fluke. For reasons I will explain below, the manufacturing renaissance should continue for years to come.
AWAY FROM THE RUST BELT
This does not mean it will be smooth sailing. The same ISM report that noted growth in the manufacturing sector for 22 consecutive months also showed a slowdown in the May purchasing managers index (PMI), which declined more than 10 percent from April, while its manufacturing employment index also suffered a decline. The Bureau of Labor Statistics confirmed this just a few days later, reporting a net loss of 5,000 manufacturing jobs in May, amid a modest gain of 54,000 jobs overall. Despite the May job losses, the trend line is encouraging—and clear. What’s also clear is that all U.S. manufacturers and manufacturing locations won’t benefit equally from the revival.
Although much has been made of the improving fortunes of America’s automakers, for example, U.S. manufacturing continues to shift from the highly unionized Rust Belt to the lower-cost South. This moves manufacturing’s center of gravity to such places as Chattanooga, Tenn., where Volkswagen just opened a new $1 billion factory; Madison, Miss., where the French automotive parts supplier Faurecia recently opened a 180,000-square-foot plant to supply a nearby Nissan (NSANY) factory; and Charlotte, N.C., where Mitsubishi Nuclear Energy Systems, which builds nuclear power plants and components, is locating a new engineering center.
While it’s important to herald America’s manufacturing renaissance, we also must remember that the U.S. has remained a manufacturing powerhouse, even as manufacturing employment took a nosedive, plummeting from a peak of 19.6 million in 1979 to 15.3 million in 2002, 14 million in 2005, and roughly 12 million today. Dramatic U.S. productivity gains enabled U.S. factories to increase output while reducing payroll. So, while China accounted for 19.8 percent of worldwide manufacturing output in 2010, the U.S. accounted for 19.4 percent.
Why the 22-month increase in manufacturing? The answer is simple: the rising cost of manufacturing in China.
CONVERGING LABOR COSTS
Production worker wages are climbing in China at 15 percent to 20 percent a year due to a mismatch between the supply of skilled labor and the demand for it. In China’s industrial heartland—the Yangtze River Delta region, which includes the provinces of Shanghai, Jiangsu, and Zheijang—productivity-adjusted costs are rapidly converging with the costs in America’s lowest-overhead states.
Looking ahead four or five years, after adjusting for the significant productivity advantage of U.S. workers—who, in many cases, produce three times the output of their Chinese counterparts—total labor expenses in Chinese cities such as Shanghai and Tianjin will be just 30 percent lower than in the lowest-cost U.S. states.
Since wage rates account for 20 percent to 30 percent of a product’s total cost, this will make manufacturing in China just 10 percent to 15 percent cheaper than manufacturing in the U.S. With the value of the yuan continuing to increase, the total cost advantage will drop to single digits after businesses factor in inventory and shipping costs—with productivity-adjusted labor costs effectively converging by 2015 or so.
This will make states such as Alabama, Louisiana, Mississippi, North Carolina, South Carolina, Tennessee, and Texas—with their competitive wages and flexible work rules—increasingly attractive as low-priced manufacturing hubs for the North American market.
In fact, these states are becoming some of the cheapest locations in the developed world for manufacturing. That’s why European companies such as Volkswagen are building plants there.
For some companies, the economics already have reached the tipping point.
BRINGING BACK PRODUCTION
Caterpillar (CAT), for example, announced last year that it planned to build a new 600,000-sq.-ft. hydraulic excavator manufacturing facility in Victoria, Tex., thanks to the area’s proximity to transportation and the company supply base. When it becomes fully operational, the plant is expected to employ more than 500 people and will triple Caterpillar’s U.S.-based excavator capacity. Caterpillar has another new plant in North Little Rock, Ark., and has announced plans to build still another in Winston-Salem, N.C.
Similarly, NCR (NCR) announced in late 2009 that it was bringing back production of its ATMs to Columbus, Ga., in order to decrease the time to market, increase internal collaboration, and lower operating costs.
The bottom line is clear. With rapidly rising wages in China, critical shortages of skilled workers in many of China’s lower-cost regions, and the higher productivity of U.S. workers, many companies are finding that it makes sense to manufacture goods for America in America.
So what should executives do?
First, don’t write off China as a highly desirable manufacturing location. While more goods sold in the U.S. will be "Made in the USA," China—as the largest and fastest-growing developing economy in the world, with a rapidly growing middle class and a population more than four times America’s—will remain a top overseas market and a key manufacturing location. Although other low-cost countries, such as Vietnam, Thailand, Cambodia, and Indonesia, will attract some manufacturing from companies seeking wage rates lower than China’s, these countries lack the supply base, infrastructure, and labor skills to absorb much of China’s manufacturing. So don’t even consider abandoning China. The new paradigm will be to manufacture in China and the U.S., not either/or. It’s all about where to put the next plant. China-based plants will be busy serving China and other export markets. The U.S. may prove the best place for the next plant to serve the North American market.
Second, differentiate between product lines. Executives also need to understand that many products intended for the U.S. market should still be sourced from China. Products that require less labor and are created in modest volume—especially heavy expensive-to-shop products, such as household appliances and construction equipment—become strong candidates to shift to U.S. production. Labor-intensive products made in high volume, such as textiles and apparel, remain strong candidates for manufacturing overseas.
Third, consider total cost. Some executives make the mistake of comparing "average" labor costs for Chinese production workers with those in the U.S. But averages can deceive. Although wages remain much lower in China, they don’t reflect the full cost of doing business or range of decisions that companies have to make. Executives planning a new factory in China to make products for sale in the U.S. need to look at all the expenses. They are likely to find that, for many goods, China’s cost advantage will shrink too much to bother with—and that’s before taking into account the added expense, time, and complexity of long-distance management, logistics, and quality control.
Those who have been writing U.S. manufacturing’s obituary need to recall Mark Twain’s famous "last" words: "The report of my death was an exaggeration."