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Vectra Bank Expert Jeff Thredgold

Renaissance Manufacturing

Written by Jeff Thredgold, President, Thredgold Economic Associates

February 21, 2012

Last week’s Tea Leaf  talked about the rebound in U.S. manufacturing that is both underway and likely to continue.  The American manufacturing sector is expected to add jobs in 2012 for the third consecutive year, after years of painful job eliminations.  The Tea Leaf also focused on some of the “common wisdoms” about manufacturing, U.S.-made auto quality, and other issues that further inspection shows to be misguided.

Another common wisdom…

…the United Stares and other major manufacturing nations simply cannot compete with the extremely low costs of “doing business” in China when it comes to manufacturing… 

…times they are a changin’

The Boston Consulting Group (BCG) in a recent study of global manufacturing noted that Chinese wage rates are rising at about 17 percent per year, while the Chinese currency, the yuan, continues to rise in value, significantly reducing that nation’s prior competitive advantage.  At the same time, a powerful shift is underway within the U.S. 

The BCG study noted that in 2000, China’s average wage rate, adjusted for productivity, was 36% of that in the U.S.   By the end of 2010, that gap had shrunk to 48%, with a BCG estimate that it will be 69% in 2015.  To note Hal Serkin of BCG, “the spread is getting down to a smaller and smaller number.  Increasingly what you’re seeing (in corporate boardrooms) is a discussion not necessarily about closing production in China but about ‘where will I locate my next plant?’”

Simply More Competitive
More flexible U.S. work rules, lower labor and land costs, higher global fuel and transportation costs, and financial incentives from many local communities and states have made the U.S. much more competitive as a low-cost base for supplying the American market (The Agurban).  Consulting firm AlixPartners reported that in 2005, Chinese-produced parts arrived at U.S. destinations an average of 22 percent cheaper than comparable products domestically.  By the end of 2008, the average price gap had dropped to 5.5 percent (Jones Lang LaSalle).  That differential has no doubt been eliminated since then.  It brings into question the need to justify the risk and complexity of producing halfway around the world.

In addition, the issue of Chinese piracy of technology, theft of intellectual property, and massive turnover of key personnel makes life difficult half a world away.  Chinese authorities talk of the need to protect global patents and limit illegal and counterfeit products…

…good luck with that one

A story in Time magazine notes that the average manufacturing wage in China is still only about $3.10 hourly, compared to $22.30 in the U.S.  In the eastern part of China it is up to 50% more than that.  For the vast majority of companies, whether small, medium-size or huge multinationals, the decision about where to produce a product is always driven by multiple factors, of which the cost of labor is but one.  “For lots of companies over the past two decades, the disparity was such that labor costs often drove the decision,” notes economist Daniel Rosen, the China director and principal of the Rhodium Group, a New York city-based consulting firm.  “Now, increasingly, that’s no longer the case.”

In the Neighborhood
As one might expect, China has many competitors when it comes to the low wage game.  Such nations as Vietnam, India, Laos, and Cambodia are attracting some of the cheapest labor manufacturing operations.
At the same time, China will remain a dominant player.  The enormous size of its population, its rising consumer affluence and spending power, and its stature as an enormous market of opportunity for companies to sell products from A to Z won’t change.

A Vast Chinese Market
It is one thing to 1) manufacture goods in China with the intent of then shipping those goods to the U.S. or Europe, and 2) produce with the intent of selling such goods in a rapidly expanding Chinese consumer market.  The second option will drive much of the global investment into Chinese manufacturing in coming years.  Rapidly expanding Chinese wages, including a sharp increase in the minimum wage in recent years, bodes well for rising demand for Chinese-produced goods across China.  Such rising affluence also boosts opportunities for U.S. and other manufacturers and service providers (such as Coke and KFC) to establish or expand operations in China.

The same Time magazine article noted that in a survey eight years ago, 75% of the members of the American Chamber of Commerce in South China were focused mainly on exports.  Today, 75% of such members are primarily focused on serving the rapidly expanding Chinese market.

We will talk in coming weeks about the rising role likely to be played by Mexico as an alternative to Chinese and Asian production of goods destined for the U.S.  Given the rise in transportation costs…can you say $100+ oil?...Mexico is likely to gain more U.S. manufacturing, as will many communities across the U.S. 

The fact that goods produced in Mexico can reach most of the U.S. within a day or two…versus at least 21 days by container ship from China…is a significant advantage (The Agurban).   At the same time, the voracious violence between Mexican drug cartels, the police, and the military, combined with limited skills availability and poor infrastructure, will limit Mexican manufacturing gains.

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