Friday, February 11, 2011

A Lean, Mean, Manufacturing Machine

The US manufacturing sector is one of the most competitive in the world.

I know, it sounds like a line that a politician would say on a stump speech in some midwestern factory. But actually, for the first time in my career as an economist, I can write that and actually believe that it’s true.


First, as I pointed out earlier, manufacturing in the US has been doing relatively well, both compared to its past (lousy) performance and compared to the rest of the US economy. But the US manufacturing sector also looks quite healthy compared to other developed countries. The following chart illustrates.

Manufacturing output in the US is nearly back to where it was in 2006. That’s generally not true for other developed countries (Korea being an obvious exception in the chart above), which are typically still 10 or 15% below their 2006 levels.

Why is that? The red bars in the graph above contain an important piece of the explanation. Unit labor costs – that is, the amount that companies have to pay to labor for each unit of output that they manufacture, and which depends on both labor compensation and labor productivity – actually fell in the US from 2006-09. In nearly all other developed economies, labor costs per unit of output rose during that time. (Note that the BLS database that has these international comparisons won’t contain 2010 figures for several more months, unfortunately.)

The measures of labor cost shown above are expressed in local currency terms, and thus do not reflect any impact of changes in exchange rates. But the fact is, as illustrated below, the US dollar has generally been depreciating over the past several years. (And yes, most of this depreciation pre-dates QE2, so don’t bother trying to blame it on that.) That means that when multinational companies are comparing the cost of production in the US to the cost of production in other countries, the US has been looking like an increasingly better deal.

This trend depreciation in the dollar just serves to magnify the way that unit labor costs in the US are looking lower and lower compared to other countries.

The End of Offshoring?

This data matches with the stories that we’re increasingly hearing, as well as my own personal experience in talking to managers and executives of multinational firms: companies are increasingly finding that it makes business sense for them to keep their remaining production in the US. (Or even move some of it back to the US.) For example, the Seattle Times recently reported that Boeing is now regretting its decision to aggressively push much of the production of its new 787 Dreamliner jet overseas. It turns out that they would have been better off leaving more production in the US.

My suspicion is that nearly all of the low-hanging fruit that could be gathered by shifting production from the US to low-cost countries like China has already been picked. Companies for which it made sense to shift production to other countries have already done so. Most of the manufacturing left in the US is, by and large, stuff that I think will probably stay in the US. (Yes, of course there will still be incidents and examples to the contrary, but I'm talking in general terms, and you know what I mean.)

The fact is that the manufacturing that remains in the US in 2011 is incredibly efficient, and thanks to a combination of productivity gains, very weak wage growth (terrible for workers but great for US manufacturing competitiveness), and a favorable exchange rate, is highly competitive with manufacturing in other countries – even low-cost countries like China. And that's an important part of the reason that US exports to China have been growing so rapidly. (Of course, it doesn't hurt that China's economy is so big and growing so fast, either.)

A Lean, Mean, Manufacturing Machine

I’ve never been one to particularly bemoan the shift of manufacturing from the US to low-cost countries. (Blame my training in international trade for that.) For the most part, I think it made sense, was inevitable, and was probably a good thing in the long run, both for the individual companies involved as well as for the US economy as a whole. But there’s no doubting that the transition has been a terribly painful process for a lot of people. (And I have always thought that we needed to do more for those who were negatively impacted – both directly and indirectly – by the offshore relocation of US production.)

However, I now think that the US economy is starting to see the benefits of the shift of large segments of US manufacturing to other countries over the past 15 years. The manufacturing that remains in the US is incredibly competitive, and, in my opinion, is probably largely here to stay. And that certainly provides an encouraging bit of foundation on which the US economy can hopefully build a lasting recovery.

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