Sunday, December 1, 2013

Cautiously optimistic about US Manufacturing

The revival of the U.S. manufacturing sector has been sufficiently robust to convince many Americans that a factory renaissance is under way.

Boston Consulting Group predicted that increased exports promoted by stagnant U.S. wages and lower energy costs will result in 2.5 million to 5 million new jobs by 2020 and a reduction of the 7.3 percent unemployment rate by two to three percentage points.

I also believe manufacturing is likely to continue its expansion. However, big gains in exports and jobs are far less likely. In 2010, President Barack Obama set a goal of doubling U.S. exports in five years, but he didn’t specify which countries would buy them.

Deleveraging by global financial institutions and by U.S. consumers has been under way for five years. After past financial crises, this process of unwinding debt has taken about a decade. So despite the huge fiscal and monetary stimulus, deleveraging and the resulting slow growth of about 2 percent a year in U.S. real gross domestic product are likely to persist for another five years.

In this environment, the traditional big buyers of global exports -- the U.S. and European countries -- have muted demand for everything.

The U.S. manufacturing trade deficit remains at the high levels it reached early in this recovery. The total trade balance has deteriorated as the revival of consumer spending favored imports. Although exports are up 40 percent since 2009, they have leveled off recently and have a long way to reach the goal of doubling by 2015.

Manufacturing employment has revived, to 11.96 million in September, from a February 2010 low of 11.5 million. Still, that is a tiny increase compared with the 19.6 million peak in June 1979. Manufacturing output has picked up along with the economy, though with the sluggish recovery, it’s still below the 2007 peak.

More important, productivity, as measured by output per employee, has resumed its robust long-term 3.4 percent annual growth rate. As a result, the gains in manufacturing jobs look more like an interruption in the long-run decline than a decided upturn.

As measured by output per hour worked, manufacturing productivity has been rising at an annual rate of about 2 percent, far faster than total nonfarm productivity, which was flat in the second quarter compared with a year earlier. So, with compensation rising at about the same rate -- 1.7 percent in manufacturing year over year, and 1.6 percent for all nonfarm employment -- unit labor costs in manufacturing (the ratio of compensation growth to productivity growth) actually declined 0.4 percent year over year, though it rose 1.6 percent for the nonfarm sector as a whole.

Wage increases have been rising more slowly than the consumer price index, which means real wages are falling. The good news is that falling unit labor costs, the result of low wage increases in a high unemployment economy and significant productivity growth, are retarding manufacturing output prices along with export prices.

Nevertheless, U.S. real wages would need to drop much more than is likely in coming years to be competitive with those prevailing in China and other developing countries. China has increased minimum wages about 25 percent over the past year in the hopes of creating more consumer purchasing power as the country shifts from an economy led by now-weak exports and now-excessive infrastructure spending to a domestic demand-led economy. Also, with Chinese labor costs jumping, low-end manufacturing is shifting to lower labor-cost countries such as Bangladesh, Vietnam and Pakistan; Chinese production is moving to higher technology exports such as telecom equipment and computers.

The result is that labor-intensive products such as textiles and shoes may only account for about 15 percent of Chinese exports. Also, even if Chinese hourly compensation rose at the extremely high rate of 25 percent a year, it would still take 15 years for it to climb from the $1.15 level in 2009 to the $35.53 an hour average U.S. compensation in manufacturing in 2011.

With these labor cost differences, it’s not surprising that the U.S. share of global manufactured goods exports dropped to 11 percent in 2011 from 19 percent in 2000. Meanwhile, the European Union’s share fell to 20 percent from 22 percent, but China’s portion leaped to 21 percent from 7 percent. Today, U.S. exports to China only represent 20 percent of Chinese exports to the U.S.

Of course, global competitiveness in manufacturing isn’t only affected by labor costs. Logistics play a large role, tool. After the March 2011 earthquake and tsunami in Japan and the subsequent supply chain disruptions, many importers in North America and Europe looked for closer sources. But that interest wasn’t enough to overcome huge labor and other cost differences and cause large shifts of production to the U.S. and Europe. Instead, the disruption benefited low-cost producers, notably Mexico.

Infrastructure is another concern. Anyone who has spent three hours in traffic getting from the Sao Paolo airport to downtown has a first-hand understanding of Brazil’s deficiencies. Then there is government bureaucracy and the accompanying corruption that adds to costs in developing countries. India insists that big-box retailers such as Wal-Mart Stores Inc. must buy from local suppliers as a condition for opening stores. Wal-Mart has thrown in the towel on expansion.

China’s new leaders are trying to curb rampant corruption among Communist Party higher-ups, as exemplified by the recent trial and conviction of one-time party rising star Bo Xilai.

Nonlabor costs are important. Boston Consulting Group estimated that this year, manufacturing labor costs in China are only 13 percent of those in the U.S. but the costs of materials, parts, containers, packaging and so on are 74 percent of those in the U.S. That means total costs are 93 percent of the U.S. average. That’s up from 82 percent in 1982, when Chinese labor costs were 7 percent of compensation for U.S. manufacturing workers.