The Midwesterner: Reshoring, and its discontents

By Richard C. Longworth

Manufacturing may be coming back to the Midwest. Whether that's good news or bad news depends on the reasons why.

A flurry of recent reports says that "re-shoring" has begun. This means that American manufacturing jobs that had been off-shored to Mexico, China, or other competing economies may be returning to the United States. At the least, according to these reports, the breakneck pace of off-shoring is ebbing.

According to University of Chicago political scientist Gary Herrigel, we're entering a new economic era: "the post-off-shoring manufacturing America."

There have been rumblings of this re-shoring for some time. It seemed logical that some lost jobs would come back, as rising oil prices made it more expensive to ship from China, or as Chinese and Mexican wages grew. There were reports that some Chinese factories were producing sub-standard goods.

But so far, most of this has been anecdotal, perhaps wishful thinking. If re-shoring were a real trend, solid proof was lacking.

Manufacturing output in the US fell 15 per cent when the recession hit. Since then, manufacturing has recovered faster than the rest of the economy, but from this extreme low point. Whether it will ever return to pre-recession employment is doubtful.

If it does, we're going to need a lot of re-shoring. Recent reports [PDF], mostly by the Boston Consulting Group, say this may be happening.

According to this report, re-shoring will help create 3 million new jobs in the United States over the next decade and will slash this nation's overall trade deficit and its deficit with China.

There are various reasons for this, according to a Brookings Institution study entitled "Why Does Manufacturing Matter?" This study cited "the increased importance of just-in-time delivery, rising oil prices, longer shipping times, rising wages in coastal Chinese cities, intellectual property leakage, the desire to create innovation hubs, and multiple decades of offshoring experience now pointing to the conclusion that actual long-term cost savings may not be as large as initially anticipated."

Specifically, the report suggested that:

• American management is finding that doing business in China involves more time and travel than may be worth it.
• Communication between American home offices and Chinese suppliers is hard and expensive.
• Quality problems exist and are hard to solve at great distances.
• Customers in the US need reliable and fast deliveries, not always possible across supply chains spanning thousands of miles.

There's another reason, and this reason may indicate that the cure is worse than the disease. According to various reports, American companies can no longer save money by off-shoring production because of the "the convergence of wages between the United States and China."

What this means is that Chinese factory wages are going up and American factory wages are going down. They're still far apart, to be sure, but they're closer than they used to be, to the point that it may no longer make sense for American firms to off-shore to China solely to take advantage of low wages there.

This should be no surprise. In 1948, the late Nobel Prize-winning economist Paul Samuelson proposed the "factor price equalisation" theory. This theory said that if an item can be made in one place for high costs and in another place for low costs, these costs will meet over time somewhere in the middle. Put another way: if a factory worker in Milwaukee is making something that can be made about as well in Shanghai, and if the Milwaukee worker is getting $20 per hour and the Shanghai worker $2 per hour, sooner or later they'll both make about $10 or $11 per hour.

That assumes, of course, that the Milwaukee worker's job won't be out-sourced immediately to China. This didn't happen in 1948, when Samuelson wrote his theory, although he assumed the workers were in industries that competed with each other. These days, the Milwaukee job is probably already gone. If it's coming back now, one reason is that the Milwaukee worker is ready to work for much less than his old $20 per hour wage. At the same time, Chinese wages have been rising, especially in the industrial heartland along the country's eastern seaboard.

Clearly, this is good for the Shanghai worker, who sees his standard of living rising. It's not so good for the Milwaukee worker. Granted, he has a job. But it doesn't pay as much as his old job did, lowering his standard of living.

It's also not so good for his family, because it's lost its middle-class way of life. Nor for the local auto dealer, where the worker can't afford to buy a new car every two years. Or for the grocery store, where he's only buying food on sale. Or, for that matter, for the entire economy, which has relied for years on workers who once made good wages and no longer do so.

According to the Boston Consulting Group, this convergence has just begun. Chinese wages are rising about 17 per cent per year, while American wages are flat or falling. Ten years ago, the average Chinese worker made only three cents for every dollar that Americans earned. That's up to nine cents now and is projected to go to 17 cents by 2015.

This still sounds like quite a gap. But the Consulting Group said Chinese manufacturing productivity is still only 29 per cent of U.S. productivity (though this Chinese figure also is rising.) That means that American factories still get triple the bang for their wage buck. In addition, wages generally account for a quarter or less of total costs. Put this all together, and the Chinese wage advantage begins to vanish.

Still, as the report said, "this wage convergence is a mixed blessing. This sort of 'race to the bottom' is problematic if one takes the view that a key purpose of an economy is to provide family-supporting jobs."

Herrigel, the Chicago professor, said this combination of converging wages, coupled with growing impatience in the US with low quality and slow supply, means that manufacturers are increasingly placing factories closer to customers, not just to cheap workers.

"Multi-national corporations are increasingly adapting build-where-you-sell strategies," Herrigel told a meeting in Madison, Wisconsin, sponsored by the American Council on Germany. The conference focused on "reinventing the industrial heartland," with an emphasis on using German methods to promote manufacturing here.

But Herrigel said this "build-where-you-sell strategy" didn't necessarily mean automatic American gains. Markets are growing in Brazil, China and other countries, so manufacturing will continue to follow customers to those countries.

If the United States is to profit from this trend, he said, it not only needs to attract foreign investment but to promote efficiency and innovation here, while reducing costs. He implied this could create job opportunities for well-trained technicians and engineers, but not necessarily for that Milwaukee assembly line worker who has already lost his job to Shanghai.

This post was originally published at The Midwesterner.

12 October 2011