Jeffrey D. Korzenik, chief investment strategist for Fifth Third Bank provided the following column. The article focuses on the rebirth of manufacturing in the U.S. and Mr. Korzenik’s guest column provides the latest insights into this important topic.
By Jeffrey D. Korzenik
Senior Vice President and Chief Investment Strategist
Fifth Third Bank
Global economic forces are aligning to produce a renaissance in American manufacturing. For the first time in decades, the calculations that once prompted corporations to send jobs abroad are now tilting toward a return of those positions to the U.S. Some refer to this phenomenon as “inshoring,” others call it “onshoring” or “reshoring.” By any name, this trend offers a tremendous opportunity for the U.S. and particularly for the industrial Midwest. Our region’s historical manufacturing roots and ample infrastructure put our states and cities in the position to retake their place as drivers of the American economy. The foundation for this shift is already in place, but we must recognize that this chance could be lost. Our business, political and labor leaders should recognize that wise choices made today, at both the national and local level, can reinforce this trend and ensure our economic future.
Observers could be forgiven for doubting our ability to reshore jobs. Previous pledges of politicians to restore American manufacturing sound like just so much more empty campaign rhetoric. Past predictions of a rebirth of manufacturing in the U.S. have proved premature, short-lived, or dead wrong. The Philadelphia Fed tested the waters in 2008 and again in 2010, surveying the District’s manufacturers. Based on the response, there was scant evidence to suggest a reshoring trend. This Fed study led many to dismiss this opportunity. Fortunately, the headlines of 2011 tell a very different story.
In the second half of last year, scarcely a week passed without news of a major corporation shifting manufacturing to the U.S. Among the most prominent stories was the UAW/Ford pact which increased projected employment by 6,000 with half of the additional jobs coming from production once outsourced to Japan, Mexico and China. The news extended well beyond the automotive industry as Otis Elevator relocated a factory from Mexico to the U.S., Electrolux announced plans to relocate a Canadian plant to Memphis, and U.S. Steel, Siemens and others expanded existing U.S. manufacturing facilities. We believe 2011 was a watershed year, the start of a multi-year trend in which industrial production will return to the U.S. So far, the evidence supports the continuation of this trend; this year’s highlights include Whirlpool’s first new U.S. plant in a decade, a new Intel facility in Arizona that will hire 4,000 people, and a recent survey by the Boston Consulting Group that indicated a third of the manufacturers polled are considering reshoring production from China.
Although the economic trends that supported these reshoring moves have been building for years, in 2011 several catalysts highlighted the advantages of American manufacturing. These events must also be understood in context of the times. 2011 was the first year since 2005 in which the U.S. economy gained jobs every single month — the recovery, albeit lackluster, was firmly in place and encouraged forward-looking planning by corporate America. The year’s steep drop in interest rates and corporate borrowing costs reduced the long-term expenses associated with plant relocation and lowered the bar for necessary investment returns. Perhaps most relevant, multinationals were forced to consider the safety of their supply chains when the Japanese earthquake and tsunami disrupted suppliers to the auto industry and subsequent floods in Thailand had similar impact on the computer industry. These interruptions spurred manufacturers to consider geographically diversifying their supply chain. When manufacturers “put pen to paper” they found a compelling case for using the U.S. as a manufacturing base.
The original impetus to send manufacturing overseas came from significantly lower labor costs. In many emerging markets, most notably in China, wages have been on the rise for years, growing at double-digit rates. Meanwhile, labor costs in the U.S. have been stagnant, or, in many cases declined. Compared to 20 years ago, when the great offshoring trends began, the U.S. labor force has become increasing more flexible and productive. From the standpoint of manufacturers (albeit to the detriment of employees), U.S. wage trends look favorable for years to come as persistently high unemployment dampens pay increases. Conversely, the continued growth in the emerging market economies, coupled with rising social demands for retirement and health benefits, suggests that their comparative advantage of lower compensation will continue to erode.
The level and direction of the U.S. dollar play critical roles in the reshoring calculation. Here, too, the trends favor U.S. based manufacturing. Even as labor costs in the emerging markets have risen, those costs are only increased when translated back into U.S. dollars. While most European currencies have changed little relative to the dollar, the Chinese Yuan, has risen over 30% since 2005. For multinationals based in both Europe and the U.S., the cost of labor outsourced to that nation has effectively risen both in local currency terms and then again by the rate of currency translation.
Even with these shifts, many countries still offer “cheaper” manufacturing than the U.S., but wages and benefits alone offer only an incomplete analysis of true labor costs. How that labor can be employed is an essential measure. Although modern industrial processes have lessened the traditional U.S. worker’s advantage of superior productivity, our nation retains a tremendous lead in labor flexibility. The World Bank’s Rigidity of Employment index is a broad measure of dozens of factors related to the ease of hiring, use and reduction of a labor force. The U.S. is a leader in labor flexibility, well ahead of the rankings of those countries that had benefited from offshoring.
In a world where labor costs differentials are lessened, U.S. advantages in superior infrastructure, more consistent quality control and rule of law (including intellectual property protection), can be the deciding factor. For manufacturers for whom outsourced production has been just a step in the supply chain, the proximity to end-users improves collaboration on design and modification. Finally, the nascent U.S. energy boom may prove the single biggest factor in driving manufacturers back to U.S. shores. The glut of natural gas and the huge differential between domestic costs and those abroad draws in those industries which use natural gas price as a direct input, e.g. petrochemical manufacture, as well as those that rely on energy intensive processes like aluminum.
We should not expect reshoring to be the panacea for all our economic woes, but it can be meaningful. Industrial employment as a percentage of the entire U.S. workforce has fallen from roughly 50% after World War II to approximately 15% today. While we could at best hope for only a modest reversal of this trend, every incremental add to manufacturing jobs has an outsized positive economic impact. Manufacturing jobs not only pay more on average than service sector jobs, but they also have a higher “multiplier effect” in supporting service sector job growth. Moreover, industrial employment can go a long way in helping those among the hardest hit in our downturn – the many unemployed who do not hold a college degree.
What can go wrong? Plenty. At the Federal level, our corporate tax rates, now the highest in the developed world, deters both the basing of new operations in the U.S. as well as the repatriation of profits earned abroad that might fund expansion here. There is broad and bipartisan recognition that our corporate tax code, based on a 1960s model, is outdated and overly complex for today’s global landscape. The partisanship in Washington, our failed budgeting process and the uncompetitive costs of our healthcare system also deter long term investment in the U.S.
Even if the U.S. recaptures a significant share of production that had once been outsourced, there is no guarantee that the Midwest will benefit. While there is a compelling case based on existing infrastructure, many traditional industrial states must combat negative perceptions within the global business community. To give but one example, a recent survey of 650 CEO’s placed both Michigan and Illinois among the five worst states for business. This subjective analysis is belied by more objective assessments such as one conducted by CNBC, which ranks both these states in the middle third nationally. Perceptions clearly matter, and Michigan in general, and Detroit in particular, would do well to bear in mind the reputational costs of scandals and budget battles.
There is change afoot in the global economy. Industrial firms increasingly view the U.S. as a viable base for production that would previously have been sent overseas. Focused Federal policy could accelerate and support this nascent trend, and Michigan, like other traditional strongholds of U.S. production, with wisdom, can capitalize on this new opportunity.
Jeff Korzenik is Senior Vice President and Chief Investment Strategist of Fifth Third Bank; where he is responsible for the Bank’s overall client investment strategy. A 25-year industry veteran in the investment industry, Korzenik’s background includes research and management roles at some of the country’s largest investment firms. He has held positions in London, Chicago, New York and Boston. Mr. Korzenik earned a Bachelor of Arts degree in Economics and a Certificate of Proficiency in Near Eastern Studies from Princeton University in Princeton, N.J.