When these factors are viewed as a whole, the global implication is that there could be a growing flow of manufacturing activity back onto US shores, tipping the scales to a degree away from the emerging market investment paradigms that have predominated the past decade. The comparative weaknesses that sapped the vitality of US manufacturing in the 1990s have moderated, and what remains is a sector primed for some rebound. The question is whether the US can attain the competitive advantages that would make its manufacturing sector a more attractive investment opportunity than developing markets and China. What are the drivers of the resurgence in US manufacturing?
We believe there are multiple dimensions and factors supporting the reports of a so-called US manufacturing renaissance. These include:
Capital goods investment – In just the past two years, there has been a jump in the number of new manufacturing facilities/ expansions by global industrial companies in the US. The announcement of nearly 30 new or expanded manufacturing facilities being made mostly in traditionally weaker union regions in the southern US illustrates the theme of a global flow of capital into the US sector. These new facilities have not only increased the activities of multinational companies within the US, but have also added thousands of manufacturing jobs in the country. The decline in the US dollar versus the Chinese yuan is likely to increase the attractiveness of the US as a competitive location for export manufacturing , and str ength in the Japanese yen is also pushing the decision for Japanese companies to actively shift their facilities away from the Chinese market.
Bullish US energy outlook – Thanks to advances in hydraulic fracturing and drilling techniques, shale gas discoveries in the US have created substantially lower natural gas prices and input costs for energy-intensive processes. As a reference, natural gas now costs 3–4 times more in Europe than it does in the US, thanks to the US domestic shale gas boom. The natural gas boom should benefit companies that have high exposure to the US oil & gas, petrochemicals, steel and fertilizer sectors.
Capacity utilization – After hitting an all-time low of 67% in June of 2009, the capacity utilization rate for US companies — effectively an indicator of the health of the manufacturing economy — has experienced a rapid rebound. Its recently recorded value of 78% in November 2012 reflects its continuing upward climb, even though it remains below the average rate of 80% observed prior to the financial crisis, signifying further growth in US factory utilization.
Wage inflation in emerging markets – Many manufacturing decisions are driven by the idea that production has essentially become a commodity to be sourced at the lowest cost. The US remains one of the most expensive countries in terms of labor cost, with hourly wages several times higher than emerging market competitors. However, wage inflation in developing countries like China is beginning to erode their cost advantage, though it will likely be a decade or more before wages in these regions reach the levels of develop country counterparts. Wage inflation has been particularly high in China, with a compound annual growth rate of 14% observed over the past eight years.
Time to market – The drawbacks to an international supply chain — extended supply chains, higher inventory and working capital costs as more goods are in transit and slower delivery times — are not new, and we do not see any factors that will make these detriments more meaningful in the near future. However, these complications and costs are part of the decision-making process as companies develop their global sourcing strategies. Recent natural disasters have encouraged companies to re-think supply chains while oil price increases have led to higher transportation costs that are beginning to outweigh the savings from cheaper labor abroad.
Productivity – Despite changes in economic output profile, the US is still leading the world in terms of manufacturing productivity. When adjusted for inflation, the productivity level of the US labor force is considerably above the global average , and this differential has only widened over time. As developing countries see their labor costs rise from wage inflation, global manufacturers could begin seeking more efficient and productive workers, a trend that could prove advantageous to the US labor pool. Products that require more capital and less labor input can be more effectively manufacturing in an environment like the US, which boasts a large population of educated workers, as opposed to low-skill, but high labor-content tasks like circuit-board assembly, which has been the most exposed to outsourcing.
Automation advances – While US manufacturing jobs have been on the decline over the past decade, productivity of capital equipment has gradually risen, signaling increased automation and more efficient production resources. The Robotic Industries Associates (RIA) estimates that only ~10% of US companies that could benefit from automated production have installed any robots so far, supporting the idea that there is opportunity for continued investments in this space. This notable and broad-based growth in robotic equipment could further increase US manufacturing productivity, though it could come at the expense of manufacturing jobs as more production becomes automated.
Tax incentives – Local tax concessions can play an important role in luring production back to the US. These concessions typically offer a near-term incentive to relocate, but only temporarily offset the higher costs of operation that are incurred in a mature economy like the US. Tax credits could also mitigate the cost of doing business in the US, leading companies to keep their factory production onshore, thereby incentivizing them to invest in US manufacturing.
Potential bumps in the on-shoring road ahead
One of the biggest impediments to manufacturing investment in the US is that high corporate tax rates limit the profitability of US manufacturing. The US has the second-highest corporate tax rate in the world (behind Japan) at 35%, making domestic operations less attractive than international expansion for corporates. That said, in recent months there has been renewed talk of tax reform to boost US economic growth and employment, including the possibility of lowering the statutory tax rate. In addition, easing the policy of taxing foreign earnings at the US rate upon repatriation would encourage US multi-industry companies to bring cash back to the US, increasing the amount of US-based cash for domestic M&A or capital spending.
A broad-based thematic trend
The uptick in US manufacturing is a broad-based thematic trend. US demand for capital goods has steadily increased since the recession, and revenues from North America as a percentage of the overall capital goods sector have been steadily rising since its trough in 2009. A shift toward US-based manufacturing would likely accelerate demand for capital goods in the region, benefiting companies that build machinery, process controls, and other automation technologies used in production facilities. The long-term impact of a manufacturing recovery could include a boost to the US economy, as jobs are re-shored and the domestic sector is revitalized; as such, US demand and GDP growth could rise substantially. While the full long-term implications are complex and still unidentified, we believe there could also be a positive read-across for global companies that have high exposure to North America.
My Account
Whether it is called re-shoring, on-shoring, or the US manufacturing renaissance, there most certainly has been a notable influx of high-profile capital goods companies investing in US manufacturing facilities in the past several years. While the media has trumpeted this trend as a resurgence of US manufacturing, our analysis indicates that the motivations behind these investment decisions are broad-ranging and more often company-specific. They encompass geo-economic factors, a bullish US energy outlook, supply chain management, tax incentives, more accommodative labor unions, advances in automation, some typical late-cycle demand, and escalating wage inflation in emerging markets that is narrowing the labor cost gap.
