Industrial renaissance in the US: miracle or mirage?
ESSAY: In the first part of a two-part essay, Phil Mullan picks apart the hype of America's much-touted manufacturing recovery.
The dominant story about the American economy today is that if we could only look past Washington’s policy dysfunction in dealing with all those fiscal cliffs and debt ceilings, we would see that the underlying economy is really on the mend. The US is experiencing an ‘industrial renaissance’. What’s the evidence for this? Is it more wishful thinking? And is the shale energy boom – a big driver of the new optimism – the economic game changer it is touted as? In the first part of a major essay, Phil Mullan looks behind the hype of an American recovery.
Part 1: The Great Economic Evasion
Throughout his presidential election campaign last year, Barack Obama talked up signs of the revival of US industry. Only to be expected from someone seeking re-election, you might think. But he did highlight something tangible that a lot of others outside his political circle have also been discussing: how after years of the outsourcing of American jobs to China and other emerging markets, businesses are now ‘insourcing’ and ‘bringing jobs back to America’.
As evidence Obama claimed that ‘after shedding jobs for more than a decade, American manufacturers have now added jobs for two years in a row’. Returning to this theme in his second inaugural address in January, he spoke about working together to ‘bring new jobs and businesses to our shores’.
Despite the small contraction in US output at the end of 2012, these claims are symptomatic of how the tone has recently become more upbeat about American, and consequently, global economic prospects. At the Davos World Economic Forum annual meeting in January, the emerging sense of global optimism was attributed mainly to the way the feared disasters of 2012 had not materialised: a break-up of the Eurozone, and falling over the US fiscal cliff.
But another important driver of Davos optimism was more forward looking and is driven out of the US: ‘The powerful potential effects of American shale gas, a topic that started out on the fringe and steadily gained momentum… The rapid availability of cheap, plentiful gas had the potential to transform the American economy’, said Robert Hormats, US under secretary of state for economic, energy and agricultural affairs. The FT’s chief economics commentator, Martin Wolf, summed up the new mood about America, writing that as result of improvements in the housing market, reductions in private debt levels, and its ‘energy revolution’, ‘the US might surprise on the upside’.
Gerard Lyons, the respected former chief economist at Standard Chartered and now chief economic adviser to the London mayor Boris Johnson, agrees that recent ‘signs from housing, jobs and lending suggest that the US economy is improving. Also, manufacturing there is receiving a competitive boost from cheap shale gas and rising wages in China.’ The Wall Street Journal reinforces this sentiment with two surveys, one showing that nearly half of US corporate finance executives express ‘greater optimism about US economic growth in 2013 compared to 2012’, and another survey of economists who ‘see more underlying strength this year’.
Cynics counter by saying ‘we’ve seen this all before; optimism about US economic prospects was the case too at the start of 2011 and of 2012, but it never materialised. Therefore, we should expect the same this year.’ Is this fair, or is something more real and substantial underway, especially with respect to the energy boom and the reshoring of manufacturing?
A manufacturing renaissance?
The notion of the revival of US industry, and of US manufacturing in particular, has been growing for some time now. In the summer of 2011, the prestigious Boston Consulting Group popularised the idea of a ‘manufacturing renaissance’ in its seminal article, ‘Made in America, Again: Why Manufacturing Will Return to the US’. It argued that a ‘combination of economic forces is fast eroding China’s cost advantage as an export platform for the North American market’. Rising costs abroad and falling costs in the United States mean that America ‘is becoming more attractive as a place to manufacture many goods consumed on this continent.’
And it’s not just starry-eyed politicians and consultants hoping that things are on the economic mend. Business leaders have endorsed this prospect of expanding production in the US. Jeffrey Immelt, CEO of the outsourcing pioneer General Electric, who is also head of President Obama’s Council on Jobs and Competitiveness, thinks outsourcing is now outdated as a viable business model. Taking advantage of low-wage Chinese workers at the end of the 1990s, when they earned about 50 cents an hour (about one thirtieth of an American worker’s salary), seemed to make a lot of sense. But now things are more complex (or perhaps they always were?). ‘Outsourcing that is based only on labour costs is yesterday’s model’, says Immelt. ‘Complex trade-offs have always been involved in location decisions, but as these trade-offs have shifted, around 2008, we came to the conclusion that outsourcing was quickly becoming mostly outdated as a business model for GE Appliances.’
Moreover, Immelt has been putting his money where his mouth is: last year GE brought back to Kentucky the production of water heaters and refrigerators that had been outsourced to China and Mexico. Immelt told the Harvard Business Review last March that his company is now ‘outsourcing less and producing more in the US, [and] created more than 7,000 American manufacturing jobs in 2010 and 2011’. At the end of last year the influential Atlantic magazine ran two articles giving many more examples of returning US companies, ranging from home appliance maker Whirlpool, lift maker Otis, and even the frisbee maker Wham-O. Since then, other huge global companies, including Apple and Lenovo, have announced plans to bring production facilities home from Asia.
A range of arguments are advanced to explain the reshoring trend. Most commonly, it’s pointed out that Chinese wages have been rising substantially year-on-year, so the gap in labour costs is now less pronounced. The Boston Consulting Group highlights how ‘wage and benefit increases of 15 to 20 per cent per year at the average Chinese factory will slash China’s labour-cost advantage over low-cost states in the US, from 55 per cent today to 39 per cent in 2015, when adjusted for the higher productivity of US workers. Because labor accounts for a small portion of a product’s manufacturing costs, the savings gained from outsourcing to China will drop to single digits for many products.’
Other champions of the inshoring trend point to a previous overestimation of the benefits of going abroad: outsourcing relationships aren’t that simple to manage, and more complex and expansive supply chains can go wrong, not least when disrupted by natural catastrophes like the 2004 Indian Ocean tsunami and the Japanese one of 2011.
And then there’s all that cheaper energy from booming US shale oil and gas encouraging the reshoring of manufacturing. Techniques such as horizontal drilling and hydraulic fracturing, known as fracking, have transformed North America’s energy landscape, unlocking vast reserves of shale energy that were long thought uneconomic. The shale boom has fuelled a rise of almost one-fifth in US gas production over the past five years. About 30 per cent of America’s gas is now sourced from domestically produced shale gas, according to Goldman Sachs, up from one per cent in 2001. The consensus forecast is that US natural gas production will rise between 25 and 30 per cent from 2010 to 2030.
Oil production has taken off, too, thanks to surging production of ‘tight oil’, as oil from shale is called. The US Energy Information Administration predicts that US oil imports will fall in 2014 to their lowest level in 25 years. Meanwhile, the International Energy Agency believes the US will be the world’s biggest oil producer by 2020, overtaking Russia and Saudi Arabia, and a net oil exporter by 2030. In its latest Energy Outlook 2030, published in January, oil giant BP predicts that the US will be 99 per cent self-sufficient in energy by 2030, up from a low of 70 per cent in 2005.
Shale energy production is seen as heralding not just energy independence for the US, but also as providing a huge boost to the competitiveness of US industry, therefore driving more domestic production again. The surge in gas production has pushed US gas prices to 10-year lows in 2012, as the country’s gas deficit turned into a surplus. From near parity in the first half of the 2000s, US gas prices are now about a quarter of the level in Europe and a fifth the level in Japan. This, it is argued, means making things in the US again much more attractive.
The American Chemistry Council, for example, claims that as a result the international chemicals industry is undergoing its most profound upheaval since the Second World War flood of discoveries (nylon, synthetic rubber, PVC plastic and polystyrene), as the prices of essential inputs, such as ethane, plummet in the US due to the shale revolution. Ethylene, for example, the building block for many plastics, and which accounts for 40 per cent of world trade in chemicals by volume, is made from ethane and is now much cheaper to produce in the US than Europe. Even with reasonable expectations of US ethane costs rising, the US ethylene price could be $400 versus $1,200 a tonne in Europe. Costs are also already lower in the US than in Latin America or China, and, in the future, they are likely to be lower even than in the Middle East.
US companies including Dow Chemical, ExxonMobil and CPChem, as well as overseas businesses including Royal Dutch Shell and LyondellBasell, both based in the Netherlands, Bayer of Germany, Formosa Plastics of Taiwan, Sasol of South Africa, PTT Global and Indorama of Thailand, and Braskem of Brazil, are looking at chemical investments in the US, and several have already made commitments. The US seems to be the place to manufacture chemicals now.
The record so far
How has the US benefited from this ‘industrial renaissance’? Not much, so far, judging by the latest data. While America’s trade deficit in energy has improved from where it was a few years ago, it is still no better than it was during the 1980s and 1990s. (See chart below.) Of course, if shale energy production takes off in the way it could, the picture will change dramatically over the next few years.
US net energy imports (quadrillion Btu)
However, the benefits of the industrial renaissance to the rest of the trade deficit are more difficult to discern. One would expect to be seeing at least signs of a narrowing of the non-energy trade deficit. Manufacturing exports did hit a new record in 2011, but so too did imports. More of the same is forecast for 2012 when the annual figures are published. The American Manufacturers Alliance for Productivity and Innovation (MAPI) reports that the US trade deficit in manufactures actually increased by seven per cent in the first half of 2012, continuing the upward trend since the end of the 2009 global recession.
The broader merchandise trade deficit figures, excluding energy, show a continuing deterioration after the fading of the normal recession-induced improvement, when imports fall away in line with declining production and household consumption. (See charts below.) This suggests, contrary to expectations of an even embryonic industrial renaissance, that the US is becoming more reliant on overseas production, not less.
US trade balance, 1974-2011 (1974=100)
US trade balance, monthly, 2010-2012
The trade body, the US Business and Industry Council, concluded that this record trade deficit ‘should put to rest widespread claims by the president and others that American manufacturing is in renaissance mode’. In a more recent study, Alan Tonelson, one of the council’s research fellows, reported that imports in 2011 captured a record share of US markets even for advanced manufactured goods, ranging from semiconductors to pharmaceuticals to ball bearings to machine tools and dozens of other capital- and technology-intensive sectors. And this is an area where the US is supposed to hold a relative competitive strength because of its higher levels of R&D and technology.
The import penetration rate exceeded 37 per cent in 2011, well up on the 25 per cent in the earliest data year of 1997, and slightly up on 2010, when the industrial renaissance supposedly was stirring. Tonelson concluded, ‘The analysis strongly indicates that, contrary to widespread optimism about an American industrial renaissance, domestic manufacturing’s highest value sectors keep falling behind foreign-based rivals.’
Far from economic recovery being driven by a domestic manufacturing revival, the rising trade deficit accompanying a return to even sluggish growth expresses how weak the US production machine continues to be. The fact that we’ve seen a continuing deterioration in the trade deficit, even with the competitiveness benefit to US industry of a fall in the dollar’s exchange rate of over 25 per cent since 2002, including nearly 10 per cent since the end of the recession in June 2009, reinforces how dire is the current state of US industry.
The recent revival of US manufacturing jobs doesn’t do much to justify the renaissance story either. As Obama has highlighted, about 500,000 factory jobs have been created over the last three years since their low of 11.5 million jobs in January 2010. This compares to the US peak manufacturing jobs in the summer of 1979 at 19.6 million. As the chart illustrates, manufacturing employment drifted down slowly and a little erratically for the next 20 years, and then more precipitously with almost 6 million more jobs being lost since the start of 2000.The return of some production to the US from abroad will have contributed some of the recent welcome half-million increase. However, this pick up over three years is less than a quarter of the 2.3 million jobs lost in the two-year period from the official start of the recession in December 2007.
US manufacturing employment, 1970-2012
(thousands of employees)
The great economic evasion
Two immediate interpretations of all this could be that the feted industrial renaissance is either a mirage or it is too embryonic yet to be picked up by the statistics. But the ‘industrial renaissance’ discussion is more important than this: it fits a broader pattern of complacency that has held back policymakers from recognising and addressing the gravity of America’s economic problems.
As the journalist Fareed Zakaria wrote in the January 2013 issue of Foreign Affairs, in an article titled ‘Can America be fixed?’, ‘With only a few exceptions, the advanced industrial democracies have spent the last few decades managing or ignoring their problems rather than tackling them head-on.’
Nowhere is this more true than in the sphere of economics and production. The roots of the economic problems that hit the US and the other Western countries in the 1970s, with the end of the post-Second World War boom and the return to a series of international recessions, have never been fixed.
Instead, an extraordinary confluence of circumstances since the late 1980s meant that these problems could be papered over with temporary palliatives at home, and a greater reliance on wealth created elsewhere, especially in emerging Asia. The Long Slump since the 1970s has been disguised for extensive periods by the greater ease these palliatives gave in maintaining the appearance of expanding prosperity. But this was a false prosperity built mainly on state-supported policies, not least the unprecedented expansion of debt.
Ultimately, these state-led methods for coping with the moribund economic condition have proved unsustainable, as shown by the post-2008 return to stagnation. Today’s ‘contained depression’, evidenced by the sluggish recoveries in the US and everywhere in the West, is a consequence primarily, not of the financial crisis itself, but of those four decades of low investment in production, of lacklustre innovation, and then of the political failure to notice and then address these deficiencies.
Today’s faith in an industrial renaissance is symptomatic of this bigger problem: the continuing evasion by the US elite of, first, recognising and second, addressing the seriousness of the US economic condition. Celebrating a few more factories set up at home, a few more jobs created, and a few more exports generated or imports replaced, avoids the gravity of the challenge arising from the decay of US production, that has been worsening for nearly 40 years.
This decay has been the driver of the continuous US trade deficit since 1983, and of the current account deficit on goods and services every year since 1991. Moribund value creation has been making America’s ability to sustain living standards for its people more and more dependent on other countries lending to it year after year.
This increasing reliance on others – facilitated by the US currency’s role as world money – has resulted in a mounting net external debt every year since 1986 (measuring the difference between US gross external debt, combined with the value of foreign investments in the US, and the value of US investments held abroad – see chart below). This net debt already comfortably exceeds $2 trillion, the equivalent of 15 percent of GDP. Even if as a result of shale the US becomes energy self-sufficient, the US’s external indebtedness would still be expanding unless something is done to address the rest of the current account deficit.
US net international investment position
(purple bars: trillions of dollar; red line: percentage of GDP)
This long-term decay of America’s productive engine stems from the lack of enough investment over a very long time. (See chart below.) Economic strength and genuine prosperity depend on durable and sustained productive investment in order to generate new sectors of wealth production and create new jobs for the people no longer needed in old sectors. This requires substantial investment in infrastructure (at least funded if not rolled out by government), in R&D, innovation and new technologies, and in the latest plant and equipment to boost capital stock.
In particular innovation and productivity can’t progress without net domestic business investment – the ‘net’ means after taking into account what is spent on simply replacing old, worn-out capital goods. Net investment underlies economic growth by increasing the economy’s productive capital stock, and is therefore a key indicator of a society’s capacity to generate rising living standards at home.
The withering away of such investment over the past 40 years illustrates the declining dynamism of the US productive machine. Rekindling business and public investment at least back to the ratios of the postwar boom years – double the recent trend levels even before the recession – is therefore the pressing need for the US economy to reverse 40 years of decline.
Net domestic investment as share of net domestic product
(blue: net business investment; red: net domestic public and private investment, excluding houses)
Will the so-called shale boom and the ‘reshoring’ of more manufacturing to America at least put it on the road to such a rekindling?
Tomorrow… read Part 2 of Phil Mullan’s essay.