Sometimes it’s a series of lucky breaks that turn an economy around.
In the U.S., the discovery of abundant reserves of natural gas is one of those bits of luck. Because new technologies, such as horizontal drilling and hydraulic fracturing (known as fracking), have significantly lowered the cost of extracting gas from shale rock, some of the largest chemical companies with plants overseas are reinvesting in factories in the U.S. and hoping to take advantage of this new inexpensive -- relative to oil -- energy source.
“The discovery of shale gas is an American manufacturing renaissance if handled well,” said Andrew N. Liveris, chairman, CEO, and president of the Dow Chemical Co. (NYSE: DOW). “It makes America a low-cost jurisdiction for any energy-intensive manufacturing of the value-add kind.”
According to Dow, $8 of value is added to the economy for every $1 of natural gas used as an energy source or raw material in the manufacturing of petrochemicals, glass, steel, and aluminum.
Because of these advantageous numbers, Dow is planning to build an ethylene plant on the Gulf Coast by 2017, adding as many as 2,000 jobs; the Exxon Mobil Corp. (NYSE: XOM) just announced a new multibillion-dollar chemical facility in Baytown, Texas, creating about 6,000 jobs; and the United States Steel Corp. (NYSE: X) recently opened a mill at its factory in Lorain, Ohio, to manufacture steel pipe for the drilling industry.
“We believe that, by 2025, the manufacturing sector could save $11.6 billion in cost, and could create up to 1 million manufacturing jobs attributed to shale gas,” said Bob McCutcheon, U.S. industrial products and metals industry leader at PricewaterhouseCoopers LLP.
Buoying The Economy
An impressive forecast, indeed. But as it turns out, that’s just one piece of a nascent manufacturing renaissance taking place in the U.S. After years of losing industrial jobs to low-cost countries, particularly in Asia, the country's manufacturing sector appears to be making a comeback.
In 1953, manufacturing accounted for nearly 30 percent of gross domestic product. By 2009, that figure had dropped to about 11 percent. In the past two years, however, the sector has staged a surprising turnaround, rising to 12.2 percent of GDP last year.
Some of this rebound is the result of shifting production from non-American plants back to the U.S. For example, Caterpillar Inc. (NYSE: CAT) is closing down Japanese assembly lines in favor of facilities in Athens, Ga. And the Ford Motor Co. (NYSE: F) is moving jobs from suppliers in China, Mexico, and Japan back to American soil.
Analysts estimate that in the next 10 years, increased production from manufacturing re-shored from China will add between $20 billion and $55 billion annually to the U.S. economy. In about five years, U.S. exports could increase by at least $65 billion annually, according to a Boston Consulting Group, or BCG, report.
The impact on employment cannot be overstated. BCG predicts the new manufacturing jobs in the U.S. will create 1.8 million to 2.8 million additional jobs in the rest of the economy in industries such as construction, food services, housing. retail, and transportation.
“The addition of this many jobs would be enough to lower the U.S. unemployment rate by 1.5 to 2 percentage points,” said Harold L. Sirkin, BCG senior partner and managing director in Chicago.
The New Math
For more than a decade, deciding where to build a manufacturing plant to supply the U.S. markets was simple for many companies: China was the clear answer.
However, the cost advantages of outsourcing factory work to China are narrowing. Although it still makes sense to manufacture in China for the booming local market, in the next few years, rising Chinese wages, higher U.S. productivity, a weak dollar, and other factors will virtually close the cost gap between the U.S. and China for many goods consumed in North America.
Labor Costs. In 2000, factory wages in China averaged just 52 cents an hour, or a mere 3 percent of what average U.S. factory workers earned. Since then, Chinese wages and benefits have risen by double digits each year, while costs for U.S. production workers increased by less than 4 percent annually, according to BCG.
China’s labor-cost advantage over low-cost states in the U.S. is expected to drop from the current 55 percent to 39 percent or less in 2015, when adjusted for the higher productivity of U.S. workers, BCG reported.
Since wages account for 20 percent to 30 percent of a product’s total cost, manufacturing in China will be only 10 to 15 percent cheaper than in the U.S. -- before inventory and shipping costs are considered. After those costs are factored in, the total cost advantage will drop to single percentage digits or be erased entirely, Sirkin said.
Currency Risk. In the past, the risk of currency fluctuation was minimal in China because the central bank kept the yuan rigidly pegged to the U.S. dollar. But in 2005, under political pressure from the U.S., Beijing allowed the yuan to fluctuate, a bit.
Since then, the yuan has appreciated about 30 percent against the dollar, adjusting for both economies’ rates of inflation. The steady appreciation of the yuan against the dollar increases the price of Chinese exports to the U.S.
Logistics. Logistical issues -- such as shipping costs, the time it takes get a manufactured product to the market, and the proximity of production lines to engineering and design teams -- are also big factors in comparing China vs. U.S. manufacturing.
For example, air-freight shipping from China to North America takes about five days on average, but that’s under the best of circumstances. And five days can quickly become seven days, said Richard G. Phillips Jr., CEO of Pilot Freight Services Inc., an international shipping and logistics company based in Lima, Pa.
Ocean shipping from China, Phillips said, “could involve days or a couple of weeks, depending on what you are trying to do and what your cost parameters are.”
Supply-Chain Threats. Finally, there are the many costs and headaches of relying on extended supply chains. These include inventory expenses, quality-control problems, and the threat of supply disruptions.
The floods in Thailand last year left Apple Inc. (Nasdaq: AAPL) with a shortage of the 2-terabyte hard drives used in its Macintosh computers since more than one-half of the world’s hard drives are made in Thailand.
The Western Digital Corp. (NYSE: WDC) took an even harder hit: It won’t be back to preflooding production of hard-disk drives until this fall. A natural disaster-related supply-chain disruption in China would obviously have a much more far-reaching and long-lasting negative impact on U.S. manufacturers.
A big shot in the arm for manufacturing in North America has come from banks, which are lending again. Commercial and industrial loans rose 15.8 percent in April, compared with the same month a year ago, according to the Federal Reserve. It was the fastest rate of increase since the recession ended in 2009, when C&I loans dropped 18.6 percent.
“The resurgence in commercial and industrial lending is generally going into corporate America for expansion,” said Christopher Petrosino, managing director of the quantitative strategies group at Manning & Napier.
Forty-four percent of manufacturers with revenue between $10 million and $1 billion said in a recent National Center for the Middle Market survey that if they had an extra dollar, they would use it for capital expenditures. The corresponding number for other firms in that revenue range was only 19 percent.
Among the companies that have recently announced larger U.S. industrial investment include the Toyota Motor Corp. (NYSE: TM; TYO: 7203); General Motors Co. (NYSE: GM); Honeywell International Inc. (NYSE: HON); Chevron Corp. (NYSE: CVX); and ConocoPhillips (NYSE: COP).
However, experts point out that much of the increase in capital investments is linked to brownfield sites -- that is, upgrading existing plants, rather than building new ones.
“[Brownfield investment] is lower-cost, and that’s probably why you are not seeing the capital-expenditure numbers swing strongly as maybe the actual improvement would suggest,” said Michael Knolla, a research analyst at Manning & Napier, which oversees about $40 billion in assets. “To go out and build a greenfield facility right now, I’m not getting the conviction that many CEOs are feeling that. But I do think that there is a growing confidence.”
Looking For Skills
Although the future looks rosy for American manufacturing, headwinds remain. The biggest risk: a widening skills gap.
Eighty-three percent of manufacturing companies indicated a moderate to serious shortage of skilled production workers, according to a survey by the Manufacturing Institute and consultancy Deloitte. Moreover, 69 percent expect this labor shortage to grow during the next three to five years as skilled workers near retirement.
“Where manufacturing will be in 10 years depends on how that skills mismatch resolves itself,” Knolla said.
And how it resolves itself will probably be determined by whether younger Americans follow their grandparents’ lead in developing pride and interest in U.S. manufacturing. The Deloitte survey found that while Americans considered manufacturing to be the second most important industry in the economy, behind energy, and the most important industry for job creation, they ranked it near the bottom as a career choice.
“Manufacturing does have associated with it the kind of job where you are tied to the production lines and plants,” said Jeffrey Bergstrand, a professor of finance at the University of Notre Dame and a former Federal Reserve economist. “There are a lot of manufacturing jobs now using technology, using computers. They are still manufacturing jobs, but they are not the ‘dirty jobs’ we often think of as manufacturing.”
And with employment increasingly hard to come by and the growth of the U.S. economy stubbornly slow, the inchoate manufacturing renaissance may pave one of the few rewarding avenues for job seekers over the coming years. In that case, even dirty jobs may begin to look attractive.