Good news for a change: American manufacturers' comparative advantage versus other nations has improved thanks to a confluence of economic and technological factors. Tom O'Halloran, Lord Abbett Partner & Director of Multi and Small Cap Growth, adds his insights on this market dynamic.

Contrary to popular belief and populist grief, American manufacturing is experiencing a renaissance that could last for years.

Three powerful factors are driving this trend:

• A large source of demand from abroad, particularly emerging markets;
• A dramatic improvement in the comparative advantage at America's manufacturers, particularly given how much the value of the dollar has declined versus other currencies in the last 10 years; and
• Productivity improvements, largely driven by advances in technology that have made American manufacturers stronger.

It may surprise some to hear that the manufacturing sector has driven an important amount of growth in the United States. Booz & Company, a global consulting firm, reports that between 1987 and 2008, productivity in the U.S. manufacturing sector grew 65% faster than business as a whole.¹

Meantime, many global manufacturers are targeting the United States for new factories.

According to a recent Boston Consulting Group (BCG) study, this reallocation of global manufacturing will become more pronounced over the next five years, especially as companies ponder where they should add future capacity. That, in turn, could lead to up to 800,000 jobs returning to the United States by mid-decade.

"While China will remain an important manufacturing platform for Asia and Europe, the United States will become increasingly attractive for the production of many goods sold to consumers in North America," BCG said.² To illustrate that point, BCG examined the relative economics of producing auto parts in selected southern U.S. states versus China's Yangtze River Delta, and projected that the total cost savings of producing in China (before transportation, duties, and other costs) will be significantly lower by 2015. (See Table 1.)

Emerging Markets Have Helped U.S. Manufacturing
With emerging nations setting the pace for global economic growth (see Table 2) and rapid industrialization (see Table 3), the strength of their currencies versus the dollar has been a boon not just for trillions of dollars' worth of U.S. manufacturing exports but also for automation systems that help control costs and improve quality. Tom O'Halloran, Lord Abbett Partner & Director of Multi and Small Cap Growth, believes that trend could provide secular growth opportunities in a range of industries, from consumer products like athletic and casual apparel, cosmetics, and jewelry, to commercial and military aviation, industrial products, infrastructure, and materials.

Consider how much U.S. exports to China alone have accelerated: a whopping 468%, between 2000 and 2010 (see Chart 1), led by computer and electronic products, agricultural products, chemicals, transportation equipment, and machinery (except electrical), according to the U.S. Commerce Department. (See Chart 2.)

"U.S. manufacturers have been, and should continue to be, a significant beneficiary of that trend," O'Halloran said. "Remember that a lot of U.S. imports from China and other emerging markets often have U.S. content, which underscores the growing importance of an integrated trading relationship."

A case in point is Caterpillar, the world's largest manufacturer of heavy machinery and mining equipment and one of a number of industrial companies that surpassed analysts' expectations in the third quarter of 2011. More than two-thirds of Caterpillar's sales are outside the United States. But that doesn't mean the company is losing its focus on its home country. As Caterpillar's CEO, Doug Oberhelman, once put it, "When we expand globally, it increases the demand for the components, products, and services that we and our suppliers make right here. Caterpillar is investing and growing in the United States and overseas. We must make those investments if we are to remain the global leader in our industry and a major employer in the United States." ³

Comparative Advantage
As the American economy struggles to lower a chronic unemployment rate, it is difficult to estimate how many of the jobs shipped overseas over the years will return. However, the rationale for such "offshoring"—cheaper labor, lower taxes, or light regulation—has reached a critical inflection point, O'Halloran said.

In the past several years, American manufacturers have gained considerable comparative advantage versus emerging nations, where higher wages have driven up costs and higher energy costs have increased transportation expense, eroding the benefits of a favorable currency.

"China's overwhelming cost advantage over the United States is shrinking fast" and will virtually close within five years, said a recent BCG report.

Among the key reasons cited by BCG:

• With wages and benefits rising 15–20% a year at the average Chinese factory, China's labor-cost advantage over the low-cost states in the United States will drop from 55% today to 39% in 2015, when adjusted for the higher productivity of U.S. workers.
• There are rising costs due to transportation, duties, supply chain risks, and
• industrial real estate.
• Diminishing returns from automation and other measures should improve productivity in China.
• Lower-cost alternatives to China may not be suitable for some higher-end manufacturing, given some countries' problems with inadequate infrastructure, skilled workers, scale, and domestic supply networks, as well as low worker productivity, corruption, and violent crime.⁴

Another factor working in the United States' favor is the relative ease of doing business there versus most developed and emerging nations. According to a recent report by Deutsche Global Markets Research, the United States ranked fourth (behind Singapore, Hong Kong, and New Zealand, respectively). China ranked 91st; Russia ranked 120th; and India finished at 132. Specific criteria included: the process of starting a business; dealing with construction permits; getting electricity; registering property; getting credit; protecting investors; paying taxes; trading across border; and enforcing contracts.⁵

Matching Supply Location with Demand Location
Popular perceptions about the decline of U.S. manufacturing are catching up to the reality. After a lengthy New York Times article questioned whether America's beleaguered manufacturing sector was falling off Washington's radar, a leading factory builder, with 22 projects in various stages of development, invited a well-known columnist to visit two nearly completed plants that symbolized a significant turnaround.

Although it will take a lot more to replace manufacturing jobs lost during the last two recessions, the columnist was impressed. Both plants in North Carolina were immense and used state-of-the-art robotics. One of the factories, which measured 850,000 square feet, will make enormous axles for mining trucks sold around the world. The other will make 280-ton gas turbines.⁶

"All of a sudden manufacturing is again finding itself as a core enabler of overall competitive advantage," says a recent report by the global consulting firm Accenture. "Many manufacturers have included a big element in their strategy over the next few years to more closely match supply location with demand location by onshoring or nearshoring manufacturing and supply. Although offshoring will continue to play a role in the supply location strategy of companies, it will largely be done in the context of chasing the demand location. This new trend of moving more supply closer to demand location appears to be a new shift for many manufacturers." ⁷

Gus Gaeta, a principal in the business effectiveness practice at KPMG, agrees. "Now rising costs in labor and logistics—as well as high inventory carrying costs caused by longer lead times—are starting to dilute those savings [and] causing companies to revisit their business models," says Gaeta.⁸

Technology-Led Improvements in Productivity
Another driver of the manufacturing renaissance is an unprecedented surge in innovation.

As one leading provider of industrial automation solutions puts it, "Highly automated, advanced facilities help protect workers from job injuries, improve industrial energy efficiency, and can better track and trace materials to help ensure consumers get safer, higher-quality goods. Automation also will play a vital role in manufacturers' ability to comply with pending carbon emissions regulations."

For all these reasons, O'Halloran foresees significant growth potential in companies that supply advanced technology and training aimed at increasing industrial productivity, flexibility, and efficiency while lowering costs and making manufacturing competitive globally.

These include the leading provider of very energy-efficient fiber optic lasers used in cutting and welding applications; a producer of machine vision systems used around the world to guide, gauge, inspect, identify, and assure the quality of items during the manufacturing and distribution process; a company that uses fiber optic probe technology and chemical sensors to monitor odors in food processing and other industrial applications; and a leading provider of 3-D measurement and imaging systems that speed up the design and development process of highly engineered products and reduce scrap.

Machines versus People
Imagine a factory outside Osaka, Japan, that produces 10% of the world's 42-inch plasma television screens, which translates to $2 billion in revenue a month. While that may sound labor-intensive, the factory only has 15 workers; the rest of the production is handled by robotics and other industrial automation.⁹

Such advances in robotics are very similar to the change that revolutionized farming in the 1920s and 1930s.¹⁰ A similar dynamic is happening in industry. Indeed, cheap labor doesn't seem to matter as much as it did 10 or 20 years ago. In the 1990s, for example, a General Motors executive told analysts that the breakeven cost of robotics at that company was about $50 an hour. Now, that cost is about $2 an hour, thanks to the price collapse of DRAMs [dynamic random access memory] and the lower cost of software, and that $2 an hour is practically the same as workers in Asia get. Small wonder that one of the world's largest electronics assembly companies plans to add hundreds of thousands of robots in the next three years to offset rising labor costs.¹¹

While experts highly doubt the successful implementation of the installation of such an immense number of robots in such a short period of time, John Dulchinos, chief executive officer of Adept Technology, said the robust growth in the robotics market around the world is strong validation of the economic value robots provide to customers in diverse applications and industries. "With the latest technological advancements, the value proposition for robotics has never been better, affording customers both small and large, improvements in quality and productivity that allow them to remain competitive in the fast-paced global economy," he said.

Dr. Shinsuke Sakakibara, president of the International Federation of Robotics, added, "Robotization is the key to improving the 3D (‘Dangerous, Dirty, and Demanding') working environment, productivity, and quality of product, and will, therefore, be advantageous to the companies by strengthening their competitiveness and expanding employment." ¹²

Industrial robots play a key role in America's manufacturing renaissance. As Jeff Burnstein, president of the Robotic Industries Association, put it, "U.S. technology and business innovators recognize that robots in factories have the potential to save and create more jobs than they eliminate. Robots help companies turn out higher-quality and lower-cost goods to compete with those made in China, Mexico, India, or other low-wage nations. They remove people from dangerous and boring jobs they shouldn't have been doing in the first place, and put them in higher-skilled, higher-paying positions." ¹³

The Bottom Line
American manufacturing has weathered tremendous adversity, but its resilience should not be underestimated. "Some might argue that the United States cannot compete with low-wage, low-cost, increasingly advanced economies like China and India, but the examples of Japan and Germany counter this argument," said Susan Hockfield, president of Massachusetts Institute of Technology (MIT). "These countries are both high-wage, high-cost economies like ours, but they each run dramatic trade surpluses. They provide proof that building a strong, advanced manufacturing sector is possible and very much worth pursuing." ¹⁴

The United States may have lost eight million manufacturing jobs since 1979, but thanks to increased productivity per worker, it still produces 22% of the world's goods. And the U.S. manufacturing sector employs 64% of U.S. scientists and engineers, who collectively conduct 70% of the research and development conducted in the United States. All of which makes the United States the world's largest manufacturer, said Suzanne Berger, an MIT professor of political science.¹⁵

Reflecting on transformative innovation, Berger noted that all of the great new American manufacturing companies of the past few decades have focused on research and development and product definition, such as Apple, Qualcomm, and Cisco. Manufacturing overseas may have made sense for those companies, but now Berger thinks the United States is at quite a different juncture. "We're seeing a wave of new technologies, in energy, biotechnology, batteries, where there has to be a closer integration between research, development, design, product definition, and production." ¹⁶

Such integration bodes well for the "Made in America" label, O'Halloran added.

—Reported by Steve Govoni