Manufacturing a Recovery?
This year, manufacturing jobs have been on the rise in the United States. Jobs that used to be performed overseas are now being held by Americans. Given that President Obama is being held accountable for the state of the economy, it’s worth examining the forces behind this movement. Why is this happening in 2012?
It’s a combination of factors, but the two largest appear to be China and energy costs. I’ll show you what I mean; the two are intertwined. We can start with a brief history.
China became a manufacturing powerhouse over the past two decades. The nation has large quantities of available land for factories, and a substantial supply of coal for electric power. Couple this with a labor force that has been willing to work long hours for low pay, and you have a compelling foundation for manufacturing.
Also, if you look at the graph to the right (you can click on it to see it in full size), you’ll note that oil prices remained fairly stable from 1986 to 2003, and at real prices matching those in place in 1973. This made for particularly inexpensive transportation costs, making it affordable to manufacture goods in China for sale 7,000 miles away in the United States.
Nearly every product category you can imagine available for sale in the United States is being made in China today. There are a few exceptions, such as perishables (such as fresh foods) and many large, bulky items (such as automobiles), but those have been more the exception than the rule.
Why has this changed? As I said, it’s China and energy. Let’s look at each in turn.
Manufacturing costs in China have been on the rise in recent years, as wages have slowly inflated over time, and downstream companies have been demanding better working conditions for Chinese laborers in the contracted factories. Couple this with the stagnating wages of their American counterparts, and the wage gap, while still significant, has been shrinking over the past two decades.
On top of this, China’s reputation was tarnished in 2008 when it was discovered that raw materials suppliers for food products were adulterating their products with melamine in order to boost the apparent protein content, so as to undercut the competition on price. This proved to be the tip of an iceberg of quality issues with Chinese products, and it quickly became apparent that supply chains in the country were sufficiently convoluted as to render it infeasible to adequately assess the quality of many types of products. Consumers in the United States began to question the source of food and cosmetics in a way that they hadn’t before.
Moreover, downstream packagers and retailers began to have similar quality concerns. With suppliers 7,000 miles away, and products being shipped by boat, it takes several months for production quality issues to manifest themselves at the point of sale. Correcting a problem, then, requires a solution for the products in the pipeline (i.e., in shipping containers on the Pacific Ocean). Do they get thrown out? If so, what is the retailer supposed to do with empty shelves for four months? Or does the retailer sell a product with known defects, further damaging the retailer’s reputation? Neither option is pretty.
For this reason, retailers began to view local suppliers with renewed interest. Shorter supply chains mean faster response in correcting problems.
While all of this was happening, oil prices rose exponentially from 2003 to 2008, reaching real prices unseen since 1979. This made the transportation costs a far more important consideration with products made so far away from the consumers. While oil prices dropped as we entered the Great Recession, they didn’t drop as quickly as coal and natural gas prices. This is an important consideration, since the lower coal and natural gas prices translate into lower manufacturing energy costs (manufacturing in the United States is almost entirely driven by electricity, which is generated mostly by coal and natural gas).
Natural gas in particular became unusually inexpensive due to a combination of two factors. First, it is difficult and expensive to ship over long distances, so North American supplies stay in North America. Second, the supply rose suddenly due to a substantial increase in the amount of hydraulic fracturing (“fracking”) in the American petroleum industry. The fracking, initially focused on producing more domestic oil, had the side effect of releasing unprecedented amounts of methane. So, with a sharp increase in supply, coupled with an inability of the rest of the world to absorb it, natural gas prices have dropped to historical lows. This still makes American manufacturing fiscally attractive compared to China.
Put all of these factors together, and American manufacturing looks more attractive than it has since the Reagan years.
If you look back at the beginning of this article, you’ll note that I said that President Obama is being held accountable for the state of the economy. Clearly, when it comes to manufacturing jobs, his actions are completely independent of the factors I outlined above. I’ve mentioned this before, but it bears repeating: Presidents don’t really have all that much they can do to affect the economy. Sure, they are probably able to impact the economy more than any other single individual. But in a nation of over 300 million people, that’s still a small impact. It’s an unfortunate facet of our system of government that the economy is typically the dominant factor in choosing a President, and yet the economy is one of the areas in which a President is inherently least effective.
In any case, we should be grateful that the stars have aligned to make American manufacturing more attractive. But there are some storm clouds on the horizon, and they’re related to hydraulic fracturing. That, though, is a topic for a future article.
- FRAK — An ETF for Fracking Stocks (wallstreetpit.com)
- Difference Engine: Awash in the stuff (economist.com)
- New report: You can all calm down about fracking and earthquakes (hotair.com)
- Romney v. Obama: Who Does Ohio Pick To Make The Most Of Oil and Gas Boom? (huffingtonpost.com)
- Natural Gas, Fracking, and the Future (valuewalk.com)
- The Fracking Revolution (businessinsider.com)
- China and India Don’t Have Enough Water to Cool Future Coal Plants (solarfeeds.com)
- Sad news for peak oil disciples (business.financialpost.com)