Wednesday, November 26, 2014

The Onshoring Myth?

CAMBRIDGE – The decade that preceded the 2008 financial crisis was marked by massive global trade imbalances, as the United States ran large bilateral deficits, especially with China. Since the crisis reached its nadir, these imbalances have been partly reversed, with America’s trade deficit, as a share of GDP, declining from its 2006 peak of 5.5% to 3.4% in 2012, and China’s surplus shrinking from 7.7% to 2.8% over the same period. But is this a temporary adjustment, or is long-term rebalancing at hand?

Many have cited as evidence of more durable rebalancing the “onshoring” of US manufacturing that had previously relocated to emerging markets. Apple, for example, has established new plants in Texas and Arizona, and General Electric plans to move production of its washing machines and refrigerators to Kentucky.

Several indicators suggest that, after decades of secular decline, America’s manufacturing competitiveness is indeed on the rise. While labor costs have increased in developing countries, they have remained relatively stable in the US. In fact, the real effective exchange rate (REER), adjusted by US manufacturing unit labor costs, has depreciated by 30% since 2001, and by 17% since 2005, suggesting a rapid erosion of emerging markets’ low-cost advantage – and giving America’s competitiveness a substantial boost.

Moreover, the shale-gas revolution in the US that took off in 2007-2008 promises to reduce energy costs considerably. And America’s share of world manufacturing exports, which declined by 4.5 percentage points from 2000 to 2008, has stabilized – and even increased by 0.35 percentage points in 2012.

Upon closer inspection, however, the data for 1999-2012 present little evidence of significant onshoring of US manufacturing. For starters, the share of US domestic demand for manufactures that is met by imports has shown no sign of reversal. In fact, the offshoring of manufacturing increased by 9%.

This trend holds even for those sectors dominated by imports from China, where labor costs are on the rise. Indeed, for sectors in which Chinese imports accounted for at least 40% of demand in 2011, the import share has increased at a faster pace than it has for manufacturing overall.

Furthermore, if relative labor costs are an important driver of America’s terms of trade (the relative price of exports in terms of imports), more labor-intensive sectors should have experienced a larger decline. But the data provide little evidence of this.

The only solid evidence of an increase in US competitiveness stems from the sharp rise in output of shale gas. Industries with large energy requirements, like chemical manufacturing, have experienced a much smaller increase in import share than less energy-intensive industries like computers and electronic products. This suggests that energy-intensive sectors are more likely to experience onshoring.

More broadly, the data on US domestic production seem to be inconsistent with the behavior of the REER and its suggestion of a significant increase in competitiveness. To a large extent, this discrepancy reflects a low and delayed exchange-rate pass-through into US import prices, linked to America’s unique advantage of having more than 90% of its imported goods priced in its own currency, with dollar prices remaining unchanged for ten months at a time. Even conditional on prices being renegotiated, the pass-through is quite low, with a 10% depreciation of the dollar appearing as a cumulative 3% increase in import prices after two years. The disconnect between America’s terms of trade and the far more volatile REER is also consistent with low and delayed exchange-rate pass-through.

The evidence is clear: Claims that manufacturing is returning to the US simply do not hold water. Of course, given that the increase in emerging economies’ labor costs and the decline in American energy prices are recent developments, import shares could begin to decline in a few years. But, with that outcome far from certain, the US cannot rely on a rapid increase in manufacturing competitiveness to underpin its economic recovery.

This commentary reflects the authors' personal views.

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    1. CommentedAnanth Krishnamurthy

      The anxiety of a state to provide on-shoring an impetus to keep the ball rolling is rather misguided. The index that a governor or the president should be concerned about is the net value created.Focus on entrepreneurship, ease of doing business and weeding out draconian regulations will provide "real" growth. Its very simple; there is no better guidepost to rational on-shoring than to answer the simple question "Would the corporation make more money if they manufactured in the US than elsewhere?" If the answer is a clear No, there are better things to do.

    2. Portrait of Pingfan Hong

      CommentedPingfan Hong

      Given the ever deepening of the vertical integration of the global production and value chain, it does not make too much sense to define "manufacturing competitiveness" for a single economy, nor does it to consider manufacturing as a single sector.

    3. CommentedSandy Montalbano

      We disagree with the statement in the article "claimed that manufacturing is returning to the US simply do not hold water."

      According to the Reshoring Initiative
      since 2003, new offshoring is DOWN by 70% to 80% and new reshoring is UP by 1500%.

      The most important accomplishment has been the net-loss of 100,000+ manufacturing jobs each year has ended.

      New reshoring is now balancing new offshoring at about 40,000 manufacturing jobs/year, resulting in the first neutral year of job loss/gain in the last 20.

      Reshoring yielded:
      - About 120,000+ manufacturing jobs
      - 20% of manufacturing job growth since the Jan. 2010 low
      - 240,000 total jobs including the manufacturing multiplier effect

      The Reshoring Initiative tracks reshoring in detail including: companies, jobs, investments, reasons, countries, states, etc. We document what’s actually happening in the trend.

    4. CommentedSandy Montalbano

      Although the reshoring trend is driven by higher wages in China, higher global energy and freight prices (but lower natural gas prices in the U.S.) and the fact that companies are beginning to adopt total cost of ownership (TCO) analysis to make their sourcing decisions are also primary factors.

      In many cases, companies find that, although the production cost is lower offshore, the total cost is higher, making it a good economic decision to reshore manufacturing back to the U.S.

      In order to help companies decide objectively to reshore manufacturing back to the U.S. or offshore, the not-for-profit Reshoring Initiative’s freeTotal Cost of Ownership Estimator can help corporations calculate the real P&L impact of reshoring or offshoring.

      Many companies are reshoring because they are finding that having manufacturing near customers gives them better flexibility to respond to customers changing needs, eliminates higher shipping expense, minimize supply chain disruptions and eliminates the larger production runs and inventories associated with long distance offshoring.

      Companies are also finding that when manufacturing is moved next to engineering, they can improve design, eliminate waste, improve quality and increase productivity, many times making the product more easily and at a lower cost.

      This was the case when GE reshored manufacturing of the GeoSpring water heater from China to Kentucky. Design engineers, manufacturing engineers and factory line workers optimized the product. Material cost went down, the labor required to produce it went down and quality improved. Time-to-market also improved because consumers are located near manufacturing.

    5. CommentedSandy Montalbano

      According to the not-for-profit Reshoring Initiative, offshoring of U.S. manufacturing is now in balance with reshoring.

      Since 2003, new offshoring is DOWN by 70% to 80% and new reshoring is UP by 1500%.

      The most important accomplishment has been the net-loss of 100,000+ manufacturing jobs each year has ended.

      New reshoring is now balancing new offshoring at about 40,000 manufacturing jobs/year, resulting in the first neutral year of job loss/gain in the last 20.