More than two years have passed since we introduced our U.S. Manufacturing Renaissance theme. At that time, we detailed initial signs of a pick-up in domestic manufacturing driven by both a return of formerly outsourced production and an expansion in goods for export. This trend was being driven by a number of factors, although headwinds to a resurgence of U.S. manufacturing also existed.
The Manufacturing Renaissance theme and overall economic growth have largely tracked the expectations we initially established, and there have also been some welcome surprises to the upside in certain elements of this theme. We continue to believe the Manufacturing Renaissance is a viable trend which still has the potential to evolve into a long-term engine of economic growth.
Checking Up on the Manufacturing Renaissance
Manufacturing activity as a share of U.S. GDP has been in steady decline for several decades. However, over the past two years there have been signs that this downward trend is abating. Evidence of the shifting tide is most apparent in durable goods output, especially in computer and electronics, motor vehicles and machinery, passing their pre-recession peak in the third quarter of 2011.
There are numerous recent examples of companies returning manufacturing activities to (or increasing manufacturing in) the U.S. Increased interest in locating production in the U.S. is largely attributable to the fact that many companies are now accounting for more than just labor costs, and are increasingly using a total cost analysis when deciding where to manufacture. Some of the major reasons for re-shoring include high and rising transportation costs, attractive domestic energy prices and increased costs in countries such as China, which have been popular locations for production facilities in years past.
Because manufacturing processes are often very energy intensive, favorable energy prices in the U.S. have proved particularly important to the re-shoring theme. Industries set to benefit most from these lower energy prices include organic chemicals, resins, agricultural chemicals, petroleum refining, metals (i.e. iron and steel) and machinery.
Signs suggest that the U.S. labor market's demand for manufacturing personnel today is stronger than it has been in some time. Average weekly hours worked per production and non-supervisory workers are at the highest level since the 1940s and overtime hours are at historically elevated levels. Wages are also beginning to show signs of life in the manufacturing sector, though some industries are seeing stronger wage growth than others.
Where Do We Go From Here?
The improvement in American manufacturing appears to be sustainable, and the potential for stronger growth exists. Favorable conditions which could foster further growth going forward include stable/lower domestic energy prices, the potential for increased capital investment, volatility in international shipping costs, and rising or unpredictable unit labor costs in emerging markets. While we believe there is a high likelihood that these positives continue to propel domestic manufacturing, other factors are acting as restraints.
Currently, labor force dynamics remain one of the more significant headwinds to the Manufacturing Renaissance. Tight manufacturing labor capacity has lead to increased wages and more overtime for workers. Although wage growth is a positive for the consumer, if wages rise too quickly, it may be sufficient to diminish the attractiveness of manufacturing in the U.S. Equally important is the fact that the workforce continues to age in many industries, resulting in the risk of a net decline in workers as Baby Boomers continue to retire. Hundreds of thousands of jobs remain unfilled in manufacturing and other skilled labor industries because the current workforce does not have the adequate skills to fill these positions.
Additionally, there are many policy risks that could threaten the sustainability of the recent gains in domestic manufacturing. While protectionism has been a relatively benign concern of late, it does bear close monitoring. Any moves toward greater protectionist policies and trade restrictions will likely have negative repercussions on the manufacturing sector. Tax policy is another factor that can influence decisions as to where a company will locate various business activities. The individual tax rate is also very important to manufacturers as two-thirds of manufacturers are flow-through entities and pay taxes at individual tax rates.
The outlook for U.S. manufacturing continues to improve, and for the past two years it has been a positive contributor to overall economic activity. The resurgence of domestic energy production, rising labor costs in the developing world, increased transportation costs and the emergence of more training programs for skilled workers are all positives for this theme. At the same time, headwinds such as rising U.S. labor costs, the skills gap, government and regulatory hurdles and lackluster global growth are sufficient to dictate restraint when forming expectations for future growth. At present, we believe that the ongoing evolution of this theme will create opportunities for select companies and industries, but it is not a big enough tailwind to change our overall slow economic growth outlook.