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Manufacturing is a tough, competitive business. Shipping across oceans has become cheap, as has international communication, so offshoring, reshoring or never changing are vital decisions. The outlook for manufacturing activity in the United States depends on many factors, including the overall state of the economy. In this article, though, I focus on the offshoring/reshoring issue: where will manufacturing activity take place in the coming years?

Many generalizations are made, such as “American manufacturing is dead” or “manufacturing is coming back to the United States.” Unfortunately, the world is too complicated for simple conclusions. Some industries are, in fact, dead in this country. Other industries, though, are returning production to the U.S. Others never left and are doing just fine, thank you very much.

To look into the future, let’s first review where we’ve been, and then figure out the challenges to local production and the challenges to offshore production. At that point, we can forecast which sectors will expand in the United States and which will use overseas locations.

Recent Manufacturing Trends

Prior to 2000, when offshoring really took off, U.S. manufacturing production grew just a tad bit slower than the overall economy. A one percent gain in GDP was correlated with a 0.94 percent gain in manufacturing production. In the years since 2000, however, the gain in manufacturing was only 0.45 percent for every percentage point of GDP growth.

Manufacturing

In the past year, however, manufacturing production has increased faster than real GDP growth, part of its cyclical recovery.

Challenges to Reshoring

Companies that have tried to bring production back into the United States often face labor challenges. They report difficulty finding workers who can pass drug tests, do basic math needed for the job, and come to work regularly. Skeptical folks will ask if the company was expecting all that for minimum wage. The upshot of the discussion: labor costs for good, reliable workers are not as low as one would think looking at the minimum wage.

Electricity costs have been rising for industrial users in the United States, despite steeply declining natural gas prices and moderately declining coal prices. One would think that cheaper fuel for electric utilities would translate into lower electricity prices, but increasing expenditures for renewable power have more than offset fuel savings.

The regulatory environment is in many ways less favorable for businesses in the United States, especially regarding land use and environmental rules. Offsetting these problems, though, is the much lower level of public-sector corruption in America. These are broad generalities, of course, but companies are aware of these issues as they dive into analysis of reshoring.

Finally, many companies are finding that their overseas markets are growing faster than domestic markets. Last year, for example, emerging economies grew by five percent inflation-adjusted, while the United States grew by just two percent. Those foreign plants make more sense when they also serve fast-growing countries.

Challenges to Offshoring

Countering the challenges to reshoring are the continuing challenges to offshore operations. Labor costs are rising in many emerging countries including China, with a ten percent increase last year. Expect foreign wages to continue to increase.

For many companies, the long supply chain has been a disadvantage to offshoring. High-value products, such as cell phones, can be air-freighted economically. Goods that travel by ship, however, have to be transported to a port, loaded on to a ship, moved across oceans, unloaded onto a truck or rail car and then sent to the final destination. This long transportation path makes fast adjustments to production very difficult. It is particularly a problem when demand fluctuates quickly, as is the case with fashion apparel.

Quality is a manageable challenge to offshoring. “Manageable” means that the buyer of foreign-made goods or the company whose own operations are located offshore can keep quality high, but at a cost in cash outlays and managerial effort. Those countries who underinvest in quality assurance will be burned.

Forecast for U.S. Manufacturing 2015-2016

Reshoring will continue, but not across the board. The greatest reshoring will occur in industries that benefit most from cheap natural gas and have access to global markets. These are chemicals and metals (both primary manufacturing and fabrication). The other major industrial user of natural gas is glass and ceramics, but these are not much traded internationally due to high shipping costs. As a result, cheap natural gas will not help our glass companies gain global market share. (For more background, see my article Energy Forecast 2013-2014: Convert To Natural Gas.)

Reshoring will also continue for products that change rapidly, including fashion apparel and technology, but whose product value/weight ratios do not justify air freight.

In addition, products that are made with relatively little labor will be more likely to reshore. Chemicals plants, for instance, have little labor relative to the value of production, so offshore production does not save much. Most of them, however, never left our shores.

Reshoring will be less pronounced in sectors with strong foreign demand for the products. Why shut down a Chinese plant if Chinese demand for the product is increasing? However, reshoring may occur in cases where total demand is rising. Instead of closing the foreign factory, a domestic U.S. factory will add to capacity.

Companies will also prefer geographic diversification over concentration. In 2011, Thailand floods closed many factories, as did Japan’s earthquake. Companies with multiple facilities were in much better shape than companies which had concentrated operations in one location.

The trend to reshoring will continue, but it will be limited to a few industries where it makes a lot of sense. Further offshoring will probably be limited — those companies that would benefit from offshoring have already made their moves. Domestic production of manufactured goods will continue based on our economic growth.

Looking forward, I assume that additional offshoring will be roughly offset by reshoring, and we’ll go back to manufacturing production moving closer to GDP growth. There will never be a one-to-one ratio of manufacturing growth to GDP growth so long as services continue to expand, aside from short-term cyclical recoveries. However, the growth of manufacturing will be much better than recent history. I won’t call it a boom, but it’s the next best thing.

Finally, don’t expect manufacturing employment to grow along with production. The fastest-growing parts of manufacturing will be those that use the least labor. Productivity in factories continues to improve, so the best jobs picture we can hope for is flat. The peak year for U.S. manufacturing employment was 1979, and we’re not going back there.

Source: Reshoring Or Offshoring: U.S. Manufacturing Forecast 2015-2016