China Gains on U.S. Manufacturing

by: Vincent Fernando, CFA

We often forget that the US is still the largest manufacturer in the world even though the percentage of people working in manufacturing has shrunk. It's made possible by leveraging each manufacturing worker with tons of high tech capital equipment (i.e. machines). And just to quell the people who bemoan more efficient manufacturing as a threat to jobs, it actually means that our manufacturing workers can earn substantially more than, say, China because each man can create much more value due to the higher amount of machinery leveraged to his manual labor.

If you want manufacturing workers to earn high salaries, they will need to have lots of machinery backing them up. Physical strength only creates so much value (almost none) without the help of machines. Anyhow, it appears that the recent downturn in US manufacturing plus the effects of Chinese government stimulus (it's growing employment at all costs to avoid social unrest), means that China could overtake the US as the world's largest manufacturer sooner than expected.

Anyone who walks the aisles of a U.S. retailer might think China already is the world's largest manufacturer. But, in fact, the U.S. retains that distinction by a wide margin. In 2007, the latest year for which data are available, the U.S. accounted for 20% of global manufacturing; China was 12%. The gap, though, is closing rapidly. According to IHS/Global Insight, an economic-forecasting firm in Lexington, Mass., China will produce more in terms of real value-added by 2015. Using value-added as a measure avoids the problem of double-counting by tallying the value created at each step of an extended production process.

As recently as two years ago, Global Insight's estimate was that China would surpass the U.S. as the world's top manufacturer by 2020. Last year, it pulled the date forward to 2016 or 2017.

"The recent deep recession in U.S. manufacturing does mean that China's catch-up is occurring a few years earlier than would have been the case if there had been no recession," says Nariman Behravesh, the group's chief economist. U.S. manufacturing is shrinking, shedding jobs and, in the wake of this deep recession, producing and exporting far fewer goods, while China's factories keep expanding.

I'll just add that perhaps what we are seeing is a more flexible economy (the US) readjusting during a downturn vs. a less flexible one (China) simply expanding due to government support for a lot of inefficient companies (for fear of rising unemployment and the social unrest which could result from it). Longer term, as the US economy reallocates workers and investment into new productive manufacturing ventures, the forecasts for China overtaking the US could be adjusted back into more future years. The goal is not lots of manufacturing, but lots of sustainably profitable manufacturing. Hopefully right now the US is shedding the inefficient bits and freeing up people and capital for investment in better ventures.