Prepare to Start Making Things Again

Why America's natural gas boom is good news for U.S. manufacturing and bad news for China.

China's march to global dominance in manufacturing is slowing down. By Chinese standards, its official claim of 14.7 percent year-to-year growth in exports for April is relatively lackluster -- and the physical trade flow data suggest that it may be overstated by as much as 60 percent. The image of the robotic "blue ant" Chinese worker-hordes is long out of date. The country's spectacular economic growth has vaulted large segments of its population into the middle class, and they want better pay and benefits, shorter work weeks, and other perquisites that their Western peers enjoy.

As China's momentum slips, U.S. manufacturing fortunes are on an upswing. U.S. corporations made unusually high profits in the wake of the Great Crash: During the weak recovery years of 2010-2012, after-tax corporate profits were 43 percent higher than during the stronger recovery of 2003-2005, according to my calculations. Workers took the brunt of the decline, while corporations invested their savings in a brutal restructuring of production operations. Cruel as that was, the United States has emerged from the crash as one of the world's most cost-competitive manufacturers.

According to the Boston Consulting Group (BCG), Chinese worker productivity is still growing at about 8 percent a year, an extraordinary rate -- but worker compensation is growing more than twice as fast. From 2000 to 2010, average wages in south China's Yangtze delta, a manufacturing hotbed, jumped from $0.72 an hour to $8.62. Factoring in worker output, land costs, and the rising costs of long-distance shipping (as well as the relative lack of corruption), U.S. manufacturing is approaching competitive parity with China. BCG also estimates that the United States can undersell firms in Japan and Europe by as much as 25 to 45 percent, and that it may also have the world's best trade logistics capabilities.

The hidden costs of outsourcing often loom the largest, but they don't show up on profit statements. For example, when General Electric, a pioneer of offshoring among U.S. flagship companies, began moving its multi-billion dollar appliance manufacturing back from China as costs converged, they discovered that the lack of contact between their design and production teams had caused their designs to stagnate. The company realized a 20 percent overall savings on their first "reshored" appliance, a water heater, just by re-engineering it to reduce material costs and labor inputs. Onshore production also makes it easier to keep up with today's just-in-time delivery mandates and ever-more-rapid product cycles. (And like all U.S. companies, GE has become very wary of the Chinese propensity to knock off market-leading product designs.)

The data supporting the manufacturing recovery story are still mostly anecdotal, but the anecdotes are coming in floods, not as straws in the wind. Recent surveys show that up to a fourth of U.S. companies offshoring in low-income countries have been moving some or all of their production back home, while a third are researching the question. Meanwhile, at home, factory automation keeps labor-force costs in check, and U.S. manufacturing unions are far less militant than they once were. Caterpillar, Ford, and Whirlpool have been reshoring major product lines as well, and other major manufacturers will likely follow.

Meanwhile, an impressive list of foreign companies is relocating factories to the United States: Samsung is building a semiconductor plant in Texas; Airbus will make planes in Alabama; Toyota is outsourcing production of minivans to Indiana for export to Asia. Rolls-Royce has been expanding its U.S. airplane engine parts production operations to service its global customers.

The nascent manufacturing reshoring boom has gotten a big shot of adrenaline from the rebirth of U.S. gas and oil sectors. Wholesale prices for U.S. natural gas are now by far the lowest in the world, while U.S. oil prices have consistently hovered at about 15-20 percent less than world prices. Some of that price advantage will erode as new pipelines ease transport bottlenecks, but it will continue to be substantial, especially in natural gas. Low U.S. energy costs will work their way through the entire productivity chain. Freight rail lines, for example, are exploring switching from diesel fuel to much cheaper, and cleaner, natural gas. China, by contrast, is heavily dependent on highly polluting coal, and is faced with a tradeoff between massive investments in clean-coal technology, or damaging the health of its populace.

Low natural gas prices are especially important for energy-intensive manufacturing, like making chemicals and steel. Natural gas is an ideal "cracking" fuel, generating the intense heat needed to break up and rearrange molecules to make usable chemicals. But it is also the raw material for plastics, Styrofoam, tires, sealants, adhesives, films, liquid crystal screens, nylons, polyesters -- nearly everything around us. Dow Chemical has restarted a long-mothballed Texas plastics plant and is building or rebuilding three others. Other big players, like Shell, Chevron, Exxon, Bayer, and Formosa Plastics are expanding current U.S. plants and starting work on new ones.

The importance of natural gas goes far beyond chemicals. Nucor began as a "mini-mill," melting scrap to make high-quality steel, and is now the nation's top structural steel vendor. But scrap steel is getting scarce and expensive, so Nucor has been locking up long-term supplies of natural gas so it can make its own iron using a highly efficient, but energy-intensive, "direct reduced iron" (DRI) technology, not feasible without low-cost gas. The company is opening a mammoth DRI plant in Louisiana, and is starting to build another. Within a few years, the company plans for all of its facilities to be run on natural gas.

The new energy sector is also a big consumer of manufacturing. Energy-bearing shale is typically quite deep, often two miles or more below the surface, and its retrievable hydrocarbons are thinly distributed. So collection well pipes must extend a mile, or even two miles, horizontally through the shale to access a meaningful amount of product. Each shale well requires up to 100 tons of high-quality steel pipe; fleets of specially adapted trucks and trailers; a small hangar of earthmoving, drilling, and other equipment; specialty chemicals, sands, and ceramics; and some very high-end seismic and other underground imaging gear. Much of these products are now U.S. specialties. According to the annual Oil & Gas Journal survey, U.S. energy industry investments will total $348 billion in 2013, equivalent to about 2 percent of GDP, with much of the investment sourced from overseas.

Recently, several Wall Street economists have raised doubts about the manufacturing recovery. Yes, the economy has added 550,000 manufacturing jobs since the Great Recession, they concede, but doesn't that always happen in a recovery? Well, no. Before this recent uptick, manufacturing employment has fallen, in good times and bad, since 1997 -- and this is an unusually weak recovery.

At the same time, foreign steel companies and chemical companies are moving operations to the United States to service the energy industry and to take advantage of low energy prices (although China is still far and away the world's largest steel producer.) Dow Chemical has compiled a list of 108 new energy-intensive manufacturing projects from more than 80 U.S. and foreign companies either under construction or in development in the United States, with total planned investment of nearly $100 billion. About one-third are already underway or due to start construction this year; 60 percent are scheduled to be under construction by 2015.

Reputable forecasting organizations, like Citi GPS, suggest a total gain of several million U.S. jobs, including both direct and indirect job creation. One of the great attractions of manufacturing, in contrast to, say, software and finance, is that it has a high employment multiplier. Manufacturing production requires raw material and machinery supply chains, physical shipping and distribution, intensive tracking, inventory, and warehousing operations.

At the same time, these are long-lead time projects. A manufacturing resurgence won't unfold with the speed of, say, a tech-stock boom. Dow Chemical's big new plastics plant will cost $1.7 billion, and take until 2017 to complete. Almost all the projects on Dow's 108-project list have similarly long lead times. But the scale of the commitments is a reason for confidence. These are permanent additions to U.S. production capacity that will fuel a recovery with much more staying power than, say, the housing boom in the 2000s.

The stars are in place for a long-lasting, well-balanced, manufacturing-driven, U.S. recovery -- one that could greatly improve prospects for the country's squeezed and struggling middle class. Meanwhile, a healthy and prosperous China is very much in the U.S. interest, and we should fear the consequences of a messy Chinese slowdown. But the twenty-first century so far has not been a joy ride for the United States. There would be no harm in taking quiet pleasure in a relative repositioning of trans-Pacific karmas.



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