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 The image of the robotic "blue ant" Chinese worker-hordes is long out of date.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.



What Happens Overseas Should Stay Overseas

Why foreign-policy wonks shouldn't write about domestic policy.

The foreign-policy universe is a bit like Mean Girls. Just as that film broke down high school into very specific subcultures, the world of foreign-policy wonks also has its own particular fiefdoms. Smug Realists, for example, can't resist teasing other cliques with taunts about Iraq or "imperialism." There are the Snooty Africanists, who disdain (often with cause) all popular media coverage of that continent as ridiculously superficial. And the Climate Change Crowd can't believe the rest of us are debating trivialities as the atmosphere gets saturated with carbon dioxide.

In recent years, however, I've noticed a new subculture emerging among foreign policy professionals. They frequent Council on Foreign Relations (CFR) meetings, Sunday morning talk shows, C-SPAN Book TV talks, and the New York Times op-ed page. Let's call them the Turning Inward crowd. To be clear, they are not isolationists -- I defy anyone to use that term on Thomas Friedman, Michael Mandelbaum, Charles Kupchan, or Richard Haass. Rather, what defines the Turning Inward crowd is the belief that the source of America's biggest problems does not lie overseas, but at home. Therefore, any responsible foreign-policy wonk needs to turn his or her analytic lens to what ails the United States first before focusing on the rest of the world.

This kind of logic has its appeal and cheerleaders -- including President Barack Obama, who has riffed a lot about "nation-building at home." This was a theme of Friedman and Mandelbaum's That Used to Be Us as well as one of the themes in Kupchan's No One's World. CFR President Richard Haass has penned the latest manifesto from the Turning Inward crowd, with Foreign Policy Begins At Home: The Case for Putting America's House in Order. More than any of these other works, Haass's book illustrates both the strengths and weaknesses of this particular subculture. Let's look at them one by one.


Reading a lot of foreign policy commentary, you'd think that the United States was facing a world of unprecedented threats -- China's rise, old-fashioned terrorism, new-fangled cyberterrorism and the like. The truth is that the United States faces no threat even remotely as big as it did during the Cold War.

This is one of the points that Haass and the Turning Inward crowd like to stress for why turning inward might be a good idea. It is precisely during a moment of minimal external threats that a country should turn inward to remedy its internal weaknesses. Indeed, the opening sentence of Haass's Foreign Policy Begins at Home concludes, "The biggest threat to America's security and prosperity comes not from abroad but from within."


Goodness, but the Turning Inward crowd likes austerity. Their general perception is that the United States has bankrupted itself over the past few years with profligate spending and borrowing, and that painful cuts are necessary. Haass epitomizes this argument, arguing that the federal government needs to cut its budget deficit by approximately "$250 billion a year over the next four to five years," explaining that: "The world is looking for a signal that the United States has the political will and ability to make hard choices."

The trouble with this argument is that it overlooks three rather important facts. First, based on borrowing rates, the world has been copacetic with U.S. fiscal policy for the entire post-2008 era. Indeed, as the Economist pointed out, "never in recent economic history have interest rates been so low for so many for so long."

Second, by engaging in expansionary Keynesian policies, the federal government (successfully) aided in the deleveraging of the private sector.

Third, this demand for fiscal austerity is two years out of date. Indeed, as the Congressional Budget Office recently reported, the budget deficit as a percent of GDP has dropped faster in recent years than at any time in postwar economic history. The contrast with the far more severe, and far less successful British exercise in austerity is rather stark.

New York Times columnist Paul Krugman recently argued that many austerians advocate these policies because of "the urge to see economics as a morality play." Haass, and the rest of the Turning Inward crowd, seem to fit this accusation all too aptly.


If you only paid attention to news coverage out of Washington right now, you would conclude that the greatest domestic threats facing the United States are homegrown terrorism, overregulation, corruption, and fiscal laxity. All of those are problems, but weaknesses in America's infrastructure and K-12 education system are more serious. It is to Haass's credit, for example, that even though he wants a smaller federal budget, he simultaneously calls for a hike in the gasoline tax to pay for better roads and bridges. He also advocates for a longer school year.


When foreign-policy wonks analyze the United States, they get easily frustrated because, to them, the solutions seem so simple and the politics seem so hard. So they start focusing on gerrymandering and outside money and special interests and the Internet and How Much Better Things Used to Be. Haass manages to avoid the gerrymandering trap, but he does fall prey to some of these other tropes.

This nostalgia for an age of pre-partisan politics makes a few errors. First, as Larry Summers pointed out last month in the Financial Times: "Throughout American history, division and slow change have been the norm rather than the exception. While often frustrating, this has not always been a bad thing.... The great mistake of the gridlock theorists is to suppose that all progress comes from legislation and that more legislation consistently represents more progress." Indeed, two of the major trends favoring the U.S. economy over the long run -- the domestic energy boom and the revival of manufacturing -- had little to do with the federal government.

Second, compared with its peers, the U.S. system of government has been surprisingly nimble. In the five years since the financial crisis, Congress has passed legislation that saved the U.S. financial system, rescued the auto sector, enacted the largest fiscal stimulus program in the world, overhauled its financial regulation, passed ambitious health-care legislation, and then took steps to rein in deficit spending. As I type this, the House and Senate are moving forward on comprehensive immigration reform. Next to either the European Union or Japan, the United States has been a hive of productive political activity.

It is certainly true that the United States has seen its share of rancorous domestic debate -- but the Turning Inward crowd mistakes this for complete paralysis. Which it isn't.

Most members of the foreign-policy community embrace economic globalization, and believe firmly in David Ricardo's principle of comparative advantage.  The problem with the Turning Inward crowd isn't that they are completely wrong about what ails the United States. It's that they, compared with those policy wonks who work on American political economy, simply don't know as much. So while the grand strategy of Turning Inward has its appeal, perhaps this clique should take a cue from Ricardo and maintain its focus on the rest of the world.

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