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The US manufacturing PMI released by the Institute of Supply Management (ISM) on Monday beat expectations, coming in at 53.4. But that’s not what we really want to talk about here. Instead, we want to ask the question that the team at Bank of America Merrill Lynch asked themselves in an impressive 73-chart, 43-page report last week. Namely: is US manufacturing in the early stages of a renaissance?
There is a popular image of the sector as being in perpetual decline due to offshoring. However, at least some of the alleged decline had more to do with other sectors growing and thus decreasing manufacturing’s share of GDP as a percentage.
With the wage gap between the US and emerging markets narrowing, a weak dollar, and a relatively inexpensive domestic natural gas supply, the manufacturing sector could see something of a comeback. Not over the near-term but rather the medium or long term.
One of the implications of this is that those investing in EM countries solely because of their growth potential, primarily when that potential is to do with input cost advantages, will need to more discerning in the future about regional allocations. Having a catch-all “EM bucket” just won’t be good enough anymore.
Let’s dig into some of the analysis around this by BAML’s John Inch and Neil Dutta. It’s basically one huge graphfest… ??
To set the scene, US manufacturing was 12 per cent of GDP in 2010, and manufactured goods represented 61 per cent of all US exports during the same year.
Here’s how the domestic manufacturing pie is broken up by industry:
From the above, the three leaders are computer & electronic products, chemicals, and food & beverage. Some thoughts as to why those particular industries are the leaders from the BAML duo (emphasis ours):
In our view, many of these growing industries possess characteristics that make offshore alternatives less attractive or unviable "“ e.g. vicinity to domestic natural resources for the chemicals and petroleum & coal industries, safety and regulations for food & beverage, high IP content and established supply chain network for aerospace assembly, etc. Going forward, we expect these attributes to continue to play an important role in driving U.S. domestic manufacturing.
So it simply doesn’t make sense to offshore these. Or as least, as much sense as it makes to offshore, say, textiles. To get a sense of the trend of these industries over time, here’s another chart that gives a few snapshots over the last three decades (click to enlarge):
For manufacturing as a whole, the next graphs show us that even though the manufacturing sector’s contribution to GDP in nominal terms has steadily been increasing…
… its share of overall GDP has been decreasing. As we stated above, this is a reflection of the rise of other sectors more than of a decline in manufacturing.
One of the reasons that a perception of manufacturing’s decline exists is the severe job losses that have been experienced within the sector — particularly given the dramatic impact such shifts can have in small communities all over America. This graph shows the decline:
There is, however, something of a silver lining to this from a macro perspective. According the BAML team:
…while job losses have indeed been severe, we argue this has helped to dramatically improve the efficiency and competitiveness of current U.S. industrial productive capacity.
But if the US is in theory becoming more competitive, who is the competition? This next graph shows that while the US’ global share of manufacturing output has decreased, China’s has increased quite dramatically (as one would expect):
That said, the US is still quite the global giant. It’s kinda funny to think this giant is only 12 per cent of US GDP then, as we stated earlier. But this little fact brings it a bit more into perspective:
The Bureau of Economic Analysis calculates that every $1 of manufacturing GDP drives an incremental $1.42 of economic activity in nonmanufacturing sectors (eg, accounting, legal, consulting, wholesaling, transportation, and agriculture) "“ this according to the National Manufacturing Institute's 2011 report. Consequently, a prospective U.S. manufacturing renaissance could provide a meaningful overall economic boost to the United States in the coming years.
FT Alphaville wonders how much additional economic activity is generated from another sector — finance. If the often lavish Christmas parties that law firms put on for their bank clients is anything to go by, the additional activity is quite substantial.
There should also be parties on offer by the American Commerce department to foreign investors who are as so kind as to invest a fair amount in the US:
About where the money goes :
Note that while FDI would include investment in areas such as property (eg, commercial real estate), the bulk of the category would encompass manufacturing and distribution capacity.
Another thing we mentioned earlier on was how the wage and input advantage of emerging nations has been decreasing, making the US look more competitive. Here are some graphs that bring this home with reference to sector leader, China (with some income info for Thailand thrown in for comparison):
What factors are driving the changes in Chinese wages? Quite a few different things, as it turns out (all of which we find quite intuitive):
Chinese wages have been increasing at a rapid pace in recent years, driven by a variety of factors including shortage of workers in the coastal manufacturing areas, rising education levels among young workers, domestic inflation, and the government's focus on raising national income levels in its 5-year plan(s).
All of this should bode well for US manufacturing, since it makes the US more competitive in cost terms. Also in the future, more of Chinese output is expect to stay in China:
Looking ahead, we expect multi-national industrial companies to continue to shift their business focus in China from a sourcing/exports model to more of "China for China" strategy "“ a trend that has been gaining traction over the years as rapid economic development in the country has been migrating from coastal cities, helping to spawn a large and widening middle class.
As for how the US stacks up against developed markets in terms of wages:
The BAML analysts also cite decreasing price tags for computing equipment as helping keep costs down. But a bigger factor in the race with the competition is surely the decline of the dollar relative to other currencies:
A weaker dollar makes U.S. companies more competitive, increasing the volume of exports, reducing the volume of imports, and potentially stimulating production in import substitution industries. Moreover, it makes foreigners view the U.S. as a less expensive vacation destination while foreign producers increasingly perceive the U.S. as a low-cost production base.
Pack the bags, we’re going to Disney World, Orlando!
And there’s also the more recent trend whereby US industries benefit from a cheap supply of natural gas:
Presently, the U.S. lacks the infrastructure needed to move the natural gas produced in the middle of the country to the global market. There is a fairly wide gap between natural gas prices in the U.S. and the rest of the world (Chart 61). As a result, U.S. consumers and factories are benefiting from the domestic natural gas windfall. Once producers figure out how to export to the rest of the world, consumers could begin paying global prices for natural gas. When this happens, local miners should gain the benefits.
Overall, a fairly convincing argument in favour of US manufacturing then. It leaves us in want of a crystal ball so that we could look forward ten years to see if renaissance really materialises. There is, after all the “u” word…
Perhaps the biggest constraint on jobs is business uncertainty. Uncertainty is the enemy of growth (and there is plenty of uncertainty today) "“ especially for the labor market. After a long period of deregulation, higher levels of regulation have likely added to the perceived cost of labor. One source of this perceived cost is from new health care mandates. While new regulations in the health-care law may have important benefits, they can also inhibit short-term growth. For example, the percentage of businesses citing government requirements as their "single-most important problem" is running at decade-high levels (Chart 84). This could point to why businesses have opted to significantly hire temporary workers, who are less likely to receive benefits. Indeed, in some cases, companies reportedly wrongly classify workers as temporary to save benefit costs and taxes.
About the heath care debate… FT Alphaville is of the view…
No, just kidding, we’re not getting started on that. Really, were not. Or, maybe later. But probably not…
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