The Inflation Reduction Act Will Bring Some Manufacturing Back To The U.S.
A battery is installed in an electric Hummer at the General Motors Factory ZERO electric vehicle … [+] AFP via Getty Images I’ve always been a bit skeptical on how much manufacturing could return to American shores after the last two decades of offshoring. While supply chain challenges over the last three years have given companies the motivation to move production back home or at least closer to market, a manufacturer still has to overcome higher costs if moving production back to the U.S. What’s changing my mind is a new wave of industrial policy incentives that started with the Infrastructure Investment and Jobs Act (IIJA) and the Inflation Reduction Act (IRA). Let’s start with the economics of offshoring, next what I see as two different types of policy incentives, and finally why my thinking on reshoring is shifting. The economics of offshoring Let’s start with what drove offshoring in the first place. The first thing to consider is tradability , to what extent can a product be produced far away from where it is sold. This is usually driven by transportation cost and product lifecycle or perishability. Products that are heavy and of relatively low in value are not tradable because the cost of transporting them over long distancse becomes too great a proportion of the overall value. Similarly, if a product spoils quickly, it’s usually not very tradable unless there is some way to extend its life. Most manufactured goods are tradable, and the growth of low-cost container shipping and international air cargo in the late 1990s and 2000s vastly expanded the range of goods that fit these conditions. The next thing to consider is labor content and labor cost differentials . Back in the early 2000s at the beginning of the offshoring boom, the labor cost in China might be as little as one tenth or less that of the U.S. For example, a product that used to cost me maybe $90 to assemble in the U.S. cost around $38 to assemble in Japan, and less than $2.50 in China. Then it might have cost $1.00 to ship the finished product back to the U.S. That meant I could hire 10 times the number of factory workers in China and still be ahead of the game (actually, more than that). Of course, going into China meant setting up a factory, hiring and training workers, and setting up the supply chain, but the costs were paid for by the savings in product cost. The payback period could be as short as a year, so it was a compelling proposition. This was the magic of labor arbitrage , the movement of jobs to produce goods or services from high-cost regions to low-cost regions. As we know, a lot of firms took advantage of this. By the early 2000s as much as 70% of the merchandise in one of the top big box discount stores came from China, and this was a big part of what kept inflation in check – until recently. Moving from a high-cost region like the U.S. to a low-cost region like China was an economic no-brainer. It paid for itself quickly. But moving production from a low-cost region like China to a high-cost region like the U.S. is not as easy, because who or what is going to pay for the move? Certainly not cost savings on the product. On top of that, the higher labor costs mean you either must have much higher labor productivity in your domestic factory, or you need a product where the labor cost doesn’t matter. Higher labor productivity can be a result of using automation or innovative new manufacturing processes. Labor costs won’t matter if they are a small percentage of the overall product cost, or because the product has such high differentiation and value that labor costs don’t really matter. Think Hermès products handmade in France, or GE Aviation jet engines assembled in North Carlolina. In those cases, production never moved in the first place. For all these reasons, I have been skeptical that a lot of manufacturing for things like household goods or electronics could move out of China back to the U.S. Granted wages in China have risen dramatically, but that means Vietnam, Malaysia, Thailand, Mexico, or Eastern Europe would be more logical destinations to transfer production to. As long as American shoppers buy on price, economics rule. That was until recently. President Joe Biden flanked by (L to R) Sen. Joe Manchin (D-WV), Majority […]
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