#501. The Shifting Economics of Global Manufacturing – Part I

Last week, our Agurban looked at why manufacturers are once again moving manufacturing plants to Mexico. This week, we begin a three-part series featuring research from The Boston Consulting Group, Inc. Their report, “The Shifting Economics of Global Manufacturing”, looks at cost competitiveness of the 25 leading exporting economies. Our first two parts will review the patterns of change in manufacturing cost competitiveness, and we will conclude with the forces that are redrawing the competitiveness map.

Part I

The Shifting Economics of Global Manufacturing
How Cost Competitiveness Is Changing Worldwide
by Harold L. Sirkin, Michael Zinser, and Justin Rose

For the better part of three decades, the view of the manufacturing world has been divided into low-cost regions, including Latin America, Eastern Europe, and most of Asia, and high-cost regions, including the U.S., Western Europe, and Japan.  But this view now appears to be out of date. Years of steady changes in wages, productivity, energy costs, currency values, and other factors are quietly but dramatically redrawing the map of global manufacturing cost competitiveness.

To understand the shifting economics of global manufacturing, The Boston Consulting Group analyzed manufacturing costs for the world’s 25 leading exporting economies along four key dimensions: manufacturing wages, labor productivity, energy costs, and exchange rates. These 25 economies account for nearly 90 percent of global exports of manufactured goods.

The new BCG Global Manufacturing Cost-Competitiveness Index has revealed shifts in relative costs that should drive many companies to rethink decades-old assumptions about sourcing strategies and where to build future production capacity. To identify and compare the shifts in relative costs, data was analyzed in 2004 and 2014.

In developing the index, BCG observed that cost competitiveness has improved for several countries and become relatively less attractive for others. Within the index, four distinct patterns of change in manufacturing cost competitiveness were identified. These patterns include under pressure, losing ground, holding steady, and rising global stars. This week we will review the first two patterns.

Under Pressure

Five countries that have traditionally been regarded as low-cost manufacturing bases have seen their competitive edge erode significantly from 2004 to 2014: Brazil, China, the Czech Republic, Poland, and Russia. In several of these countries, average manufacturing costs are now estimated to be than those of the U.S. Brazil experienced the most dramatic swing: its average costs were around 3 percent lower than in the U.S. in 2004 and are estimated to be 23 percent higher in 2014. In 2004, average costs in Poland and Russia were estimated to be 6 percent and 13 percent cheaper, respectively, than in the U.S. Now they are both roughly at parity. Costs in the Czech Republic were around 3 percent lower than in the U.S. in 2004 but are now an estimated 7 percent higher than in the U.S. China’s estimated manufacturing-cost advantage over the U.S. has shrunk from 14 percent to just 4 percent over that period.

The key factors driving these changes vary widely by economy. Skyrocketing labor and energy costs have eroded the competitiveness of China and Russia. A decade ago, for example, manufacturing wages adjusted for productivity averaged an estimated $4.35 an hour in China and $6.76 in Russia, compared with $17.54 in the U.S. Again, adjusted for productivity differences, labor costs have roughly tripled in both countries, to an estimated $12.47 an hour in China and $21.90 in Russia. Average productivity-adjusted manufacturing labor costs in the U.S. have risen by only 27 percent since 2004, to $22.32. The cost of industrial electricity increased by an estimated 66 percent in China and 78 percent in Russia, while the cost of natural gas soared by an estimated 138 percent in China and 202 percent in Russia from 2004 to 2014.

Losing Ground

Several traditional high-cost countries that were already relatively expensive a decade ago have lost additional ground, resulting in 16 to 30 percent cost gaps relative to the U.S. This is largely because of weak productivity growth and rising energy costs. The countries losing ground include Australia, Belgium, France, Italy, Sweden, and Switzerland.

Rising energy costs, strong currencies, and weak productivity growth are the main culprits. Electricity costs have risen by an average of 59 percent in the six economies. Natural-­gas costs have soared by an estimated 94 percent since 2004 on average. Wages in those countries losing ground rose by approximately 10 percent more than they did in the U.S., while productivity growth lagged that of the U.S. by an estimated 10 percent. In Australia, for example, wages rose by 48 percent from 2004 to 2014, and labor productivity remained virtually flat.

To get a sense of how dramatically productivity gains have lagged in some losing-ground countries, consider the following comparison. In South Korea, average output per manufacturing worker increased by nearly 56 percent from 2004 to 2014. In Italy, output per worker declined by more than 6 percent over that same period. Italy’s performance also is in stark contrast with that of neighboring Austria, where output per worker rose by around 24 percent since 2004. Even though Austria has the sixth-highest average factory wage of the 25 countries in our index, its relative cost competitiveness did not drop significantly over the past decade as productivity gains helped to offset other increases.

Relatively inflexible labor markets also contribute to the high productivity-adjusted labor costs in most losing-ground countries. France, another laggard in productivity, illustrates some of the challenges. From 2004 to 2014, this economy’s growth in output per worker was approximately 14 percent lower than that of the U.S. Part of the reason is that France has the most rigid work rules of any major exporting economy in our index. For example, the official workday is seven hours, employers must pay for 30 days of annual leave for workers, and night work is highly restricted.

Next week we will review the final two of the four patterns of change in manufacturing cost competitiveness.