#502. The Shifting Economics of Global Manufacturing – Part II

Last week we began a series featuring research from The Boston Consulting Group,that looks at global manufacturing cost competitiveness. We began by looking at the first two of four distinct patterns of change in manufacturing cost competitiveness. Those first two patterns are under pressure and losing ground. The final two patterns are holding steady and rising global stars.

Part II

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

Holding Steady

Four countries in our group of 25—representing both developing and developed economies—managed to sustain their cost competitiveness from 2004 to 2014, despite higher global energy costs. They are India, Indonesia, the Netherlands, and the UK. Overall costs in each nation changed by no more than 2 percent in either direction compared with the U.S.

The UK has emerged as the lowest-cost manufacturing economy of Western Europe, just ahead of Spain. The UK’s flexible labor market, which makes it easier to adjust the size of the workforce when economic circumstances change, is a major competitive edge. The UK, therefore, may be a more attractive proposition as a location for investment in new capacity.

In the Netherlands, productivity-adjusted labor costs fell from 2004 to 2014 relative to the U.S. That is because manufacturing wages rose by only around 1.7 percent annually during that period, while productivity grew by an estimated 2 percent annually. Natural gas and electricity for industrial users cost approximately 10 to 30 percent less in the Netherlands than in most of its European neighbors.

Manufacturing costs in India and Indonesia experienced more significant movement, rising in some dimensions but declining in others. Even though average manufacturing wages more than doubled in both countries over the past decade, these increases were offset by productivity gains and by currency devaluation

Rising Global Stars

The manufacturing cost competitiveness of the U.S. and Mexico improved substantially over the past decade compared with all the other economies in our index. For these two rising global stars, productivity-adjusted wages and currency rates have remained stable or improved relative to the other countries. Both nations also have very competitive energy costs.

Mexico has regained its status as a leading low-cost manufacturing base. The country enjoyed a surge of manufacturing investment and booming exports to the U.S. following the signing of the North American Free Trade Agreement in 1994. But a significant share of factory work went to China after that country entered the World Trade Organization in 2001. The pendulum is now starting to swing back.

The biggest factor is the cost of labor adjusted for productivity. In 2000, Mexican manufacturing labor was roughly twice as expensive as Chinese manufacturing labor. Since 2004, however, Chinese wages have nearly quintupled, and Mexican wages have risen by only 67 percent—less than 50 percent in dollar terms. And despite the fact that China has had higher productivity growth, the average Mexican productivity-adjusted labor costs are now estimated to be 13 percent lower than those of China. Add attractive electricity and natural-gas costs, and Mexico’s total costs are estimated to be 5 percent below those of China, 9 percent below those of the U.S., 10 percent below those of Poland, 11 percent below those of South Korea, and a full 25 percent below those of Brazil.

The manufacturing-cost gap between the U.S. and other highly developed economies widened significantly from 2004 to 2014. Average U.S. costs are now estimated to be 9 percentage points lower than those of the UK, 11 points lower than in Japan, 21 points lower than in Germany, and 24 points lower than in France. Of the large developed-economy exporters, only South Korea—at roughly 2 percent higher costs—is close. Indeed, the U.S. has emerged as the lowest-cost manufacturing location of the developed world. At the same time, the U.S. has achieved approximate cost parity with low-cost countries in Eastern Europe. The cost gap with China has shrunk dramatically and, if the trend of the last ten years continues, will disappear before the end of the decade.

Labor is one key to the growing U.S. competitive advantage. The U.S. has one of the developed world’s most flexible labor markets, ranking as the most favorable economy in terms of labor regulation among the top 25 manufacturing exporters. The U.S. also has by far the highest worker productivity among the world’s 25 biggest manufactured-goods exporters. Adjusted for productivity, U.S. labor costs are an estimated 20 to 54 percent lower than those of Western Europe and Japan for many products.

The big U.S. energy-cost advantage is a recent development. While industrial prices for natural gas have risen around the world, they have fallen in the U.S. by around 50 percent since 2005, when large-scale recovery from underground shale deposits began in earnest. Natural gas currently costs more than three times as much in China, France, and Germany than in the U.S.—and nearly four times as much in Japan. In addition to being an important feedstock for industries such as chemicals, low-priced shale gas has also helped keep electricity prices in the U.S. below those of most other major exporters. That translates into a sizable cost advantage for energy-intensive industries such as steel and glass. Natural gas accounts for only 2 percent of average U.S. manufacturing costs, and electricity represents just 1 percent. But in most other major goods-exporting countries, natural gas accounts for 5 to 8 percent of manufacturing costs and electricity for 2 to 5 percent.

Next week we will conclude our series with a look at the forces that are redrawing the competitiveness map.