As a follow up to “Made in America,” I would like to explore some of the dynamics of competition in manufacturing in a world market. We have all seen the effects of American manufacturing outsourcing to Mexico, Japan, India and China. Maybe this progression should take many years, maybe American political policy has contributed to how quickly the change is taking place. And of course that makes it much harder to adjust to.
Reducing the cost of manufacturing is always an issue. Who doesn’t want lower prices? But labor costs alone are not the whole story. And its hard to compete directly when labor forces are wildly disparate. With US labor costs of $12-45 an hour competing with costs of $.64 an hour in China, it is hard to deny the merit of the strategy of just moving everything over.
In fact, intermediate macroeconomics will tell you that all markets gravitate to the lowest price. As trade between countries becomes more widespread, using foreign labor becomes more prevalent. The US moved a lot of its automotive parts to Canada and Mexico for that very reason. And high scrap rates out of Mexico were tolerated as we tried to take advantage of the proximity of the labor force and low cost labor.
This also makes the point that the main barriers to using foreign labor are distance, which means transportation costs, and quality which means scrap cost. Transportation costs are constantly changing, as recent fuel cost show. Transportation costs, which were steadily decreasing in the 1990’s, may have contributed to the “offshoring” strategy. As fuel costs increase, the cost of using foreign labor increases as well.
Scrap cost or serious product deficiency that results in recalls or injury to customers creates huge expense and bad press for the product involved. These situations can severely impact revenue and the risk may not be worth it.
Tariff and duty charged by national governments are cost barriers that are political means of creating barriers to foreign goods. The US has had difficulty with balancing trade with its trade partners. Special situations where foreign governments have large loans to the US make negotiations even tougher.
The big issue is the value of currency. As the dollar falls in value, other currencies become more expensive, so the relative cost of labor changes. Again, a very dynamic situation over time. And this is exactly the case with our largest trade partner, China. Not only is the currency going up, but China’s millions of emerging consumers are experiencing inflation at the same time.
But beyond the standard economic factors, there are hidden costs to using foreign labor. A growing number of US manufacturers have found that offshore labor costs aren’t the bargain they initially appear to be when the foreign manufacturer requires constant on site support in order to maintain promised product performance or delivery schedules. Off-shoring involves significant risks.
All of which leads to returning manufacturing to the US.