EconomicsUSA: Outsourcing loses luster to American companies -- costs too much!

Analysis: 

Will Costs Drive Firms Home?

By JOHN BUSSEY

For years, the U.S. manufacturing sector seems to have been sliding into the Slough of Despond.

Companies have been eagerly outsourcing to lower-cost venues such as China, India and Mexico. And with the production go jobs. Occasionally a company might bring some manufacturing back to the U.S. But it's a trickle, and the exceptions seem to prove the rule.General Electric, Caterpillar, a handful of others—the list is short.

Now, that may be about to change.

A combination of forces—rapidly rising labor rates abroad, loftier materials and shipping costs, deep-discount tax incentives from U.S. states—are changing some of the calculations by which companies decide to move production abroad, or even keep what's there now.
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First some caveats: Employment at manufacturing companies in the U.S. may have dropped over the last 40 years. But those companies have gotten a lot more productive, and manufacturing output has actually risen. Companies are making — in the U.S. — more than double what they did four decades ago.

Second, companies will certainly keep expanding production in places like China and India to serve those growing markets. It's the factories they have abroad building product for shipment to the U.S. market that are in question.

The forces at work are potent ones:

Wage rates are soaring in China as the market for skilled workers tightens and the previously mute labor movement finds its voice and agitates for higher salaries. This is cutting into the cost advantage that cheap Chinese labor provided U.S. manufacturers.

In many sectors, annual wage growth is running at 15% or more. And in higher value sectors, Chinese managers are earning as much as their Western counterparts.

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"China's low-wage advantage will disappear over the next five years," Christian Murck, president of the Beijing-based American Chamber of Commerce in China, warned a gathering of corporate and trade officials in Washington Tuesday. "Supply chains are already being disrupted."

Then there's the rest of inflation: the tab for energy, raw materials, real estate, shipping. All are on the rise, rapidly boosting the cost of doing business abroad.

U.S. states, meanwhile, panicked as they are by the loss of jobs and their worsening budgets, are hanging out the "Open for Business" shingle. While many semiconductor companies have expanded production abroad (Intel, which has big operations in the U.S. and around the world, has invested in new chip-making and assembly plants in Vietnam and China), Globalfoundries Inc., a spinoff of Advanced Micro Devices, is setting up a new shop in Malta —that would be Malta, NY.

New York ponied up $1.3 billion in grants and tax relief to attract the semiconductor plant. That package "leveled the playing field with other countries," says Doug Grose, chief executive of Globalfoundries.

Harold Sirkin, senior partner at Boston Consulting Group, says the decision point for other companies is right around the corner.

"China has been the default" for production, he says. "We began hearing from our clients three years ago about problems getting the right labor pool and at the right costs." If current trends continue, "sometime around 2015 it will make more sense to put the incremental plant in the U.S. as opposed to China," he contends.

Why not just shift that production to Vietnam, India or another low-cost locale? Companies often discover that few other locations have the supply base, shipping infrastructure, and skilled labor to pull off what China does.

So, after calculating in all the factors—including a more flexible workforce in America and an appreciating Chinese currency—Mr. Sirkin believes companies in certain sectors, such as electronics, will opt to build in the U.S. Production of products such as clothing and shoes would likely remain abroad, he says.

BCG is so confident about its read of the trend lines that, in a study it's releasing Thursday, the firm predicts the U.S. could see a "manufacturing renaissance" in the next five years as production stays or returns home.

Out in Beijing, Mr. Murck isn't yet seeing this trend take hold, though he says it might in time. Similarly, Jeremie Waterman, a China expert at the U.S. Chamber of Commerce, isn't convinced.

"It's not necessarily a slam dunk," he says. "If China follows through on its plans to create a more dynamic economy, you could see productivity improve," driving manufacturing costs back down.

And those state subsidies? States in the U.S. can certainly make themselves more attractive to manufacturers. They'll be competing against a champ, though: When it comes to piling on incentives, history shows there are few pockets as deep as those of China Inc.

Write to John Bussey at john.bussey@wsj.com

-- Bussey / WSJ materials posted by EconoMix