Testimony before the U.S.-China Economic and Security Review Commission
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Summary
Reshoring is feasible and with FDI has already brought back about 1 million manufacturing jobs. The Chinese factory price is, on average, 30% lower than the U.S. price. There are two basic reshoring strategies. Both should be followed. - Change perspectives: Educate companies to source based on Total Cost, not just factory price.
- Level the playing field: Reduce the actual factory price gap.
The simplest measure of bolstered resilience is broad reduction of the trade deficit. Recommended government actions and policy changes will achieve balanced trade and increase U.S. manufacturing by 40 to 50% spread over 20 to 30 years, mainly limited by workforce availability. China has been the source of 44% of reshoring and is especially vulnerable now due to the perceived risk of decoupling and the rapid rise in Chinese wages.
Introduction
The purpose of this statement is to demonstrate that reshoring, especially from China, is essential, is already substantial and can be further accelerated by the recommended industrial policies.
The development of effective reshoring policy recommendations requires a clear understanding of the causes of offshoring. Companies source products and site their factories at least 70% based on FOB price/manufacturing cost (“price”) comparisons of the offshore and domestic alternatives. (Appendix 1) Many of the chart’s smaller categories are driven by price, e.g. the product is unavailable here because our industry was eliminated by low priced imports. U.S. price averages about 40% higher than Chinese price (Appendix 2) and about 15% higher than most other developed countries. Faced with domestic and offshore competitors accessing those lower prices, U.S. companies aggressively offshored, starting with Japan and Mexico, followed by S. Korea, India, S.E Asia and China. As long as that huge price differential remains, our trade imbalance and weak supply chain will not improve. To subsidize enough domestic production to overcome our $1.1 trillion 2021 goods trade deficit would cost about $330 billion/year. Probably more, since other countries would respond with more aggressive pricing.
There are two basic ways to attack the underlying lack of price competitiveness. The simplest should be to change perceptions, to educate companies to use Total Cost of Ownership (TCO) to quantify all of the costs and risks associated with offshoring. By switching to TCO, companies will see that about 20% of what they now import from China can be sourced domestically without raising prices or cutting profits. Appendix 10 shows the China price, TCO and TCO including a 15% Section 301 tariff for 180 cases comparing China sources to U.S. sources. The U.S. win rate goes from 8% to 32% to 46% just by doing the math correctly. A 20% reduction in imports would cut the goods trade deficit by 50% . A more basic, certain approach would be to reduce the price differential, to level the playing field by instituting an industrial policy, including: massive transfer of resources from liberal arts university education to engineering, apprenticeships and credentials; 20 to 30% lower USD; not raising the corporate income tax; and implementing a well-designed border adjustment tax (BAT). Appendices 3 & 4 show how employment would respond to a mix of these actions. This policy would make the U.S. more like Germany that has equally high wage rates but achieved a 2020 trade balance of about +5.7% of GDP vs. U.S. -3.1% . Balancing trade would increase U.S. manufacturing by 40 to 50%, requiring 5 to 6 million more manufacturing employees at current levels of U.S. productivity.
Subsidies of a few essential industries such as chips and rare earth minerals are necessary because the U.S. has fallen so far behind. We applaud the administration for these actions. In the longer-term, subsidized industries will fail if they and their domestic customer industries are not price competitive. It is essential to level the playing field vs. all or most countries, not just vs. China. Otherwise, work will flow from China to SE Asian factories, often owned by the same Chinese companies. China will be hurt moderately. The U.S. will be less dependent on China, but still vulnerable to disruption and militarization of the western Pacific and U.S. manufacturing will not be strengthened. Balancing our trade deficit with most countries will increase our manufacturing output and investment faster, providing the needed critical mass and productivity increases. Increasing our manufacturing broadly and quickly will eliminate supply chain gaps, reducing our dependence on China. Much stronger U.S. manufacturing is essential to achieve defense industry capabilities, reduced budget deficits enabling higher defense expenditures, improved income equality, and climate goals. The only way to increase manufacturing’s share of the GDP is to import less (reshore) or export more. It is far easier to import less because importing/exporting adds 20 to 25% to the Total Cost of a product.
Trend, Drivers and Impact
Reshoring by U.S. headquartered companies plus foreign direct investment (FDI) by foreign headquartered companies has surged from about 6,000 jobs per year in 2010 to about 260,000/year in 2021. We forecast 400,000/year in 2022. (Appendix 5). No one tracks offshoring. We believe that new offshoring (closing U.S. factories and replacing with either factories or outsourcing offshore) has fallen dramatically since around 2010. The best evidence is the trend in manufacturing employment, consistent with an increased rate of reshoring and reduced rate of new offshoring. (Appendix 6). Dec. 31, 2021 employment was about six million higher than would have been projected before the Great Recession. Because of this positive trend, the goods trade deficit stayed flat at about 4% of GDP from 2010 to 2019 prior to an import surge driven by COVID. (Appendix 7).
The primary driver of offshoring is lower prices available offshore, especially in LLC countries but also in most developed countries. The lower LLC prices are primarily driven by lower wages. The difference in FOB prices is consistent with the wage differential and labor’s share of manufacturing cost. Initially, very low wages attracted work to China. Today, China’s faster response times and increasing technology and productivity also play a role. U.S. factories in China also sold to a rapidly growing middle class. A strong reshoring effort, coupled with China’s slowing economic growth and shrinking population will help convince companies to shift more of their investment to the U.S.
U.S. government policies, or the lack of appropriate policies, have been the major cause of the trade deficit. These policies include: prioritizing degrees over skills training, allowing the USD to stay at uncompetitive levels, high corporate tax rates and regulations, high medical insurance expense paid by the employer, low duty rates, etc. A large goods trade deficit is not pre-ordained for the U.S. In contrast to the U.S., many of the top developed countries have trade surpluses: Germany, Ireland, Netherlands, Italy, S. Korea, Australia, Singapore, Switzerland, Belgium, etc.
Our resulting uncompetitive price structure drove offshoring, hollowing out U.S. manufacturing, reducing investment in automation and reducing the appeal of manufacturing careers. Until about 1980 the U.S. had at least balanced trade and was self-sufficient in a broad range of products and industries. Now, our trade profile looks more like that of a developing country than the Arsenal of Democracy. (Appendix 8). The U.S. has trade surpluses in a few high-tech categories such as aircraft and semiconductor manufacturing machinery, but mainly in commodities like minerals and agricultural products. The U.S. has large trade deficits in most manufactured products including most high-tech products. The U.S. lacks the industrial infrastructure to respond timely to a catastrophe such as COVID or to provide the increased materiel for an extended war. Defense Department reports show a growing list of needed raw materials and components that cannot be sourced domestically.
The current supply chain structure puts U.S. consumers at risk for availability of most goods other than food and at risk for their jobs. A disruption such as China decoupling would be economically devastating for the months or years it took companies to create or find alternate sources.
Reshoring, Nearshoring, Friend Shoring and FDI
The U.S. supply chain can be strengthened by any of four processes. In priority order: reshoring, FDI, nearshoring and friend shoring.
Reshoring: Always the best choice, if economically feasible. Optimal impact on manufacturing, economy and domestic supply chain. Example: Two huge nitrile glove factories (PPE) funded by the U.S.: United Safety Technology, Inc. and Renco Corporation. Reshoring also increases U.S. purchases of raw materials and components from our trading partners, providing diplomatic advantage. FDI: Achieves the same benefit in terms of manufacturing and self-sufficiency, but more of the profits are lost to offshore and engineering is less likely to be here. About 50% of the 1.3 million jobs brought from offshore since 2010 have been due to FDI. FDI is often the best source of product and process technology when filling supply chain gaps. For example, the large FDI automotive assembly plants (BMW, Toyota, Mercedes, etc.) brought with them many of their suppliers from their native countries. Many EV battery plants have been either pure FDI or joint ventures with auto companies here. Example: GM and LG. Nearshoring: Essentially means Canada and Mexico, which are friends, so nearshoring is a sub-set of friend shoring. The biggest driver of jobs to the U.S. is proximity to the market, so nearshoring is more feasible than other friend shoring. Exports to the U.S. from Mexico are reported to contain 40% U.S. content vs. 5% for exports from China. Mexican wages are lower than Chinese wages. U.S. jobs are offshored to Mexico for the saving in wages and due to the availability of labor. Nearshoring from Asia to Mexico increases U.S. exports and makes supply accessible. Longer term, the nearshoring raises Mexican wages, reduces new offshoring to Mexico, and stabilizes our neighbor’s economy. Canada is an excellent source, but offers little economic advantage vs. reshoring except for certain minerals and electricity intense manufacturing. Mexico is an excellent source for apparel and other assembly operations, including aerospace and automotive. Other friend shoring: Far better than sourcing from China but less preferable than any of the first three processes. Much offshoring has resulted from the U.S. providing privileged access to its market, sacrificing U.S. manufacturing to achieve its diplomatic and humanitarian goals: spreading democracy, pulling countries out of poverty, geo-politics, etc. via Most Favored Nation status and other favors. For example, China’s Most Favored Nation status contributed to our loss of millions of jobs. So, friend shoring should be with friends without added benefits. Reshoring is optimal if:
The work can be done here profitably, based on TCO. Workforce can be made available. The needed technology and components can be available. From a company’s perspective, the industries/products best suited for substantial reshoring are those for whom the Total Cost of Ownership (TCO) for the products is lower here or can be made lower via workforce training, automation and product redesign for manufacturability. The characteristics of such products include:
Low labor content, e.g. plastic injection molding, populating printed circuit boards and high volume machining of standard workpieces such as bar stock. High offshore freight cost and time vs. labor content, e.g. machinery (CAT has reshored production to new plants in Texas and Georgia) and commodity materials. A supply chain gap large enough that a new U.S. factory could be large and automated enough to compete with the imports. Section 301 25% tariffs apply. 50% of such products can be sourced domestically w/o raising prices or reducing profits if companies use TCO. Frequent product design changes. Volatile demand, e.g. some apparel. Risk of IP loss. A good estimate of what products can be reshored is what have been reshored. Appendix 9 shows the mix of jobs reshored and FDI’d by NAICS code industry. From the nation’s perspective the characteristics of such products include:
Competitive TCO and thus profitability, as above. Otherwise, the subsidies will be unsustainable. Filling a supply chain gap eliminates a bottleneck, enabling a flood of additional reshoring in the downstream and upstream supply chain, especially for growing markets, e.g. batteries for EVs. Steve Jobs was asked why Apple does not assemble products in the U.S. He answered that almost all of the components are produced in Asia. The product is essential for health and defense and not dependably available from a close-by friend shore, e.g. rare-earth minerals, PPE, pharmaceuticals. The product is sourced primarily from China. Ideally, the industries and companies should not need to be approached to reshore. A well-designed, permanent industrial policy would level the playing field enough that the companies would decide to reshore in their own self-interest. In the short-term it is necessary to select and subsidize specific critical industries such as chips. In the longer-run the subsidized industries will fail if their manufacturing costs are not competitive and they do not find a growing domestic market. In a few years there will be an oversupply of chips since so many foundries have been announced worldwide. The U.S. is at risk of going from being dependent on China and Taiwan for chips to being dependent on China to buy our overpriced chips to assemble into infotainment systems, medical devices and servers to ship to us. The solution is to level the broad industrial playing field, to have a tide that lifts all, or most, U.S. industries.
China has played a huge role in offshoring, 33% of our goods trade deficit, and in jobs brought back, about 44% of reshoring and 15% of FDI during 2010 to 2021. Since China is an adversary, it is especially unwise to be dependent on them and to fund their growth and military via our consumer and industrial spending. China got a big head-start by devaluing its currency, especially in 2003 to 2013. China has subsidized industries and stolen IP. Balance with China must be restored. China is concerned by U.S. supply chain actions. I was interviewed May 27 by a Beijing reporter for Caijing, a leading Chinese business and economics magazine. The reporter asked me to show how the U.S. could reshore, especially chips, despite our “70% higher cost” and skilled labor and engineering shortages. A recent article by noted geo-political expert, George Friedman, observed that China has not yet reached the critical mass needed to grow based on domestic consumption instead of exports . The U.S. needs to reshore more from China while it is still our choice to reshore rather than wait till China chooses to decouple.
However, the other 67% of our trade deficit has similar negative impact on our economy. The U.S. has a trade deficit with 9 of our top 10 trading partners, all except the United Kingdom . Balancing our Chinese trade deficit would leave a $700+ billion deficit. Getting out of China is essential, but is just the first priority in eliminating our deficit.
Congress and the administration are currently placing a high priority on reducing the rate of inflation. Delaying reshoring is not a logical conclusion. About 30% of goods now imported from China (0.3 X $506B = $152B in 2021 ) can individually be sourced in the U.S. without raising prices or cutting profits (Appendix 10) if companies acted and priced based on TCO. If companies continue to source and price based on FOB prices, CPI would increase about 0.1% one time. If all or most of the 30% is reshored immediately prices will temporarily rise because the country lacks the capacity to increase manufacturing by about 8%. Factories can be added in a few years. Recruiting and training the engineering and technical workforce is the larger, longer-term, problem.
Enabling Companies to Reshore
There are a range of actions companies should take and information they need to be able to accelerate reshoring:
Develop the skilled workforce: Much more aggressively recruit and train the skilled workforce which is needed to increase output, productivity and competitiveness. Adopt TCO: About 60% of companies make sourcing decisions based on wage rates, FOB (factory) price or Landed Cost (price plus duty and freight). By doing so, instead of sourcing based on Total Cost of Ownership (TCO: Landed Cost plus carrying cost of inventory; risk of IP loss, disruption and stocking out; travel cost; etc.) companies ignore about 20% of relevant costs and risks. By switching to TCO, companies will see that about 20% of what they now import from China can be sourced domestically without raising prices or cutting profits. Companies also use TCO to convince customer companies to stop importing and buy from them. (Example: Morey Corp used TCO to win a $60M order for PCBs vs. China) - Obtain Information: TCO calculation requires two types of information that are not readily available. Making the data available would accelerate the use of TCO and reshoring:
- Company data that is not sorted by product or supplier. For example: quality and warranty costs, travel, inventory carrying cost, engineering support. ERP system providers such as Oracle or SAP could incorporate TCO and collection of needed data in their systems. One company excuse would be eliminated.
- Risks, especially geo-political risks. It is almost impossible for the procurement staff to estimate risks, e.g. the probability of decoupling by China, one of the largest factors driving reshoring today. If professional estimates of the probabilities of the most impactful risks could be publicly, readily available, ideally from non-governmental sources, companies would be able to justify including the risks as factors in their decisions. The Reshoring Initiative is including expected value calculations of the impacts of these risks in the revised, free, online TCO Estimator but does not have a source for such probabilities. (Example: Geopolitical Futures recently published the results of a Taiwanese population survey of the probability of war with China. Seven percent strongly agreeing there will be war and 21% partially agreeing .) For many companies, China decoupling would be either devastating or existential. If companies accept that decoupling is possible, they will be much more likely to reshore, nearshore or friend shore.
Invest in automation: Take a longer-term focus, investing more in automation. S. Korea and China invest more in robots than does the U.S. despite their lower wage rates. China invests 3X as much in CNC machine tools as does the U.S. To be competitive despite high wages, the U.S. needs to be more productive than our LLC country competitors. Chinese productivity has been rising at 6 to 8%/year. U.S. productivity at less than 1%/year. As the reshoring surge continues, capacity utilization will rise above 80% and investment should accelerate. Companies will have the demand to justify investment and the cash to afford it. Fill supply chain gaps: Understand the existing large supply chain gaps so they can evaluate the feasibility of filling those gaps. Reduce cost and time to quote and deliver: Adopt lean, Critical Manufacturing Path Time (MCT) and Quick Response Manufacturing (QRM) methods that have the potential to reduce manufacturing costs by 10% and delivery times by 50%. Some companies claim that they can get product from China by ocean freight faster than from local U.S. suppliers. There are cases of Chinese companies providing prototypes before the U.S. competitor provided a quote. Achieve efficient assembly: Find domestic suppliers that can efficiently produce assemblies. Many companies shut their U.S. assembly plants when they offshored, often to contract manufacturers. It is easy to find U.S. machine shops and foundries that make components. It is much more difficult to find automated assembly shops. (Example: RE: Build Manufacturing’s strategy is to offer complete solutions for reshoring.)
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