The second half of 2019 was not good for manufacturing. Demand dropped, hiring sputtered, and tariffs forced producers to reconfigure supply chains on the fly. Going into 2020, the picture suddenly brightened. Demand, orders, and hiring rose. Then the coronavirus pandemic hit. This article looks at some of the implications of the pandemic on the economy and how it might affect manufacturing.
THE second half of 2019 was not good for manufacturing. Demand dropped, hiring sputtered, and tariffs forced producers to reconfigure supply chains on the fly. Going into 2020, the picture suddenly brightened. Demand, orders, and hiring rose. Then the coronavirus pandemic hit.
It started in Wuhan in December and spread quickly. To stop it, the Chinese government locked down hundreds of millions of people in Wuhan, the surrounding Hubei Province, and dozens of other large cities, ordering people not to leave their apartments.
This turned off the flow of manufactured Chinese goods overnight. China’s February Purchasing Management Index, which measures new orders, collapsed to the lowest level ever recorded: 26.5 for services and 35.7 for industry. For reference, a PMI below 50 indicates a contracting economy and below 42, a recession.
Despite two years of tariff increases, the U.S. and Chinese economies remain tightly bound, and China’s slowdown became America’s supply chain disruption. By early March-before U.S. Covid-19 cases soared— nearly three out of five purchasing managers were reporting longer lead times—on average, two weeks longer than the end of 2019—for tier-1 components from China. In fact, more than half of the 628 respondents surveyed by the Institute for Supply Management (ISM) said they could not get accurate supply chain information from China. More disturbingly, 44 percent of them had no plan to address the supply disruption.
Meanwhile, Covid-19 chewed up the world’s economies. Europe and Japan, both with weak, trade-centered economies, may have already fallen into a recession. The U.S. saw economic activity drop as businesses and communities shut down for weeks. Soon, manufacturers turned their attention from supply chains to the possibility of a deep, long recession.
A 60 percent drop in oil prices exacerbated the problem. While the virus slackened demand, a price war over market share between Russia and Saudi Arabia was the main culprit. This could dislodge another pillar of the American economy: oil production.
U.S. operators that fractionate shale wells must continuously drill to keep oil flowing. This translates into demand for drills, pipes, pumps, compressors, chemicals, and other industrial equipment.
When oil prices fall too low, they throttle back production. This happened between 2014 and 2016 and contributed to a manufacturing slump. A prolonged trade war could do the same in 2020.
While Covid-19 and falling oil prices are game changers, they cannot mask the underlying trends in U.S. manufacturing. These range from the restructuring of global trade to the startling potential of smart industrial technology. In the following pages, we explore them.
Since March 2018, the Trump Administration has imposed tariffs on steel, aluminum, and $550 billion worth of Chinese imports. Its stated goal was to reboot U.S. manufacturing while protecting industry from subsidized Chinese imports and intellectual property theft.
Tariffs protected some producers but punished others by raising raw materials costs and subjecting U.S. exports to tariffs, according to a recent study by Federal Reserve economists Aaron Flaaen and Justin Pierce. They found tariffs did more harm than good and failed to boost manufacturing overall.
They also had unintended consequences. Steel producers took advantage of tariffs to raise prices. This left their customers vulnerable to imports made from cheaper offshore steel. So, while imports of raw steel declined, imports of steel products rose sharply. To compete, some companies, like cookware maker Tramontina, consolidated manufacturing overseas.
This past February, the Administration announced an additional tariff on steel products, such as nails, staples, wire, cable, and vehicle parts. Chad Brown, a senior economist at Peterson Institute for International trade, wonders where such “cascading protectionism” will end.
Meanwhile producers are scrambling to rebalance overseas supply lines. Consultant Bain & Company surveyed 204 U.S. multinationals with factories or suppliers in China. It found that 25 percent planned to redirect investments out of China and 42 percent expected to get goods from a different region in 2020. (Surveys by other firms yielded similar results.)
Many companies have little choice than to remain in China, where costs are low, workers highly trained, supply chains deep, and technology sophisticated. Others are moving out, among them: Crocs shoes, GoPro and Olympus cameras, Hasbro toys, Ricoh copiers, Roomba vacuums, Kenda tires, and Yeti beer coolers. Even Chinese companies are moving factories offshore.
Near-shoring to Latin and South America has also picked up, according to QIMA, an international firm that assesses product quality. Regional inspection and audit demand from U.S. buyers doubled in 2019. European companies moved work to North Africa and the Mideast, where inspection and audit volumes tripled last year .
This is part of a long-term trend toward more robust supply chains. Companies are diversifying to reduce risk and bring production closer to their customers. The trade war and coronavirus outbreak sped things up and emphasized the risks of offshore manufacturing. The ramifications may take years to play out.
Going into 2020, manufacturers were predicting that capital investments would decline 2.1 percent, the first drop in 11 years, according to a survey by Institute for Supply Management. About four out of every 10 companies cited domestic economic conditions for the decline, while just 3 percent blamed tariffs. (This was before the coronavirus pandemic.)
Still, despite 11 years of investment, manufacturing’s share of capital expenditures has not kept up with other U.S. industries, according to a Bureau of Census analysis. Between 2008 and 2017, producers invested $35.2 billion. While that was the third largest of any industry, it amounted to only a 16.5 percent increase. It lagged well behind IT (53.5 percent) and real estate (48.1 percent).
Yet, most analyses of competitiveness find the United States among the leaders. This is true whether the study focuses on direct inputs like labor and energy or broader criteria, such as innovation and rule of law. So why are investments lagging?
According to A.T. Kearney, it still makes sense for companies to invest overseas, despite new trade and tax policies. Its sixth annual Reshoring Index, completed in 2019, claims low-cost countries still have a fundamental economic advantage. Yet the mix of thos trading partners is changing.
“Rather than incentivizing companies to reshore, the trade war with China has simply accelerated an already ongoing shift toward manufacturing in lower-cost countries such as Vietnam,” said Patrick Van den Bossche, the Kearney partner who coauthored the study.
Others disagree. The Reshoring Initiative’s latest report, which focuses exclusively on manufacturing, found that 1,389 companies and 145,000 jobs returned to the United States in 2018. Among the reasons: government incentives, proximity to customers, skilled workforce, supply chain ecosystems, and faster time to market. Moreover, two-thirds of the 750,000 jobs reshored since 2010 were in factories that made high-and medium-tech goods.
Yet many of those “reshored” factories were actually foreign-owned. The same was true of 400,000 of the 750,000 jobs gained by reshoring during 2010-18.
This plays out even for China. While 791 U.S. companies returned 64,252 jobs from China, Chinese firms built factories that created 80,048 jobs in America. In fact, international companies have generated 62 percent of all new U.S. factory jobs in the past five years, according to the Global Business Alliance, a trade group for foreign investors.
Like American firms who returned to the United States, they want to get closer to their customers, too.
For years, automation and technology companies pledged to reinvent factories. They may finally be getting closer to delivering on that promise. That’s the conclusion of a study by McKinsey & Company and the World Economic Forum. They looked at 44 global lighthouse factories, beacons of how to scale—and integrate-digital technologies ranging from AI, IoT sensors, augmented reality, and integrated software.
“We see that around 20 to 30 use cases, applied to one site, creates a transformation of the value,” said Enno de Boer, a McKinsey partner who worked on the study. “Bayer, in Italy, was able to increase productivity by 40 percent. The Bosch Wuxi site in China was already operating at 94 percent overall equipment effectiveness and was able to squeeze out another 6 percent of output without doing capital investments. These are stepchange performance changes.”
Some lighthouse plants boosted productivity up to 90 percent. They also achieved 10-percent to 80-percent reductions in lead times, 15-percent to 20-percent improvements in configuration accuracy, and 50-percent jumps in energy efficiency. Even worker satisfaction rose.
This works with old as well as new plants because “sensorsing has become so affordable that you can sensor out all the factories with existing equipment and then put the data to work,” de Boer said.
This is another “winner takes all” situation, warned McKinsey’s Katy George, who also worked on the study. Lighthouses boost capacity and productivity without increasing workforce or fixed assets. For the laggards, she said, “There is a serious question about what will happen to them as they try to catch up.”
Productivity—divided by input’drives manufacturing. When it grows, it generates wealth to share among workers and owners and creates better jobs. In the U.S., manufacturing productivity has been declining for years.
According to a study by the federal Bureau of Labor Statistics, productivity contracted -0.3 percent annually between 2005 and 2016, after rising 2 percent annually from 1992 to 2004. No one is certain why.
The BLS study found, for example, manufacturing industries that bought rather than made intermediate components had lower levels of productivity. This follows what engineers have long known: Innovation—and productivity-rise when engineers struggle to reduce costs and improve quality in their factories.
Some economists claim productivity is down because companies have already done the easy things, like computerizing and outsourcing. Others blame technology. For most of the past century, it was axiomatic that automation and technology investments generated better jobs and higher pay. Today, however, they seem to be splitting the workforce in half.
On one side are engineers, managers, and skilled factory technicians. They get high-paying jobs with benefits. Yet they are vulnerable to automation. In factories, sensor-and-software-linked equipment makes parts with minimal human intervention. In professional jobs, software enables engineers and managers to do more with fewer people.
The computer and electronic products industry, for example, almost doubled its output between 2007 and 2018—while its workforce shrank 17 percent.
This is true for other industries as well. At Scottsdale, Ariz.-based Axon Enterprises, robots quadrupled Taser cartridge output. The 80 workers on that line kept their jobs only because Axon reshored its Mexican operations. Other companies fired their workers.
In fact, every industry that invested in technology to boost productivity also reduced its workforce, according to a recent study by MIT labor economist David Autor and Anna Salomons of Utrecht University. Automation and technology also forced down wages, they wrote.
But automation has not yet produced widespread unemployment. Instead, terminated workers are often hired by industries that rely on low-cost labor—not technology—to turn a profit. Substituting cheap labor for automation is another reason productivity has declined.
This is likely to remain an issue for years to come.