Manufacturing matters

For years, the “postindustrial” paradigm was king in the West: we thought we could locate plants and machinery offshore without significant economic cost. But is this true?

During a conference at École Polytechnique de Montréal in the late 1980s, economist Kimon Valaskakis rhetorically asked, “What is the difference between an entertainer earning $3 million to sing the American anthem at the opening of the Super Bowl and a company like Bombardier selling a jet plane for the same amount?” In his view, it was obvious there is no difference.  

Is there really no economic difference between a plane and a song? Doesn’t the vast infrastructure of manufacturing contribute something to the economy? Until recently, there was a notion in some quarters that developed countries lived in a postindustrial world, which seemed to mean that manufacturing was neither important nor necessary. “It was a very narrow view that claimed that manufacturing was dirty and primitive and that we could let the Chinese do most of it for us,” says Harry Moser, founder and president of Illinois-based Reshoring Initiative, a not-for-profit aimed at bringing manufacturing back to North America. The idea was that “the economy could make it by design, innovation and financial manipulation alone. But it doesn’t work.”

Over the past 40 years, the postindustrial view has provided intellectual support for the considerable erosion of manufacturing’s relative share of GDP in advanced economies. In a blog, posted on the US Chamber of Commerce Foundation website, Mark Perry, professor of economics at the University of Michigan, reports that manufacturing’s share of US GDP slid to 12.8% in 2010 from 24.3% in 1970. In Japan, over the same period, it fell to 20% from 35%; even in Germany, the West’s leading manufacturing powerhouse, it slid to 18% from 32%. Worldwide, the decline dropped to about 16% from 27%. In Canada, the decline has paralleled that of the US, falling to 13% from 22%, according to Livio di Matteo, professor of economics at Lakehead University in Thunder Bay, Ont.

A change of manifesto

Not the least alarmed by such declining numbers, Perry sees them as an occasion to celebrate, not to complain. His comment could be seen as representative of the postindustrial ideology.

“[W]e really are experiencing an inevitable shift to a postindustrial, Information Age economy,” he writes, “where manufacturing’s importance to output and jobs is declining, similar to the trend in agriculture over the last century. It’s a sign that advances in manufacturing productivity and efficiency are translating into lower prices for consumers when they purchase things like cars, food, clothing, appliances, furniture and electronic goods.”

But a 2012 report by Washington, DC-based think-tank Information Technology & Innovation Foundation, titled “Worse Than the Great Depression: What the Experts Are Missing About American Manufacturing Decline,” suggests that the postindustrial view is wrong. It only takes into account manufacturing output as measured in US dollars. That simplistic measure ranks US manufacturing output as first in the world, 46% above even that of China, which comes in second. But a better measure compares the change in ratio of manufacturing real value-added to real GDP. By that measure, from 2000 to 2010, the US has witnessed a 20.2% decline in its manufacturing capacity. Canada fared worse: it dropped 30%.

For a growing number of thinkers, economists and consultants, manufacturing is an absolutely essential part of the economic landscape and the so-called postindustrial countries urgently need to revitalize it. “The simple truth is that services never succeeded in taking the place of manufacturing,” says Louis Duhamel, strategic adviser, consulting, growth enterprises, with Deloitte in Montreal and coauthor of a 2012 study on Quebec manufacturing. “A strong manufacturing sector is essential to the development of a prosperous society and a diversified economy.”

Postindustrial or preindustrial?

In fact, services are not in any way an autonomous part of the economy. A large part of the growth in services comes from manufacturing, says Ian McCarthy, a professor of technology and operations management at Simon Fraser University’s Beedie School of Business. “Twenty or 30 years ago, manufacturers had their own IT services and trucking operations for logistics. In recent years, they have been outsourcing most of that.”

The evidence is that manufacturing still constitutes an overwhelming part of the global economy: on a 2012 world trade of US$21.55 trillion in merchandise and services, manufactured products accounted for 73% of the total, or US$15.7 trillion, while services accounted for only US$4.25 trillion, or 20%, according to the World Trade Organization. (Raw materials and agricultural products made up the remaining 7%.) In the US, manufacturing accounted for more than 80% of exports, noted former US president Bill Clinton in a June 2013 Bloomberg Businessweek interview. In Canada, that proportion was almost 70% in 2012.

“If in the extreme case an economy was composed only of services, then it would be very poor, because it couldn’t trade for goods; its currency would be worth very little,” writes Jon Rynn, author of “Manufacturing Green Prosperity: The Power to Rebuild the American Middle Class,” in think-tank Roosevelt Institute’s blog. “A postindustrial economy is really a pre-industrial economy — that is, poor.”

Rynn sees many other reasons why countries such as the US and Canada should put efforts into a manufacturing revival. First, manufacturing has been the path to wealth and power of every country, from England, Germany and the US to Japan, Korea and China. Without the massive influx of manufacturing, China’s economy would still be led by earth-tilling peasants, not industry-savvy urbanites.

Even services are dependent on manufactured goods, Rynn says. “Services are mostly the act of using manufactured goods. You can’t export the experience of using something. Retail and wholesale, which make up about 11% of the economy, are the act of buying and selling manufactured goods. The same goes for real estate, another 13%, which is the act of buying and selling a ‘real’ or physical asset, a building. Even health, which makes up about 8% of the economy, is the act of using medical equipment and drugs.”

Manufacturing “creates a much better mix of jobs than advanced services — jobs for everyone from ordinary blue collar workers to capable engineers, brilliant scientists and resourceful and far-sighted top managers,” wrote former Forbes and Financial Times editor Eamonn Fingleton in a 2012 Forbes column. If the US had the same share of GDP in manufacturing as Japan did in 2005, it would have had seven million more high-quality, long-term, well-paying jobs, according to Rynn. “If we were equal with Germany,” he says, “we would have 10 million more.”

The manufacturing revival that is picking up steam in the US is not a call to bring back an old economy that has vanished. “A lot of the jobs we’ve lost in manufacturing are not necessarily jobs you would want to get back,” says Mike Holden, director of policy and economics at Canadian Manufacturers and Exporters in Calgary. “We don’t want to compete on jobs that they have in Vietnam. We’ve lost that kind of manufacturing and it’s not necessarily a bad thing.”

What is at stake is a very different reality. “The image of manufacturing as ‘dumb, dirty, dangerous and disappearing’ is far from accurate,” states a report by the US Council on Competitiveness. “Today, manufacturing is smart, safe, sustainable and surging. It has evolved to encompass a wide range of digital, mechanical and chemical technologies that infuse every step of designing, developing, fabricating, delivering and servicing manufactured goods. This includes high-tech modeling and simulation as well as robotics, artificial intelligence and sensors for process control and measurement. Manufacturing is about managing global supply and digital networks.”

Bringing jobs back

In spite of much resistance to the idea in academia and other circles, the US is spearheading a manufacturing revival. Reports, studies and initiatives abound. Reshoring is one such initiative. In 2003, about 150,000 US jobs were offshored and only 2,000 were reshored, reports Moser.

In 2013, the count was neutral: about 50,000 offshored jobs were counterbalanced by 50,000 reshored ones. “The bleeding has stopped,” Moser says. He predicts that in 2016, reshoring and foreign direct investment will have a positive balance of 50,000 jobs returned to the US.

Moser has a database of hundreds of companies bringing jobs home, among them GE, Walmart, Caterpillar, Stanley Black & Decker and Electrolux. In Canada, though offshoring has been widely practised, evidence of any reshoring taking place is only anecdotal, says Ian Howcroft, vice-president of the Ontario division of Canadian Manufacturers and Exporters. He couldn’t point to a single concrete case of a company reshoring some or most of its manufacturing activity.

However, even if there is no obvious reshoring movement in Canada, offshoring seems to be losing momentum. The KPMG Canadian Manufacturing Outlook 2014 finds that only 14% of manufacturers planned to source from China in 2014 compared with 31% that had the same intention in 2013.

Many reasons prompt US companies to reshore. An obvious one, according to Moser, is that wages in the US have remained stable and in certain industries have even declined in real terms in the past 15 years, while in China they have been increasing by about 15% every year. Other reasons include regaining an innovation edge, a heightened responsiveness to the marketplace and viewing reshoring in terms of total cost of ownership rather than just salary arbitrage.

However, reshoring is part of a larger global movement in which “manufacturing is moving closer to demand and centres of innovation,” says Bruce Simpson, director at management consultants McKinsey & Co. Inc. in Toronto. He calls that phenomenon next-shoring.

Next-shoring would appear to be the impetus behind Superior Radiant Products’ decision to move manufacturing capacity from China to Stoney Creek, Ont. (the only example of Canadian reshoring CPA Magazine was able to unearth). To produce a high-end, luxury outdoor heater, the company brought back about 12 jobs, out of a total of 60. “We did it for reasons of quality control and to have a greater proximity to North American markets,” says Susan Samson, sales and marketing communications manager.

Double-edged sword

If McKinsey’s analysis is correct, next-shoring is a sword that could cut both ways. If manufacturers are moving closer to where products are bought and to centres of innovation, the tide of reshoring could turn back just as quickly in the direction of China or other developing countries because that’s where demand and innovation capacities are rising fastest. “By 2025, half the world population will be in the consuming class and 53% of those will live in the developing world, most of them in cities,” says Simpson.

And many of the world’s innovation brains already reside in developing countries, mostly in China and India. Many think that the US has the highest brain count in the world, but that is not the case. “China has the largest R&D population in the world,” says Simpson.

There is a crucial lesson here: manufacturing, R&D and innovation are intimately linked. In fact, the largest and most significant part of innovation arises from the manufacturing part of the economy. “Manufacturing ... accounts for 90% of [US] patents and R&D spending according to the US International Trade Commission and the Department of Commerce,” Clinton said in the Bloomberg Businessweek interview. In Canada, according to Canadian Manufacturers and Exporters, 55% of business R&D expenditures issued from manufacturing in 2012.

Everyone agrees that innovation is the key to our future prosperity, but what is now becoming clearer is that the path that leads to innovation essentially passes through manufacturing. A country that loses its manufacturing is at risk of losing its innovation capacity, claim Harvard Business School professors Gary Pisano and Willy Shih, authors of articles and books seminal in the US manufacturing revival.

Pisano and Shih give a stark example of an innovation drain. “In the semiconductor industry, outside of Intel and a few smaller players, most US semiconductor manufacturing has moved offshore to Taiwan, Singapore, South Korea and increasingly China,” says Shih in a 2011 Harvard Business School newsletter interview. “As more and more capability moved offshore, other industries in the host countries have benefited from the semiconductor manufacturers’ capabilities. It’s no coincidence that the entire flat-panel display industry emerged from semiconductor industry capabilities. The people who built the factories to make semiconductors used that knowledge to build factories to make flatpanel displays.” That’s why companies such as Samsung and LG totally dominate that industry today.

Luckily, the US retains a strong R&D capacity, according to an OECD study. From 2000 to 2009, R&D intensity grew to 2.9% of GDP from 2.71%. However, capacity in China skyrocketed to 1.77% of GDP from 0.9%, a 20% yearly increase. In Canada, R&D numbers are taking an ominous turn. According to Statistics Canada R&D reached 2.01% of GDP in 2004. In 2012, that percentage had sunk to 1.71%.

A call to arms

In the US, there is a strong impetus for revitalizing manufacturing, starting at the highest level with President Obama pronouncing the word “manufacturing” 15 times in his 2012 State of the Union address, says Duhamel.

In Canada, such an impetus can’t be found. Politicians don’t speak about it. Academia is still entrenched in the postindustrial mind-set. “We need a call to arms,” says Simpson. “Canada is languishing.” A McKinsey Global Institute study shows that, among the top 15 manufacturing countries by share of global nominal manufacturing gross value added, Canada slowly slipped from 10th place in 1990 to 15th in 2010. It now stands behind countries such as Brazil, Indonesia, even Mexico.

Of the many fronts Canada needs to work on, three stand out, according to Howcroft: productivity, government regulation and skills. For years, commentators have been pointing out Canada’s weak productivity performance, heavy regulatory framework and technical skills shortage. Unfortunately, these specific debates are not taking place as part of a move to revive manufacturing.

The postindustrial era has been one of the most troubled in modern economic history, with the economy repeatedly impacted by financial shocks in 1987, 1997, 2000 and 2008. Perhaps it was a gamble not worth taking.