Competition hollows out US supply base in race to bottom

09 November 2017 Consultancy.uk

Much has been said about the importance of manufacturing in the US, which is said to have seen steep declines in recent years. Decreased competitiveness is blamed by a new report as one of the key drivers of decline, with smaller suppliers and employees losing out as companies aim to cut costs through outsourcing, automation, redundancies and poorer working conditions.

A year on from the surprise electoral victory of the uncompromising US President Donald Trump, political and economic analysts are still wrestling with the causes of his unlikely triumph. While the electoral college system, which means that the popular vote does not elect the President directly, is what ultimately handed Trump the keys to the Whitehouse, defeated Democrat candidate Hillary Clinton notably did not campaign in ‘rust-belt states’ such as Michigan, on the assumption she could rely on their support. Michigan ultimately went ‘Red’ on November 8th 2016, with the electorate plumping for the Republicans despite staunchly supporting the Obama administration for eight years, noting first and foremost that losses of employment in the manufacturing trade – something the region had been dependent upon – was a major factor.

Manufacturing remains a key issue for the US as one of the larger employment sectors, as well as a key driver for innovation. The industry has indeed seen considerable declines in recent years, as found by a new report from McKinsey & Company‘s Global Institute titled ‘Making it in America.’ The report explores some of the key causes of the steep decline of the industry since the early 2000s, and further looks into the effect that wider labour market changes have had on employment and suppliers in the US.

US ranks second in world for manufacturing value added

The US remains one of the world’s largest manufacturing hubs, creating around $2.2 trillion in value added in 2015; well above the next closest, Japan, on $768 billion and Germany or $668 billion. The US has fallen behind China, however, whose place in the ranking saw it grow to number one in 2015, up from number 8 in 1985 and number three in 2005. China’s value added came in at $3.1 trillion in 2015.

The manufacturing industry also remains one of the largest drivers of research and development, at around 70% of all private sector research. In terms of export activity, the sector generated around $1.3 trillion in export products in 2015, a 20% increase on 2005, and accounts for 60% of total exports from the country.

Domestic supply base hollowed out saw trade deficit increase

Deficit concerns

While exports remain high, McKinsey’s report does note concern in terms of the widening trade deficit, which has, unlike in most other advanced economies, seen considerable declines in various manufacturing industries – particularly since the start of the recession. Petrochemicals & fertilisers and pharma saw relatively minor dips, further into the negative, while computers fell back to levels seen in the late 2000s. Semiconductors fell sharply, as did automobiles. Aerospace was the only industry to see significant gains since 2010, up to more than $100 billion in the positive, while medical devices saw small declines but remained in the black.

A number of factors have influenced the growth of the trade deficit of around $800 billion, $380 billion of which stems from advanced manufacturers. The primary reasons for the decline are related to, among others, competition and the relatively strong US dollar and changes in consumer demand - which has led US manufacturers to increased pressure on supply chains, with considerable supply acquired from imports. This is something the incumbent Trump administration has threatened action over, with the possibility on large import tariffs for parts hoped to encourage manufacturers to choose ‘American made’ parts. However, experts expect that this may ultimately prove to have a negative impact on US manufacturing, as the cost of more expensive domestic or foreign parts will ultimately be passed on to consumers, who may divest from numerous products as a result – further hurting employment in the long-run.

Job declines and modest rebound

Aside from changes in dependence on imports, the industry has also seen considerable drops in employment within the manufacturing industry. The drop was most pronounced in the early 2000s, when the industry shed around 3 million jobs, before dropping by a total of 5.5 million jobs at the depth of the most recent recession. In the  years up to 2016, the number of jobs in the sector has increased by almost a million, but remains considerably below the height of employment in the industry – starting in the 1960s.

The number of production plants operating in the US has declined by around 30% since 1997, while automation has increasingly improved productivity and reduced the need for workers, with surviving plants employing around 15-20% fewer workers. The research notes that relatively poor competitiveness is one of the key reasons for the decline in US manufacturing, with companies using off-shoring, automation and hollowing out employment packages, to reduce costs in a bid to stay competitive. In addition, around 10% of manufacturing jobs are in the hands of temporary workers, many of whom rely on food-stamps and other government programmes to make ends meet.

Real manufacturing value added

The loss of competitiveness has had a range of knock on effects on the wider manufacturing industry. Smaller suppliers, in particular have been squeezed, with many smaller players being wiped out as the supply chain in the US was hollowed out for overseas produced parts. While consumers benefitted in lower product prices, the margins of many companies in the sector was squeezed further, creating a competitive race to the bottom.

Not all segments of manufacturing have fared the same, with asset light and innovation heavy segments, including high tech and pharmaceuticals, seeing their relative value added remain at almost record levels – last seen in the years prior to the financial crisis – to which profit growth has been concentrated, thereby highlighting increased inequality in the business environment.

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