Why BCG’s Hal Sirkin Is Bullish on the Future of American Manufacturing

For years, conventional wisdom has maintained that manufacturing in the U.S. is in terminal decline. But the tide is now turning, according to Hal Sirkin, a senior partner and managing director at the Boston Consulting Group. Rising wages and currency rates, among other factors, have dramatically narrowed the gap between manufacturing costs in China and the U.S., with the result that several U.S. companies are now “in-sourcing” manufacturing jobs back to America. Sirkin, who recently spoke at the White House about this research, discusses the implications for U.S. jobs and competitiveness in an interview with Knowledge@Wharton.  

An edited transcript of the conversation follows.

Knowledge@Wharton: Hal, thank you so much for joining us today.

Sirkin: A pleasure to be with you.

Knowledge@Wharton: I would love to talk to you about your research in the area of the renaissance of American manufacturing. But before we get into that, I wanted to ask you about the conventional view. The conventional view is that manufacturing in the U.S. is in a long-term decline and services are going up — what’s wrong with that picture?

Sirkin: We have seen this prediction of U.S. manufacturing’s death many, many times. If you go back to the 1970s when I was here at Wharton, we were reading articles all the time about how Japan, Inc. was going to take over the world. They were going to bring over televisions, cars, radios and were going to manufacture just about everything. At that point in time, parents were literally sending their kids to school to learn Japanese because that was going to be the new language of the world. Japan, which had lost the war in 1945, by 1975 was going to dominate the world again. And of course what we’ve seen is that didn’t happen…. We saw it again in the 1980s and 1990s when the Asian Tigers were going to dominate the world. The low-cost production facilities in Korea, Taiwan, Hong Kong and Singapore were going to dominate manufacturing. There was going to be a huge cost advantage, and U.S. manufacturing was going to go away. But of course everybody knows that didn’t happen either.

In the current situation starting in 2001 with China’s entry in the WTO, the conventional wisdom was the same — that China was going to roll up U.S. manufacturing, that we were basically going to become the farmers and bankers of the world and that was what was left. But of course in many ways as we’re starting to see now, that hasn’t happened, and it’s not going to happen. It’s because the U.S. economy responds tremendously well to threats. We have a system where our people want to work and they find ways to do this. We have a system in which our companies are forced to get more productive because it’s do or die. There aren’t state-owned companies in this country. We don’t subsidize companies in many ways in this country. And therefore, it’s the free market at work. And it does some amazing things.

So between 1972 and 2010, [production of manufactured goods increased 2.5 times]. We do that with 30% less labor, which is an amazing increase in productivity. Our society has gotten incredibly productive. We use our resources very efficiently, and that makes all the difference. That’s what’s going to cause the change as we start to move from off shore into China to in-sourcing around the world.

Knowledge@Wharton: We’ll come back to the point about in-sourcing in a bit, but let’s talk about your point about productivity first. As you said, as productivity goes up, we are able to produce more with fewer people. But at the same time, there are some recent reports that manufacturing jobs in the U.S. have actually gone up — 300,000 new manufacturing jobs in the past two years. What’s driving this trend?

Sirkin: It’s basic economics. It’s now becoming more effective to produce in the U.S. than it is to produce in a lot of different countries. Between the shift in the dollar and the incredibly rapid rise in wages in China, people are starting to do this. In a report, we predicted that this would not happen until 2015. We’re surprised in a very good way because we’re starting to see it happen in 2010, 2011 and 2012. Now we think this is just the tip of the iceberg that we’re seeing — that we’re going to see a whole lot more because the economics continue to shift in favor of the U.S. The fundamentals are that the tide has turned, as it did with Japan, as it did with the Asian Tigers. We’re seeing a repeat of this with China.

Knowledge@Wharton: What are the factors that have driven that turning of the tide?

Sirkin: Well, it’s very simple economics. It’s the things I learned in my Intro to Economics class at Wharton, just applied for overall business. It is that wages are rising very quickly in China, somewhere on the order of 15% to 20% a year and maybe even higher. The Renminbi, of course, which is still a controlled currency, is rising at 4% a year. And many economists believe if it was left to float, it would be double its value. But even with the 4% it makes a difference. And China, while it’s getting very productive and it’s increasing productivity to 8% a year — that’s being swamped by the wage increases and the shift in the Renminbi. In 2001, when China entered the WTO, you could get workers for 58 cents an hour. It was a very simple decision for most companies to off-shore to China. Wages have risen a lot. There’s also some other issues that people call “the intangibles” that go there — things like you don’t want to just compare manufacturing cost to manufacturing cost because you have to ship it from China.

And in 2001, oil prices were in the $20/$30 a barrel. Now it’s around $100 a barrel. So transportation costs have gone up. People are understanding the risks of intellectual property theft and valuing them in their equations. And then there are the fundamentals of being far away from the customer. It’s hard to manufacture when you’re 6,000 miles away and you have to interact with people who don’t speak your native language. So companies are starting to realize that there are a whole bunch of costs. Our predictions are that by 2015, the manufactured costs in China will be about 10% lower than the manufactured costs in the U.S. for a whole lot of goods. That doesn’t mean all the goods. It’s not for clothing and shoes. But it’s for a wide range of goods — about 70% of the goods that we, the United States, imports from China. And because of that, we’re going to see a shift because that 10% is going to be eaten [away] by things like the transportation costs and the other risks. It will just make more sense to produce in the U.S. Companies are starting to turn on to this.

Knowledge@Wharton: Speaking about the wage cost increase in China, at least a few years ago it was widely believed that even though in some urban centers or strong manufacturing centers the wage costs are going up, that there was a large rural work force in China that would continue to migrate and that would ultimately bring wage costs down in China. It was a common view. Do you still see that happening? Or are there changes that have taken place that takes that away?

Sirkin: Wages are rising very rapidly. China actually was extremely smart in how it set up its economy. It was brilliant. And, in fact, I would have to call it like the reverse perfect storm. Everything was done right. They set up these clusters of companies so that if you’re making shoes, you would be located in one city, if you’re making electronics, you may be located in a different city. Then what they put in those clusters was everything the businesses needed to produce for export. So there were universities that would produce engineers who were trained specifically in your kind of business. There are worker training centers where they train workers for production in your kind of business. They set up incredible ports — an amazing ability to produce high quality ports that they could export from — and all the infrastructure necessary to get it from the ports in these clusters, which were of course designed for export and therefore all along the coast line. Wages rose a lot there. [Many] rural people moved into cities. But now it’s getting pretty crowded.

When you go further out into China, there are some disadvantages to production. The infrastructure isn’t the same as you see on the coasts, which is one of the reasons that China has been so productive. So the work force in the rural areas isn’t as productive. And the transportation times get long. You’re already starting with a long transportation time to export to the U.S. So that raises a lot of issues, [including] how long you want your supply chain.

Knowledge@Wharton: What are some of the other factors that you think are making it possible for U.S. companies to become more competitive in manufacturing?

Sirkin: I think that we continue to focus on productivity of our work force. We are growing productivity quite nicely — not at 8% a year, but at a substantial rate. U.S. companies are beginning to realize there are some problems with producing far away, that there are actual costs to that. I remember one CEO, when he worked out the economics, said the best thing for him was that his wife wouldn’t bother him at two o’clock in the morning because he was on the phone. And he didn’t have to fly 6,000 miles to go see his factory. That’s an intangible, but it’s real, and it points out the value of being close. When wages were 58 cents an hour when China entered the WTO, it was a very simple decision to go to China because [the wages] were so low. But those wages have gone up dramatically, and they continue to go up dramatically. Now it’s not such a simple decision. Companies are beginning to rethink it. We expect over the next few years that there will be a lot of rethinking because manufacturing in the U.S. is becoming very competitive.

Knowledge@Wharton: Could you give examples of companies that are driving this renaissance in manufacturing? And what are some of the kinds of jobs that are coming back?

Sirkin: There are a lot of companies that are doing it. Again, I think we’re still in the early stages. You see big companies like National Cash Register — NCR — that was manufacturing their ATMs in China for the U.S. and is now manufacturing in Columbus, Georgia. You see Ford adding jobs into its plants. I think they committed to 12,000 jobs. And you see companies like General Electric adding capacity to produce water heaters in their Louisville, Kentucky, plant. It’s also smaller companies. So Farouk Systems, which makes hair dryers, has moved I think 1,500 jobs back from China to the U.S. You see Coleman, the manufacturer of water coolers, starting to build water coolers in the U.S. I can go on and on and on with the list. Every day we seem to find more and more companies that have made the decision.

They’re realizing that the total costs of manufacturing in China — with the wages being higher and all the other intangible issues — are starting to make it just far more economic, far more logical to do this. Now some people may think that means factories will close in China. That’s not going to happen. That’s not going to happen because of the way the Chinese economy is structured. China’s growing 8%, 10%, 12% a year. China actually needs to build more factories just to support the domestic demand. So it’s not about companies making decisions to close a plant in China. Ironically, it’s the fact that the Chinese economy is growing so rapidly that makes it possible for U.S. companies to very quickly build plants in the U.S. because they need to put another plant in their system. They can just convert the stuff they used to ship from China to the U.S. to domestic consumption in China, and then just build the plant in the United States. So ironically, China’s success is what’s causing this manufacturing renaissance.

Knowledge@Wharton: That’s very, very interesting. Now as we know, the IMF predicted some time ago that by 2016, China will overtake the U.S. as the world’s largest economy. Do you see that having a significant impact on this trend? Or do you think the rise of manufacturing will continue, regardless of which economy is larger?

Sirkin: The U.S. is still a very big economy. Even if China is bigger in purchasing power, in absolute terms the U.S. will be bigger for an even longer period of time. But I don’t think it matters whether the U.S. is bigger or China is bigger. They’re both huge economies and both significant portions of the total world GDP. So they both will have scale and the ability to produce. I think that’s what’s really required.

Knowledge@Wharton: These are very counter intuitive kind of ideas. How did you figure this all out?

Sirkin: This came to me from a wide set of areas. The first thing that I figured out — and in discussions with some of my colleagues in China — was they were talking about the wage increases in China being 15% to 20% a year. That made no sense to me. It didn’t feel right. But we looked into it, and of course they were right. Wages are rising at 15% to 20% a year. It came to me when my wife said, the U.S. doesn’t manufacture anything anymore. My wife also has a degree from the University of Pennsylvania and a PhD in molecular genetics, so she’s a very smart woman. But she looked at the conventional wisdom. It’s easy to believe that if you look at things like clothing and shoes. But the U.S. manufactures 75% of everything that it consumes. That’s a pretty high number, considering what the conventional wisdom is — that we don’t make anything any more. It came to me sitting in a board meeting of one of my clients which has around 80% of their manufacturing in China and needs to build a new plant. So they decided they would [have] 85% of their manufacturing in China. I just raised the question: Do you really want to have all that manufacturing in China? Aren’t there alternatives?

So we looked at lots of other countries. We looked at Vietnam. We looked at Indonesia. We looked at many different countries. For a lark, I put in a plant in the southern part of the United States just to see if it would work. We did the math in 2010. Of course, it didn’t work because the wages haven’t sort of reached their full potential in China of rising. But we then did the math and said, “What does it look like in 2015?” — because plants are going to last for 20, 30, 40, 50 years. So deciding now on today’s economics doesn’t make a lot of sense. So we just said, “Let’s pick 2015. What does it look like?” We did the math, and the difference was less than 10% at the manufacturing gates of a U.S. plant or of a Chinese plant. Then the decision was to say, “Let’s understand the transportation costs and all the intangibles.” When they looked at I,t they said, “You know, it does make more sense to produce in the United States.”

Knowledge@Wharton: That’s really interesting. Now coming back to your earlier point about trying to be close to where your customers are, it’s also a reality that consumption is growing very rapidly in the emerging markets. From that perspective, do you think that it makes sense for companies not just to set up manufacturing in the U.S, but also in places where those emerging customers are? And have manufacturing in different parts of the world?

Sirkin: Yes, I think what we’re talking about is more localized manufacturing. If you’re going to consume the product or you’re going to sell the product in the U.S., you want to produce more of it in the U.S. If you’re going to sell the product in China or an emerging market, you probably want to produce there, because some of the factors that make the difference are the transportation costs. If you’re selling in China, it’s probably better to have your plant in China because you’re closer to the customer, for the same reason the U.S. would be the case or Europe would be the case to do that. It’s just that the economics of China and the U.S. are getting a lot closer, while that hasn’t happened in Europe yet.

Knowledge@Wharton: Which industries do you think are best positioned to benefit from the manufacturing renaissance?

Sirkin: It’s things like computers and electronics. It’s furniture — obviously a lot of wood is produced in the U.S. so it’s a great thing. It’s things like plastics and rubber and machinery. It’s appliances and electronic equipment. There’s about 70% of what we import from China that is in the area we call the “tipping zone” — the kinds of products that you need to think carefully about where you put your next plant because the U.S. might be a very good place to put it for U.S. consumption.

Knowledge@Wharton: I wonder if you could speak a little bit about the public policy implications. What can the government do to accelerate this trend of manufacturing jobs coming back?

Sirkin: Sure. The government can play an important role. Hopefully, we can get the Democrats and the Republicans in Congress to actually unite around creating more jobs for Americans, because it will require legislation to do this. If they decide to continue to fight a war among themselves and not look after the American people, that’s going to be a problem. But assuming that happens, we can accelerate the trend that we predicted by several years, which means a whole lot more jobs sooner and a whole lot more strength for the American economy.

It’s going to take several things. Obviously, there are tax policy implications. We might want to look at all those funds that U.S. companies are repatriating to the U.S. and in essence bring them back in a non-taxable or low tax form, if they create new jobs in manufacturing plants to tide them over until that point in 2015 where the numbers start to cross over. We can look at trying to make sure the playing field is leveled for U.S. manufacturing. It isn’t right now. And there are clearly predatory practices that take place. We’re seeing a step up in the government on anti-dumping and other sorts of things which are there.

There are a lot of things that can be done, including increases in training. We can think about subsidization of training for new workers, because if you build a new manufacturing plant you have to train the workers. That goes on in China. We could do that in the U.S. And we could think about actually expanding our educational system. We all tell our children — and it’s the right thing to do — that you should get a college education. But you can also learn a trade in a college education. I believe at Wharton I not only got a great liberal arts education, but I also learned a very important trade that stood me well in life. But we can think about a vocational version of that in which you have a four-year college — as I did at Wharton — where [one can] basically do two years of liberal arts and two years of business. That was the way the program works. We can do the same thing but it could be two years of liberal arts and two years of plumbing or welding or other skills that would be appropriate for the new manufacturing area that we’re entering.

Knowledge@Wharton: Does the U.S. need a new industrial policy?

Sirkin: I think what the U.S. needs is a job policy. We can talk about industrial policy, and that’s something that we may want to focus on. But there’s a jobs policy and we should be thinking about where we want to place our bets in terms of jobs. The kinds of things that we want to do, the industries that we want to make sure are industries for the future — to make sure that the U.S. is not locked out of those. Clearly, green energy is an issue. It has its ups and downs. But fundamentally at some point in time, the world’s got to move to green energy because we’re going to run out of fossil fuels. We’ve continued to find more, but it gets more and more expensive. And that means green energy will be important, whether it’s in two years or five years or 10 years or 20 years. We don’t want to be left out of industries like that.

Knowledge@Wharton: I remember from a past conversation that you’ve done a great deal of work on globalization. Can you help situate what’s going on within the broader trend of where you see the global economy itself evolving to? And what are some of the long-term implications of the manufacturing renaissance we’re seeing in the U.S?

Sirkin: I’ve spent a lot of time thinking about globalization and how the world’s evolving. I think this is just another piece in the puzzle that fell on my doorstep. So the initial wave of globalization was in Western companies looking at the low cost markets, setting up manufacturing or out sourcing manufacturing eventually to companies in those markets to produce and to sell the product back into the Western markets or the developed world markets. The second wave was this growth of what we call “the challengers” — companies that were saying, “Hey, I can manufacture this stuff, but I don’t want to be just doing it and putting your name on it. I want to manufacture it and have my name on it. I want to be the big player. I don’t want to be just a supplier. I want to get the big margins, and I want to have my own brand.”

That was the second wave. We saw many global challengers emerge and do incredibly well. But what’s taking place is the next step in economics, because economics I learned here at Wharton is all about the evolution of them. They’re never permanent. They change all the time.

What’s taking place is with the wages rising in China and all the other costs that are rising overall in China, the economics are now shifting back towards the logic of U.S production. That’s the third wave of globalization. We’re reaching a new equilibrium, at least with China. It has not happened yet with a lot of the other countries, and it may over time. We’ll see how it plays out. But we’re seeing a new equilibrium of globalization, which would be more of a steady state until there’s some perturbation that would change that. But we’re seeing the fundamentals of the economics [equalizing] between the U.S. and China. Now as that happens, we’re seeing some second order effects too, because the system that we have here in the U.S. is very different than the European system. The European system, for most of the countries, have very high exit barriers. And, of course, high exit barriers mean that you’re more reluctant to build a new plant because once you have a plant there, the costs to get out are very low. In the U.S., we can debate which social system is better, but in the U.S., the facts are just different. It’s a lot easier to get out of being in a plant if you don’t need it.

And so the fundamentals are starting to shift. What we see are European companies, not just U.S. companies, looking at producing in the U.S., first for domestic consumption. Car companies have been doing this for a long time. But other companies are thinking about it, as well as Japanese companies who are doing the same thing, [and] thinking about the U.S. as an export platform. One company set up a power turbine plant in — I believe it’s Georgia — where they make power turbines. And they’ve just signed an order with Saudi Arabia to ship from Georgia six major power turbines — quite an interesting thing that we see.

We see announcements by some of the Japanese automakers that they’re thinking about the U.S. as an export platform. Now that’s why jobs are going to be rising in the U.S. And that’s the real sign that what we’re talking about in the shift in economics is really happening. Because people are putting their money down, making some very important decisions and realizing that the U.S. has a very highly productive work force, a very flexible work force and the ability to be a very low-cost manufacturing platform for some very important industries.

Knowledge@Wharton: Which areas in the U.S. do you think will benefit most from this?

Sirkin: We used to think it would be the southern part of the U.S. for the most part. But actually our thinking has evolved on that. As we begin to understand that the wage differential is a lot lower than we might have thought because the averages are misleading, we’ve got to look at the wages for the startup of new plants, not for existing plants. And so our new thinking is that it’s going to happen in most states. Interestingly enough, we’re seeing things in places that we never had thought we’d see. We’re seeing plants of this nature open in places like Ohio. We’re seeing it in California. We’re seeing it in the rest of the Pacific Northwest. It’s very interesting. It isn’t an issue of right to work states. It’s actually an issue of where it makes sense to produce.

Knowledge@Wharton: Hal, thanks so much for speaking with us today.

Sirkin: You’re welcome.

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