How manufacturing can create value and jobs

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Bring back manufacturing! This refrain has echoed about since the start of the crisis: is it a serious proposition to win back manufacturing activity after years of decline and if so, how?

From the US to France, politicians, economists and voters have stomped the boards lamenting the loss of manufacturing jobs. Some point to the shift in the economic centre of gravity towards emerging markets and the need for firms to be where the demand is; others criticise outsourcing and relocation of firms from developed countries to developing countries to cut labour costs and increase margins; still others blame labour replacing technology.

In truth, manufacturing production is still a very important driver of OECD economies, which account for some 60% of global manufacturing value-added in 2010. However, other countries, particularly in Asia, have been catching up. Manufacturing jobs have declined in most, but not all, OECD countries too. Even in Germany they fell by about 5% from 2000 to 2008, though this pales in comparison to drops of over 25% in the UK and 20% in the US.

Some employment losses may be due to job destruction and firm closure, others reflect relocation to reduce costs, albeit creating jobs elsewhere, including within the OECD area: Poland and Estonia saw increases in manufacturing jobs for instance, as did Luxembourg, New Zealand and (to a lesser extent) Austria and Italy. But most of the shift in jobs has been in response to shifts in demand, particularly towards China, where manufacturing employment jumped by over 30 million in the same period.

Why should policymakers lament this shift? One obvious reason is the sharp rise in unemployment in several countries since the start of the crisis. People point to Germany, where joblessness has generally remained low, thanks in part to a strong, export-driven, manufacturing sector.

Policy appeal
Bringing manufacturing back is an appealing proposition to policymakers for several reasons. Manufacturing in OECD countries boasts faster productivity growth than services, for instance, and generates well-paid jobs in a range of skills and professions, and not just on the production side; in fact, many large manufacturing companies are also services companies, in sales, design and so on. Factories plug into local businesses and drive services too. Crucially for any leading economy, manufacturing also drives technological change. Also, manufactures are easier to trade than most services, and can bolster export revenues.

Manufacturing has changed in the OECD area, thanks in part to better technology and to outsourcing of the more laborious, low-skilled processes along the value chain. What factories do has changed: a good portion of the cost of building cars and trucks in OECD countries nowadays is in software development and component design, for instance, and this demands specific skills and planning. Many factories are cogs in worldwide operations, forming complex global value chains, so their tasks and functions, as well as their location, depend on where they are on that value chain–with R&D closer to home, for instance, but assembly further away. Factories have even become more comfortable and attractive places to work, with the likes of production line seats, air conditioning, escalators, training and a range of health and safety improvements.

Cost opportunity
There is another recent trend now attracting policy attention, and that is the rising costs of doing business in emerging markets, and the relative falling cost in OECD ones as the crisis bites deeper.

While a narrowing in the cost gap will not change the fact that demand has shifted to burgeoning economies of Asia and Latin America, it might cause more firms to reconsider (or even reverse) offshoring plans.

Moving business to far away countries brings challenges; reports in Area Development: Site and Facility Planning have decried complex supply chains, quality, intellectual property issues, and higher costs related to shipping and inventories, and also labour. “Gone are the days when overseas manufacturers could realise 30 to 50% cost savings in manufacturing their products”, one report said, pointing out that the cost advantage of China could recede further as tariff and wage laws come into effect.

This naturally presents an opportunity for policymakers in the OECD area to reinforce their industrial bases and make their manufacturing more competitive. Such actions could also attract those who wish to use this “backshoring” to spread risk in light of natural disasters or political changes. But would those measures help tackle unemployment and offer a route out of the crisis?

The answer is far from certain. For policymakers to make a real difference, they need to know several things, starting with why firms stay or leave, and why they choose particular locations. Costs savings, being closer to cheap labour, tapping into growing markets, accessing commodities, even tastes: they can all matter.

Policymakers must also look at the long-term outlook for demand, and despite global turbulence in the short term, the room for growth in emerging and other middle income markets remains substantial. Several Asian, African and Latin American countries boast burgeoning middle classes, and there are millions more people in lower income groups poised to join them.

In contrast, the OECD markets face saturation for many products and services, although there is always hope that some game-changing innovation, analogous to the dot.com revolution, will appear on the scene to transform the economic future. But even if that were to happen, in the long run most growth in mass manufacturing jobs will most likely take place outside the OECD area. Indeed, it is hard to see how any major job growth in manufacturing can take place in OECD countries, again–there is simply too much productivity growth elsewhere. However, other sectors will grow.

It’s value, stupid
To understand which ones, a good place to look is those global value chains. Should policy target those activities that lie closer to the high-value strategic end, such as R&D and design, or towards the low cost end such as assembly?

The development of global value chains involving offshoring of production, sourcing, and specialisation in upstream (and downstream) activities has been a major factor in the decline in manufacturing employment in OECD countries where production has become more capital intensive and skills-based.

Click to enlarge

In fact, the environment for investment in knowledge-based capital is likely to determine which countries retain or move into the highly value-adding segments of different industries. For example, in 2006, the iPod accounted for 41,000 jobs, with 27,000 outside the US and 14,000 inside. But in earnings the ratio was reversed, as US workers–where the focus was on design, R&D, software and marketing–earned a total of US$753 million, while those abroad earned $318 million.

Conversely, there has been a global increase in manufacturing jobs in poorer and middle income countries as labour-intensive, low-value added jobs, such as assembly and packaging, locate and expand relocate. Realistically, OECD countries cannot durably compete with low-cost countries for this kind of production.

Sure enough, the defining lines have become somewhat blurred in recent years, with concerns about a rising loss of middle skilled jobs too, and attendant effects on income inequality. Even R&D has shifted abroad.

This puts a higher premium on skills in middle-income countries and helps explain the cost increases there. It is also a nudge for OECD countries to compete for such activities again. In short, global value chains have changed the nature of global competition, and this should influence policy too.

One point seems clear: high value-added manufacturing investment does not necessarily lead to vast numbers of new jobs being created directly on site. A steel plant today may employ 50 people, not 500, because of huge gains in technology. A glance around the OECD countries reflects the importance of value-added, from automotive components firms in Austria to pharmaceuticals in Ireland, and even in traditional industries, such as Italy’s shoe trade, where local conditions and artisanal craftsmanship cannot easily be replicated by moving location.

The key lesson for policy is to encourage the accumulation of knowledge-based capital at home, and to be able to capture as much value from the investment as possible. Through ensuring good business frameworks, such as those affecting the supply of skills and the operation of intellectual property rights, governments can help encourage firms to invest in certain high value functions, such as R&D, prototyping, design, etc, and while some low-skilled jobs will inevitably stay, most growth in low paid jobs will take place elsewhere.

The discussion on which activities could be kept close to home and which ones should go is a dynamic one. Technology may enable more manufacturing on demand, which could favour production closer to the customer. An example of this is the printing industry, with quite large jobs being done rapidly close to market, and print runs with longer lead times being outsourced to lower cost countries. Also, firms may prefer to keep close control to ensure quality is not compromised, or timely deliveries.

Manufacturing remains central to OECD economies, in terms of productivity and income growth, and for innovation. But while there may not be many new jobs in manufacturing production, successful investments will stimulate job creation in upstream and downstream sectors, not to mention in related services.

As for offshoring versus backshoring, there will always be firms that bring activities back. However, it would be premature to expect this to become a big trend or to risk entire strategies on what could prove to be a false promise.

References

Goldsberry, Clare (2010), “Bringing Manufacturing Back to the United States”.

OECD (2011), Attractiveness for Innovation: Location Factors for International Investment, OECD Publishing.

Visit www.oecd.org/innovation


©OECD Observer No 292, Q3 2012




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