The narrowing wage gap is not enough to revitalize US manufacturing

on September 10, 2013

There is a lot of “buzz” about revitalizing US manufacturing because of a narrowing wage gap between US and China and a “buy America” sentiment.    A look at data shows that this may be over blown and that other strategies need to be employed for US manufacturing to truly rebound.

The wage gap between US labor and China labor is closing.  Many optimists are hoping that the wage gap closes enough so that manufacturing will return to the US in bunches.    So far there has been a small trend for manufacturing to return to the US, but many skeptics are claiming that the existing data barely supports the notion of a trend.  There are many examples given of companies bringing back manufacturing operations from china, but most of these are more anecdotal than statistically significant.

Some people look at corporate reports and conclude that labor is only 5 % to 12 % of a typical product.  That means for a product with an overall cost of $100.00, the labor component is $5.00 to $12.00.  Let’s say $10.00 to make it easy.  At the current average wage gap, Chinese labor cost would be about 20% of US costs.  So in the case of the $100.00 product cost, the labor savings would be $8.00.  Many would wonder with the added shipping costs and supply chain issues if it is really worthwhile.

The issue with the analysis is that typically labor cost is reported only as the personnel directly working on the product.  But there are other costs that sometimes get labeled as overhead.  These elements can include:

  • Quality Control
  • Material Handling
  • Maintenance
  • Supervision
  • Management
  • Shipping/Receiving
  • Floor engineering

There is no universal data on these costs but the total salary associated with building a product can be 2 -3 times the “labor cost”  So if we roughly apply that to the $100.00 product that savings can increase to $16.00 to $24.00.

Another factor to consider is material cost.  Typically material is 40% to 60% of the total cost.  However in some cases component cost in China is cheaper, after all it took labor to build the material.

So making the case that there is only an $8.00 savings on a $100.00 product is misleading.   If the direct labor cost were the only component to consider, many US companies would not outsource to China.

On the other hand there are added costs to manufacture in China, obviously shipping is one, air travel by support and management also goes up.   For many US companies, even with the majority of the manufacturing operation sourced in China, there still needs to be some duplicate resources.

While the wage gap is closing, it still is considerable when we look at the average.  The chart below shows average China Labor rates vs. average and low end US labor rates.  The trend shows the gap is closing faster, but still considerable.   The top red line is average production wages as reported by the bureau of labor statistics, the green line is average production wages in lower cost states such as Tennessee.   The Blue line is the average Chinese labor rate in urban areas.

One can see from the above chart that China labor is increasing at much faster rate; while US labor rates have stagnated after the “great recession” of 2008.  Even if the wage increase continues at the same pace, there is still going to be an $8.00 to $12.00 per hour gap in 2015.

Another factor to consider is that China productivity continues to improve as well as the infrastructure.    The Chinese government is much more supportive of corporate expansion than the US.

There is definitely a place for US growth in manufacturing, but manufacturing returning to the US based solely on labor wage gap changes or even consumer pressure does not appear to be enough incentive to make a major dent.   A more realistic approach is for the US to focus on its inherent advantages:

  • Automation:   Removing the labor component from operations is the best way to minimize the cost advantages in moving to China.  This implies that lower skill labor will need to be replaced by higher skilled technicians to operate the automated equipment.  This will require training programs for the US labor force.
  • Heavy Industry:  The cost to transport heavy product from China is large enough to offset any labor savings.  US needs to continue to invest in heavy equipment production.
  • High Energy Consumption:   The US has the cheapest energy supply in the world.   Production that requires a high level energy should be less expensive in the US than China.

The US needs to put programs in place to optimize its advantages.   Incentives to invest in automation, training programs for the workforce and continued exploitation of energy will bring better results than relying on the wage gap narrowing or even a “buy America” movement.