Back in 2004 Andy Redleaf and I wrote that U.S. manufacturing would begin to rebound in the next decade, for the simple reason that the 50 year international labor cost arbitrage was just about exhausted. Looking at the data,  we discovered that it takes about 25 years for the latest “super-cheap-let’s-go-build-it-there” emerging industrial economy to lose its effective labor cost advantage over the U.S.  People often miss how fast and fleeting the labor cost edge is because they look at raw wage differentials: a buck per hour in the latest Asian wasteland vs. $20 per hour in Detroit. The raw figures miss two big points. 

First, those $1 an hour workers are always much less productive than American workers. Workers who are an order of magnitude cheaper are typically an order of magnitude less productive.  So the real spread between Detroit and Asia is closer to 2 to 1, than to 20 to 1.

Second, labor cost is a small and shrinking percentage of the total cost of manufactured products, so even the 2 to 1 advantage vastly overstates how much manufacturers save by moving to the low-cost-country-of-the-moment. Because wages in emerging industrial economies rise so quickly, for instance,   the Japan that could compete  on cheap wages in the 1950s and 60s, had to compete on quality by the 1980s. As we wrote at the time:

“When Japan stopped being cheap, new Asian Tigers emerged, like South Korea and Taiwan. In the late 1970s and early 1980s, the wage spread between factory workers in the U.S. and the Tigers was on the order of 20:1. By 2001 U.S. factory labor was only 2.5 times as costly as in Korea. . . Practically speaking, and depending on the productivity of the industry and the potential for automation, in many industries a 2X advantage might as well be zero. Few screams are heard about U.S. job loss to Korea or Taiwan today. In five years few will be none.

“These things happen very quickly. Just 25 years after they became the bargain hunters’ destination of choice, both Korea and Taiwan now have to compete on quality and productivity, not wages, to maintain their positions against China. The same thing is happening even in China itself. Already there are scattered reports of coastal China shipping jobs to the interior as manufacturers fed up with the soaring demands of workers on the coast look for the next cheapest place.

“In 2001, according to the same Oxford survey, factory labor cost 40 times as much in the U.S. as in China. Just two years later, that gap was only 36 times. Chinese labor costs jumped 20 percent in 2 years, while U.S. labor costs rose only 8.5 percent.”

Now, eight years later, comes an intriguing report from the Boston Consulting Group confirming what we predicted back then. By the end of this decade and probably before, about 20-25 years after the emergence of China as “the next cheap place”, the Chinese wage advantage will be trivial for high-margin manufacturing. And with Brazil, India, Russia and even some parts of Africa following the same path, there really is no “next cheap place” big enough to manufacture everything for everyone else.

All this comes down to a splendid example of Say’s Law (supply creates its own demand) in action. Essentially, within a generation the workers employed in making a widget can usually buy the widget, or at least the low end version, for themselves. In about a generation, the Chinese ex-peasants who make cars are paid enough to buy the cars they make. At that point they are not really in a position to dramatically underbid workers from longer-developed countries. They have to compete on quality.

And we are just about there.

-RV