SPECIAL REPORT. On November 6, 2012, elections were held for the President of the United States, all 435 Members of the House of Representatives, and 33 of 100 Senators. The election results did not significantly change the makeup of American leadership. What has changed, however, is the severity of the challenges facing the new 113th Congress, as well as American companies in 2013 and beyond.

Uncertainty and U.S. Fiscal Policy

As the U.S. Senate, which began the process early morning January 1, 2013, and members of the House of Representatives work to mitigate damage caused by the “fiscal cliff” and eliminate budgetary uncertainty, the likelihood that the U.S. economy falls into recession is lessened.

By adequately addressing various fiscal issues, including the Budget Control Act of 2011 and the termination of George W. Bush’s tax cuts, the dire impact of potential economic missteps—$136 billion in spending cuts and $535 billion in tax increases, according to The Wall Street Journal—could be averted. Many leading economists believe, unless prevented, these spending cuts and tax increases could put the U.S. in recession during 2013.

Uncertainty in terms of fiscal policy can have serious consequences. Since tax policy is partly designed to encourage certain behaviors, its absence encourages others. For example, on December 7, 2012 The Wall Street Journal said, “Tax uncertainty in Washington is setting off a mad scramble among wealthy taxpayers and charities to maximize donations by the end of the year.” The uncertainty of whether or not charitable donations would be tax deductible in 2013 has dramatically influenced personal behaviors.

The greater impact of uncertainty, though, has been much deeper and, according to some CEOs, paralyzed their decision-making processes. In turn, many companies have held onto their cash, failing to invest their profits or use it to hire employees. And the amount of unused funds has added up. According to The Wall Street Journal, “American nonfinancial corporations held $1.74 trillion in cash and other liquid assets at the end of the third quarter.”

Such restrained corporate action has affected many areas of the economy, including employment. Partly due to this action, the November unemployment rate, at 7.7 percent, continued to remain high. Ironically, though the rate declined from 7.9 percent in October, the number of Americans employed actually fell from 143,384,000 to 143,262,000, according to Household data published on December 7, 2012 by the Bureau of Labor Statistics.

Though many factors likely influenced this data, one sobering fact remains indisputable: many Americans gave up looking for jobs, technically exited the workforce, and are no longer considered unemployed. This is reflected in the Bureau of Labor Statistics’ civilian labor force numbers and the workforce participation rate, which from October to November declined from 155,641,000 to 155,291,000 or 63.8 percent to 63.6 percent.

Why Economic Growth Will Remain Modest

U.S. economic growth, measured by gross domestic product (GDP), is likely to clock in at approximately 2 percent in 2012. Assuming adequate measures are taken to remedy the “fiscal cliff,” a number of credible organizations project 2013 GDP growth to remain about the same, with a turn slightly upward in 2014.

Overall, growth is likely to remain modest for a variety of reasons. For one, American consumers, typically representing 71 percent of GDP, continue to remain less confident about the economy than before the recession began, and in turn have curtailed spending to save money and pay off debts.

There are many reasons why confidence continues to be an issue. The decline in housing values, which has translated into a deterioration in the largest assets of many, reduced the wealth of millions of Americans. Although the housing market recently has shown signs of improved health, nearly 11 million homeowners still owe more on their homes than they are worth according to the latest data from Corelogic, a provider of real estate information. Furthermore, in 2011 the total amount of residential new-builds were roughly half the amount of those built in 2004, suggesting a long road back to where we once were.

Logically, many wonder what is required to return the economy to a more normal prerecession unemployment rate of 5 to 6 percent. According to a 2011 report by McKinsey, a global management consulting firm, the United States will need to create 21 million new jobs within the decade to reach prerecession employment levels by 2020 and accommodate new entrants into the labor force. This figure, which breaks down to the necessary creation of 175,000 jobs each month, has never been achieved before on a long-term sustainable basis.

Historically, 20.9 million net jobs were created in the 1970s, 18.5 million in the 1980s, 16.1 million in the 1990s, and 5.6 million in the last decade, according to the Labor Department’s Household data. Of course, many factors impact these numbers, including the growth rate of the Civilian Non-Institutional Population (members of the U.S. population age 16 or over not in the military or incarcerated), and trends in the number of retirees, immigrants, and women departing or entering the workforce. Nonetheless, given historical precedent, the creation of 21 million jobs in less than a decade seems unlikely.

Factors beyond high unemployment also continue to have a significant drag on the U.S. economy. For example, Europe is the source of 71 percent of U.S. inbound foreign direct investment on a cumulative basis and the destination of 22 percent of American exports, according to the Department of Commerce. Any disruption of U.S.-European trade and investment will continue to impact this side of the Atlantic. Additionally, U.S. government purchases at the federal, state, and local levels will continue to decline, negatively impacting overall economic demand.

Why It’s Essential to Engage Globally

As the United States continues to plod along economically, it is important for American firms to seek faster-growing markets abroad. China’s GDP, for example, is projected to grow slightly above 8 percent through 2017, based on International Monetary Fund (IMF) reports. Even if lower estimates of 6 to 7 percent become a reality, China’s growth trajectory will still be considerably higher than that of the United States, which the IMF projects to only be slightly greater than 3 percent from 2014 through 2017.

As a whole, Developing Asia’s GDP is projected to grow in the 7 percent range during this same period, while advanced economies trudge along at less than 2.6 percent, says the IMF. While Central and South America are estimated to grow at 4 percent from 2014 through 2017, a much slower rate than Developing Asia, they also should remain an important export market.

In 2011, Central and South America purchased $169 billion in merchandise from American firms. This figure does not include Mexico, which alone imported $196 billion in goods from the United States, as indicated by Department of Commerce data.

The bottom line: American firms must expand beyond the U.S. population of 313 million consumers and pursue the remaining world market of 6.7 billion. Put another way, markets outside the United States represent 73 percent of global purchasing power, 87 percent of economic growth, and 95 percent of world consumers, according to the U.S. Chamber of Commerce. This is far too large a market to ignore.

Importantly, the OECD, an independent organization that promotes policies to improve global economic prosperity, currently estimates the world’s middle class population at 1.8 billion. It projects this number to climb to 5 billion by 2030, with the vast majority living in Asia.

Pursuing faster-growing markets abroad offers considerably more than an increased customer base. On average, U.S. companies that export employ twice as many workers, produce twice as much output, and generally offer better health insurance and pensions than non-exporting companies, says the Peterson Institute of International Economics, a Washington, D.C. think tank. Moreover, according to the Department of Commerce, exporting firms also have higher productivity levels and pay employees more. And, the Business Roundtable, an association of U.S. CEOs, says one in five American jobs are linked to international trade.

How to Get There

As foreign markets continue to expand at a considerably faster rate than the U.S., President Obama’s National Export Initiative, aiming to double exports over a period of five years, is helping. American free trade agreements (FTAs), which level the global playing field, also help U.S. firms profit globally.

Three FTAs involving South Korea, Panama, and Columbia were recently implemented. This brings the total count of American FTAs to 14 and the number of partnering countries to 20. There are, however, more than 300 FTAs around the world that eliminate tariffs and barriers to trade without U.S. participation, according to the WTO. This puts U.S. firms at a competitive disadvantage.

The good news: more FTAs are on the way. The Trans-Pacific Partnership, an emerging FTA that involves the United States and 10 other countries, is making strong progress. It held its 15th round of negotiations in early December in New Zealand and reported solid steps forward. Russia, which was admitted to the World Trade Organization in August 2012, is likely to become a more profitable trade partner as the country adopts and adheres to global trade rules.

Existing free trade deals also continue to benefit U.S. companies and workers. For example, the North American Free Trade Agreement (NAFTA), first implemented on January 1, 1994, is performing well. A recent report published by the U.S. Chamber of Commerce says trade with Canada and Mexico supports nearly 14 million U.S. jobs, and nearly 5 million of these net jobs are supported by the increase in trade generated by NAFTA.

Importantly, the report says “in 2011, the United States registered a trade surplus with its NAFTA partners in manufactured goods ($14.5 billion), services ($40 billion), and agricultural goods ($2.6 billion).” The overall deficit with our NAFTA partners, the report indicates, is caused by U.S. petroleum imports.

U.S. Manufacturing Sector to Strengthen

The number of workers employed in a particular sector is little indication of that industry’s strength or output. Nowhere is this more telling than in American manufacturing.

Since 1979, when the U.S. manufacturing labor force was at its height at 19.5 million, through November 2012, when the number had declined to 12 million, manufacturing value-added output more than tripled, moving from $545 billion to $1.84 trillion. This increase in output is surprising to many who were under the false impression that U.S. manufacturing was on the decline. What is not surprising, however, is the decrease in the number employed in the sector.

U.S. innovation, technology, and productivity have empowered fewer workers to produce much more in less time. A similar trend was experienced in American agriculture. In 1940 there were 9.5 million farm jobs. By 2012, less than 2 million existed, the Department of Labor reports, though agricultural output has skyrocketed.

How does the American manufacturing sector stand up when compared globally? U.S. manufacturing value-added output only slightly declined from 22 percent of global output in 1979 to 18.5 percent in 2010, says the latest United Nations data. Although China ranks as the world’s largest exporter, the U.S. is far ahead in terms of overall output per employee.

The Department of Commerce indicates that the U.S. workforce, at 142 million in 2011, generated a total GDP of $15.1 trillion. During the same year, the Chinese workforce of 802 million generated $7.3 trillion in GDP, according to United Nations’ data. The result: the U.S. labor force, which is approximately one-sixth of China’s, produced more than two times China’s output. This is attributable to the remarkable productivity of the American workforce, and U.S. innovation and technology which continues to boost U.S. productivity levels even higher.

New Factors Driving Investment

For decades, inexpensive labor has been an important factor in foreign investment but only one of many considered by U.S. manufacturers when determining where to invest or establish facilities abroad. Other very important factors have included and continue to include proximity to markets, worker skills, productivity levels, transportation infrastructure, supplier capabilities, taxes, government regulations, incentives, political stability, currency exchange rates, etc.

Due to these vital factors, 73.4 percent of U.S. foreign direct investment stock went to high wage countries and regions, including Canada, Europe, Japan, Australia and New Zealand through 2011, says the Bureau of Economic Analysis. These factors are also why the U.S. remains the top destination of the world’s foreign direct investment.

Recent trends, however, are changing these patterns of investment. The implementation of new technologies and the ability to automate much of production has caused labor costs, as a percentage of a product’s total cost, to decline to 20-30 percent on average, according to Boston Consulting Group, a business management firm. Susan Helper, a professor of Economics at Case Western Reserve University, says in most manufacturing facilities, labor costs are likely down to between 10-20 percent of overall costs. Others say the percentage is even less. As a result, inexpensive labor located in various developing countries is becoming a less important factor in determining where a company may establish future production facilities.

For those product lines where automation is difficult, inexpensive labor abroad still is very attractive for many firms. However, over the last few years labor rates in China have been rising 18 percent annually. When accounting for the increased value of the country’s currency, the renminbi, the labor cost rise is about 25 percent per year, says global consulting firm InterChina Consulting.

For these firms and their still labor-intensive product lines other traditionally low-labor cost countries, like Vietnam, Indonesia, Thailand and Bangladesh, will continue to be candidates for production facilities. Overall though, rising labor rates across Asia are increasingly forcing U.S. manufacturers to rework their math.

When considering all the costs related to producing abroad, especially larger capital outlays associated with longer lead times, bigger inventories, and duties paid to get components into a country for manufacturing or assembly, the U.S. is becoming a more attractive manufacturing destination. In turn, an increasing number of U.S. firms are “backshoring” or returning production operations to the United States that previously were offshored. Certain low-cost southern states where the overall cost gap with China is narrowing are becoming beneficiaries.

For American manufacturers, a backshoring strategy makes sense if their target markets primarily are in North America. If, however, their target markets are in Asia, it still makes sense for many firms to maintain production facilities there.

Another trend taking shape is “nearshoring.” More recently and in the coming years, many manufacturers plan to more closely match supply functions with demand location by nearshoring or moving manufacturing and distribution facilities closer to faster-growing markets. This action, which may have the opposite effect of backshoring, is designed to better serve consumers while reducing transportation costs and delivery times.

To make nearshoring a success, manufacturers will need to grasp changing demographic data to identify where tomorrow’s fastest-growing markets will be, how much cash consumers likely will spend, and what they are likely to buy.

Another important trend affecting investment decisions involves the availability of skilled labor. Many may be baffled by questions of labor scarcity when the U.S. unemployment rate is hovering near 8 percent.

In order to enhance competitiveness, companies are delving deeper into their core competencies. They do this in hopes of becoming the world’s best at what they produce. This requires highly skilled employees with the ability to think critically, solve complex analytical problems, and manipulate sophisticated technologies.

Herein lies the problem: a skills deficit—and not only at the highest levels. As a result of this skills deficit 600,000 U.S. manufacturing jobs went unfilled in 2011, says the University of Michigan. If companies cannot find workers with the skills they need, they may have to move to a region or country where such workers exist.

The final trend driving investment may be more impactful than all the rest. The combined use of horizontal drilling and hydraulic fracturing has enabled American companies to exploit untouched and unconventional domestic energy resources such as shale gas, shale oil, and tight oil, once considered too difficult to extract. In turn, due to improved recovery rates, assessments of these obtainable reserves have skyrocketed even in previously tapped fields.

As a result, it is estimated that a Persian Gulf may lie beneath North Dakota and Montana, says a Harvard study. And the Marcellus shale, which lies beneath much of the eastern United States, alone may hold 141 trillion cubic feet of natural gas reserves, an amount equal to total world consumption in 10 years, the U.S. Energy Information Administration reports. Advances in drilling and extraction, combined with these newly discovered massive energy resources, could supercharge American manufacturing.

According to a BlackRock Investment Institute study, a division of the world’s largest asset manager, the U.S. is awash in gas. This is helping to “knock down U.S. prices to record lows.” As stated in a report published by PricewaterhouseCoopers LLC, greater investment in U.S. manufacturing facilities will result from more affordable natural gas feedstock. In fact, the firm estimates lower feedstock and energy costs could save American manufacturers $11.6 billion annually through 2025.

Combined, greater automation, backshoring, and the domestic energy revolution likely will continue to drive investment in American manufacturing while enhancing its level of global competitiveness. This will benefit the United States and American companies, workers, and communities.

The New China

For approximately three decades, China’s GDP averaged 10 percent per year, the World Bank says. This growth rate was largely based on the Middle Kingdom’s export model and its success in mass-producing labor-intensive goods for Europe and United States. However, due to the Great Recession, weak European and U.S. demand has significantly impacted this strategy.

According to data from the United Nations, U.S. import growth declined from an average annual rate of 11.7 percent to 4.8 percent during the periods of 2004-2007 and 2008-2011, respectively. European Union import growth rates also dropped, from 15.5 percent to 4.4 percent during the same time periods. Not surprisingly, China’s average annual export growth rate also declined from 29.2 percent to 13.3 percent during the same period. These trends are likely to continue.

In an effort to become less dependent on foreign markets and in step with other countries’ paths toward developed-country status, China has long recognized the need to stimulate greater domestic demand. This has proven difficult, largely because of weak Chinese social safety nets that encourage the population to save at very high rates to cover potential healthcare costs and other unforeseen expenses.

In an effort to help China, the World Bank has made a number of important recommendations. In 2012, it said “China should complete its transition to a market economy—through enterprise, land, labor, and financial sector reforms—strengthen its private sector, open its market to greater competition and innovation, and ensure equality of opportunity to help achieve its goal of a new structure for economic growth.” This is a tall order that will be need to be addressed by incoming President Xi Jinping.

President Xi Jinping and the 18th Party Congress also face major issues involving social stability and unrest, party corruption, and internal and external demands for reform. The reform process, which began after China joined the WTO in December 2001, has regrettably tapered off over the last few years.

It remains to be seen whether or not President Xi will significantly engage in substantial economic and political reform or retain the more conservative approach that has been prevalent since at least 2008. Although the answer will not be known for some time, some analysts consider President Xi a reformer who must gain greater party influence before promoting fundamental changes. Over the long term, this could spur greater trade and investment in China.

During the short term, problems that plague many American and European firms are likely to continue. In recent years, many American business leaders said China has been a more difficult place to do business and cite its piracy of intellectual property, the value of its currency, the inconsistent application of its standards and regulations, market access barriers, and the subsidizing of Chinese companies as troubling. Nevertheless, China continues to be an important market. Since China joined the WTO, U.S. exports there have increased by 440 percent while, in comparison, U.S. exports to the rest of the world increased only by 100 percent.

Ten Strategies to Enhance Competitiveness

As we enter 2013 and beyond, tackling the tremendous challenges ahead, there are a number of strategies companies can implement to enhance their level of competitiveness. The following list summarizes points previously noted and identifies others not yet discussed:

  1. Engage globally and increase alliances and partnerships with foreign firms.
  2. Understand shifting world demographics and track your target markets, which are more representative of moving targets.
  3. When expanding abroad, consider many factors, including country GDP growth rates, size of the middle class, government and currency stability, protectionist trends, and labor cost, skill base, and productivity levels.
  4. Focus on core competencies and offer more value and proprietary high-tech products.
  5. Due to greater skill shortages, develop creative strategies to attract and retain talent.
  6. Drive down costs by improving efficiencies, refining information flows across all departments, and streamlining operations.
  7. Establish a customer-centric focus by offering faster delivery and customized production runs.
  8. Don’t simply alter products destined for the U.S. market. Design products and value propositions specifically for developing country needs and budgets.
  9. Emphasize customer loyalty through improved customer support and branding strategies.
  10. Operate foreign facilities ethically or social media quickly will inform your American customers.
This Special Report appeared in International Insights, a Fifth Third Bank publication, January 2013
Share

John Manzella
About The Author John Manzella [Full Bio]
John Manzella, founder of the ManzellaReport.com, is a world-recognized speaker, author of several books, and a nationally syndicated columnist on global business, trade policy, and economic trends. His latest book is Global America: Understanding Global and Economic Trends and How To Ensure Competitiveness.




More Articles | Speaker Programs | Speaker Demo | Videos | Latest Book


Talkback

  • No comments found

Leave your comments

0

Quick Search

Stock Watch

FREE Impact Analysis

Get an inside perspective and stay on top of the most important issues in today's Global Economic Arena. Subscribe to The Manzella Report's FREE Impact Analysis Newsletter today!