The rise of the US dollar against the euro and other world currencies over the past year has reduced the cost-competitiveness of US manufacturing compared with economies such as Germany, France, Japan, Australia, and Brazil. But the US still maintains a very significant cost advantage over these economies, and therefore manufacturers are unlikely to shift production to other nations. These are among the findings of new research released by Boston Consulting Group (BCG), the American consultancy firm.
Since mid-2014, the manufacturing cost advantages of China, South Korea, India, and Mexico have narrowed considerably against European economies and Japan, though not against the US, because their currencies have remained relatively stable against the dollar. Switzerland and South Korea lost competitive ground against all major goods-exporting economies mainly because of currency fluctuations. The decline in the euro did tip the competitive balance in two European economies — the Czech Republic and Poland — where average manufacturing costs are now lower than in the US.
The findings are based on an updated assessment of direct manufacturing costs based on BCG’s Global Manufacturing Cost-Competitiveness Index. Introduced in mid-2014, the index tracks changes in production costs in the world’s 25 largest export economies. The index covers four primary drivers of manufacturing competitiveness: wages, productivity growth, energy costs, and currency exchange rates. Research conducted last year found that manufacturing cost competitiveness around the world had changed dramatically over the previous decade. Several economies traditionally regarded as having high costs, such as the US, had become much more competitive. Most emerging markets known for low costs — particularly the largest market, China — had become far more expensive.
“While the major drop in the euro has reduced costs for European exporters, they’re still about 10% more expensive on average than US-based manufacturers," said Harold L. Sirkin, a BCG senior partner and a coauthor of the analysis. “The US remains one of the lowest-cost locations for manufacturing in the developed world.”
Several factors have enabled the US and other developed economies to retain their competitiveness relative to many of their trade partners. One factor is differences in labour productivity. In the US, increases in labour productivity continue to largely offset increases in wages. In the UK, where the pound has risen sharply against the euro and moderately against the dollar, manufacturing wages adjusted for productivity dropped by 9% over the past year. In the Netherlands, productivity-adjusted wages declined by 17%.
The US also has a big energy-cost advantage that has largely been driven by the sharp fall in US natural-gas prices since large-scale production of US shale gas began in 2005. Natural gas is a key input in industries such as chemicals and plastics, and a major factor in sectors that use a lot of electricity, such as steel. The spot price of natural gas traded on the New York Mercantile Exchange has dropped by more than 40%, to about $2.75 per million British thermal units, over the past year.
BCG says that as a result of these factors, most European economies have been unable to close the cost gap with the US. The 18% decline in the euro against the US dollar between mid-2014 and mid-2015 translated into an improvement for most European exporters in the BCG Global Manufacturing Cost-Competitiveness Index of around 6 to 12 percentage points relative to the US since 2014. Even after adjusting for changes in exchange rates, however, direct manufacturing costs were around 10 to 20% higher in economies such as France, Germany, Italy, and Belgium.
A similar pattern applied to several other developed economies. The US dollar gained around 13% against the yen, but Japan’s manufacturing cost structure remains 7 percentage points higher than that of the US. The dollar gained 14% against the Canadian dollar, but that nation’s cost-competitiveness improved by 6 points. The US dollar rose 20% against the Brazilian real and 10% against the Australian dollar, but manufacturing costs in those countries remain 17% higher and 19% higher, respectively, than those in the US.
“The underlying trends that have driven the improvement in US cost competitiveness over the past decade have not changed,” said Justin Rose, a BCG partner who, along with Sirkin and Michael Zinser, is a coauthor of The US Manufacturing Renaissance: How Shifting Global Economics Are Creating an American Comeback (Knowledge@Wharton, 2012). “Manufacturers know that sharp gains in the dollar can quickly reverse,” Rose said. “So they are far more likely to focus on trends in wages, productivity, and energy costs when making long-term decisions over where to locate plants.”
The authors note that while manufacturers should consider hedging options to cope with exchange-rate volatility and energy-price changes, they should stick with their long-term strategies for managing global manufacturing footprints and geographically diversifying their supply chains. They should also reduce their exposure in low-cost economies where wages are rising quickly if those goods are being exported around the world. Instead, companies should focus on increasing productivity and making greater use of automation, such as robotics.
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