December 2014 Monthly Article – The Changing Nature of Production Costs

Posted on Posted in Monthly Article

By Jerry Pacheco

Economic cycles are constantly changing the various economies of the world. Many people who grew up in the 1960s remember that post-World War II Japan was a low-cost country that competitively manufactured items such as transistor radios, automobiles and television sets. Japan’s low-cost production advantage was eventually lost to countries such as Taiwan, the Philippines, and Malaysia. In South America, after shaking itself loose from military governments, Brazil saw its popularity as a production base rise the past 20 years.

From the 1960s through the early 2000s, Mexico experienced an inflow of foreign manufacturers eager to take advantage of the country’s low production costs and close proximity to the U.S. Within the last 25 years, China established an enormous manufacturing base due to its low cost of labor. This has resulted in many industries which manufacture products such as textiles and basic consumer products to move their operations from Mexico to China. I remember talking to people 15 years ago who automatically assumed that Mexico’s entire production base, particularly its maquiladora (twin plant) industry, had packed up and moved to China – this was far from true.

Today, there is a common belief that countries such as China, Brazil and regions such as eastern Europe have production cost advantages over North American countries. The findings of a recently published study by the Boston Consulting Group (BCG) entitled, “The Shifting Economies of Global Manufacturing,” not only refute this belief, but develop some surprising conclusions. The study analyzed manufacturing costs in the top 25 exporting economies (representing approximately 90 percent of global exports of manufactured goods), based on four factors: manufacturing wages, labor productivity, energy costs, and exchange rates. BGC then created a manufacturing index based on cost structure as a weighted average across all industries.

The study categorizes the traditionally low-cost countries of Brazil, China, the Czech Republic, Poland and Russia as “Under Pressure” to maintain their cost advantages, due to a myriad of factors that are making them less competitive. It is pointed out that China’s manufacturing cost advantage over the U.S. has shrunk to only five percent. Countries in much of western Europe and Australia, which were previously classified as high-cost, have lost even more advantage to the U.S. because of their weak productivity growth and rising energy costs.

Countries such as India, Indonesia, the Netherlands, and the United Kingdom are classified as “Holding Steady,” – meaning that they are successfully maintaining their relative competitiveness versus global leaders. Although London is one of the most expensive cities in the world, surprisingly, the U.K. has become the low-cost producer in western Europe.

Two countries in the report are classified as “Rising Stars,” – meaning their competitiveness has improved compared to other global leaders because of “moderate wage growth, sustained productivity gains, stable exchange rates, and energy cost advantages.” These two countries, both located in North America, are the U.S. and Mexico. With the exception of China and South Korea, the report concludes that the rest of the top ten exporters are 10 to 25 percent more expensive than the U.S. for manufacturing purposes.

The lowest cost countries reviewed in the study by index are: Indonesia (83), India (87), Thailand and Mexico (91), and China (96). The U.S., ranked at (100), is surpassed in costs by South Korea (101), Canada (115), Japan (121), Brazil (123), and all of western Europe, whose production costs are 9 to 25 percent higher than the U.S. Production costs in Russia and eastern Europe have risen to near parity with that of the U.S.

BGC concludes in the report that the “dramatic changes in relative costs could drive a large shift in the global economy as companies are prompted to reassess their manufacturing footprints. One implication is that global manufacturing could become increasingly regional.”

The conclusions of the report, especially the regional manufacturing component, correlate well with what is happening in North America with the North American Free Trade Agreement partners: Canada, Mexico and the U.S. Our region is in a position to take advantage of our increasing global competitiveness and develop existing industries, while attracting new manufacturing investments. This is certainly a welcome turn of events brought to us by the ever changing economic cycles.