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Middle America, Uncle Sam's underappreciated asset: Erica Alini

Competition is't just about labour costs

American jobs, goes the conventional wisdom, went to China because workers there were willing to work for close to nothing. But with wages in the People’s Republic now rising by some 18 per cent a year on average, fewer and fewer American jobs nowadays are heading to China.

The conventional wisdom is pretty much right—and likely holds for Canada too. But it’s only part of the story. Sure, China, India and other emerging economies are losing some of their competitive edge because their workers are (finally) commanding higher wages, but America, it seems, is also discovering a previously under-appreciated asset: relatively cheap and rather well-connected Middle America.

Away from the dense urban centres where real estate would be a significant cost, there is plenty of available land, a good supply of skilled workers, and a decent network of roads, rails and bridges to ship products and receive supplies.

A great example of this comes from a recent paper (gated content) in the Journal of Power Sources by Ralph Brodd, a Nevada businessman, and Carlos Helou, of Grep International, an Illinois consulting group (hat tip to the Brookings Institution’s Mark Muro). They sat down with managers and researchers at a number manufacturing companies in the U.S. and China that produce lithium-ion cells for consumer electronics, asking about cost structures. And they did the math.

The upfront cost of building a facility capable of producing 30 million batteries a year, they found, comes down to about $120 million in the U.S. and about $102 million in China, which seems surprisingly high. That’s because land costs in China, believe or not, are much higher. A square meter of land costs between $155 and $226 around China’s main industrial hubs, but it can be as cheap as $20 in Alabama and $14 in Tennessee and North Carolina.

Sure, write Brodd and Helou, you can find real cheap deals in inland China, but good luck getting your product to market from there. Beijing hasn’t quite gotten around to building decent infrastructure to connect the rural areas to the coast. Even in the more developed regions, say the authors, transportation is pricey. Trucking  goods across America, they note, costs about $1.75 per mile on average, but in China the figure is somewhere between $2.50 and $3 per mile, partly due to a highly fragmented logistics industry, which, according to KPMG, counts between 60,000 and 70,000 companies. And the further you get from the big export centres, the bumpier the road gets—literally and figuratively.

Labour costs, the paper finds, played “a lesser role” in manufacturers’ decisions on where to set up shop. An advanced batter producer would be able to pay engineers less than $15 an hour in China, compared to $40 in the U.S., and Chinese building maintenance personnel earn less than a quarter what their American counterparts make, according to the authors’ calculations. But that doesn’t amount to much if labour costs are less than 13% of total costs, which Brodd and Helou say is the case for lithium battery manufacturers in the U.S.

Add in all the perks of producing at home—such as eliminating exchange rate uncertainty, lower chances of supply chain disruptions, a more plentiful supply of qualified labour and the synergies that develop when the R&D guys can easily chat with factory floor employees—and the overall costs of building a new factory in the U.S. or China are roughly equal.

Now, that doesn’t mean that T-shirt and ball-pen makers are suddenly going to start to pop-up across America. Labour intensive industries are likely gone for good—except for a few niche producers—and they’re leaving China too, moving to cheaper jurisdictions like Cambodia or Vietnam.

What this study shows is that offshoring might start to make little sense well before foreign and domestic salaries actually converge.

Erica Alini is a California-based reporter and a regular contributor to CanadianBusiness.com, where she covers the U.S. economy. Follow her on Twitter: @ealini.