Outlook 2014: The industrial renaissance
After almost twenty years of outsourcing, western countries have started to insource again: they have started to produce more for their own consumers and import less from China or other Asian countries. This increasing local production – or ‘industrial renaissance’, as we call it – has started in the US but we expect Europe and Japan to follow soon. The industrial renaissance will be one of the dominating trends over the next ten years for both investors and politicians. There are three main drivers behind the start of the industrial renaissance in the US.
First, thanks to the shale revolution, energy has become 50-80% cheaper in the US than abroad. This is a strong competitive advantage in industries that are natural-gas and power-intensive, such as chemicals, metal products and paper, especially since some products use natural gas or ethane as feedstock. A clear example of an energy-intensive manufacturer that is already moving to the US is Orascom, which wants to produce fertiliser from a new plant in Ohio. We expect more energy-intensive companies to follow soon.
The disconnect between US gas prices and global oil prices is especially striking. Since China entered the WTO in 2001 and outsourcing to China really speeded up, US gas prices have gone from $4.10/MMBtu to $3.20/MMBtu (with run-ups to almost $14.00/MMBtu and a post-crisis tumble all the way down to $2.00/MMBtu). Global oil prices, by contrast, have exploded from $24/bbl to $107/bbl (with a brief stop-off just shy of $150/bbl before Lehman Brothers went bust). So US energy prices declined while transportation costs rose significantly due to increasing fuel costs.
According to the International Energy Agency’s chief economist Fatih Birol, the increasing production from shales of both gas and oil will allow NAFTA (US, Canada and Mexico) to be self-sufficient in energy by 2020. On its own, the US might be self-sufficient in energy by 2035. Although these are just projections, it might lead the US government to rethink its budget spending, as a large part of its budget is still allocated to military purposes. Perhaps the budget for peacekeeping in the Middle East could be redirected to the facilitation of new production companies in the US with proper infrastructure or subsidies.
The second driver behind the Industrial Renaissance is the end of cheap labour in China. According to Boston Consulting Group, Chinese factory workers have seen their real salaries increase by 10% per year in the 2000-05 period and by as much as 19% per year from 2005 to 2010. Combined with the annual increase of 13% in minimum wages that the Chinese government has planned until 2015, this will cause the wage gap – although still large – to narrow further. In the US and Europe, on the other hand, wages have hardly kept up with inflation in the last decade.
We do not expect a rush to repatriate production just because of different speeds of labour inflation; China retains huge potential in terms of domestic demand for industrial or consumer goods. But this is definitely one of the variables that companies consider when determining the next production location. It is also obvious that developed countries will not be the only beneficiaries: Mexico, for instance, might even be better positioned from a labour-cost perspective to take some share from China in the production for US customers.
The third driver behind the Industrial Renaissance is what some have called the ‘third industrial revolution’, following the first industrial revolution, with the invention of the steam engine, and the second, with the introduction of mass production and assembly lines. Individualisation of products, production close to consumption and the elimination of startup costs will be the outcome of this process. New technologies like robotics, artificial intelligence, 3D printing, automation, nanotechnology and cloud computing are already allowing smart robots to perform surgery, milk cows or fly fighter jets. We expect this to spread to more industries at an exponential rate. The use of robots and automation tools has already been increasing steadily in the US and according to the International Federation of Robotics, growth will speed-up to 2015.
Already, standard robots are available that can work safely alongside humans and can learn and adapt to most repetitive tasks in a production environment. It will not take long for standard robots like the ‘Baxter’ to be able to perform new tasks by simply downloading a new app from the cloud, just as smart phones do today. If a new arm or part of the robot is needed, the design for this part will again be downloaded and locally printed with the latest 3D printer. It is clear that when technologies like cloud computing, 3D printing and robotics are used, there is no reason not to manufacture close to consumption and remove transportation costs.
It is already happening in the US….
In 2012 there have been more than 100 announcements of new manufacturing sites in the US. Most of the companies concerned focus on using cheap shale gas to replace expensive oil. However there are also other examples such as Honda, which has announced it will expand its manufacturing sites in the US to become a net exporter of cars and motorbikes. Boston Consulting Group forecasts that 30% of products currently imported from China will be produced in the US by 2020.
.… but the rest of the west will follow
Thanks to the availability of cheap shale gas, the industrial renaissance has started in the US. Other countries like Japan and Southern Europe are expected to follow. In Japan, ‘Abenomics’ might ultimately turn out to be the key driver of an industrial revival, with a big help coming from the weakening yen; for now, the initial reaction of corporate Japan seems to be to limit foreign capacity expansion. Cheap and widely available solar energy, combined with large youth unemployment, could drive a fast adaptation of new production techniques and an industrial renaissance in southern Europe. So, while the industrial renaissance is currently no more than an incipient US phenomenon, the potential for it to take hold worldwide is certainly there.
Henk Grootveld is head of thematic investing at Robeco