Three Ways to Revitalize U.S. Manufacturing
Don’t count it out, yet. Despite huge pressures, McKinsey sees technology and process improvements boosting U.S. factories
By Irving Wladawsky-Berger
In today’s service economy it’s easy to forget that manufacturing jobs helped build the U.S. middle class after WWII. In the 1950s, it accounted for roughly 30% of employment and close to 30% of GDP. Manufacturing has significantly declined in the intervening decades, now comprising only 8% of the workforce and 11% of GDP. Manufacturing growth has particularly slowed down over the past 30 years, from 4.9% in the 1990s to 1.4% in each of the past two decades.
Despite its dramatic decline, manufacturing continues to have a disproportionate impact on the U.S. economy, accounting for 35% of productivity growth, 55% of patents, 70% of R&D spending, and 60% of exports. According to McKinsey, these outsize economic contributions uniquely position manufacturing to strengthen the U.S. recovery over the long term.
“The COVID-19 pandemic has underscored manufacturing’s role in providing products that are critical to health, safety, national security, and the continuity of multiple industries,” said McKinsey in a recent discussion paper, Building a More Competitive US Manufacturing Sector. “It has also revealed the extent to which global supply chains are exposed to shocks and disruptions. All of this has occurred at a moment when new technologies, process innovations, and demand growth are reshaping the sector worldwide. The United States can seize on these developments to make its own manufacturing sector more competitive.”
Today’s Manufacturing Environment
The paper examined the future of U.S. manufacturing by looking at four distinct types, each characterized by its distinct growth opportunities, competitive dynamics, investment profiles, and occupational mix.
- Scale-based, standardized manufacturing requires large investments in physical capital, high plant utilization, the standardization of parts and processes, and long, global supply chains. Examples include auto parts, metal foundries, petrochemicals, and specialty chemicals. U.S. employment in scale-based manufacturing industries declined by 25% and the number of establishments declined by 13% between 1998 and 2017, while the U.S. share of global industry GDP declined by 6% between 1995 and 2000.
- Learning-curve driven manufacturing is characterized by successive product generations, each one requiring large investments in time, capital and engineering to achieve exponential process improvements and productivity gains. It includes semiconductors, precision tools, lithium-ion batteries, and communications equipment. U.S. employment in learning-curve driven manufacturing declined by 37%, the number of establishments declined by 20% between 1998 and 2017, and the US share of global industry GDP declined by 11% between 1995 and 2000.
- R&D- and design-driven manufacturing requires large investments in research, intellectual property, design, software and other intangible assets to develop highly differentiated products whose production is often outsourced. It includes computer systems design and service, innovative digital devices, leading edge pharmaceuticals, and scientific R&D. In these types of industries, U.S. employment increased by 118%, the number of establishments increased by 66% between 1998 and 2017, and the U.S. share of global industry GDP increased by 4% between 1995 and 2000. R&D- and design-based industries are the most profitable, which is why U.S. companies have gravitated to this segment of the market.
- Flexible and customizable manufacturing is based on customization, distributed production, and after-sales services, relying on digital production technologies to reduce the scale necessary to be profitable. Examples include aerospace, maritime, and railroad equipment; military equipment; and medical devices. In these types of manufacturing industries, U.S. employment declined by 28% and the number of establishments declined by 18% between 1998 and 2017, while the U.S. share of global industry GDP declined by 4% between 1995 and 2000.
“Although demand continues to rise, manufacturing is under pressure worldwide. The average profit for a dollar of capital investment in manufacturing has fallen by 80 percent over the past two decades.
In this environment, even small differences in currency valuations, compliance costs, or input costs can make or break a manufacturer — and most of these trends have not favored the United States.” U.S. investors expect manufacturing companies to produce higher returns on capital than their counterparts in the OECD and China, placing U.S. companies at a competitive disadvantage.
What’s Needed Tomorrow
Despite these challenges, the U.S. has a number of opportunities to improve its competitiveness. Three major trends could help revitalize U.S. manufacturing:
- Labor costs have been equalizing over time. “The United States matches OECD peers such as Japan and Germany in productivity-adjusted labor costs, while Chinese wages are catching up.”
- Technological advances, process improvements and changing industry structures are also creating opportunities. “Industry 4.0 technologies, for example, can raise productivity by up to 40 percent and transform some scale-based activity into flexible production.” Advanced technologies — including analytics, machine learning, robotics, Internet of Things, and 3D-printing— touch on every aspect of manufacturing, from market research and product design to demand forecasting and after-sale services.
- Supply-chain resilience and speed to market can help increase domestic sourcing. “Peer countries tend to meet 80 to 90 percent of domestic demand with regional production, but only 70 percent of U.S. domestic demand is met with locally produced goods.” While labor costs continue to be important — especially for low-margin, commodity product — companies in many industries are taking a closer look at the downsides of offshoring and complex supply chains.
In addition, as noted in a 2017 McKinsey article, the U.S. is one of the most lucrative and diverse markets in the world. “U.S. demand for heavy machinery, equipment, and building materials could also increase if public investment revives from its 50-year lows,” something we will likely see as economic conditions improve, partly driven by the administration’s infrastructure initiatives. “U.S. consumers are more diverse and tech-savvy than in the past — and they have high expectations for quality, low prices, and variety.” Serving the increasingly fragmented U.S. markets challenges companies to develop a wide range of products and marketing approaches, a learning experience which will serve them well as they compete in the highly diverse global markets.
To take advantage of these trends, U.S. companies must catch up with the global leaders in technology adoption and process improvements.
It also requires the creation of networks of small and medium-size regional suppliers, which could spur new economic activity in small towns across the country. The U.S. also needs more specialized manufacturing talent, including scientists, product designers, software developers, industrial engineers, production technicians, operation managers and factory workers with higher-level digital skills.
Overall, improving the competitiveness of the manufacturing sectors could increase GDP by $275 billion to $460 billion by 2030, while adding up to 1.5 million jobs.
“The stars could be aligning for U.S. manufacturing,” concludes the McKinsey paper. “There is both public- and private-sector resolve to shore up a sector that has long been an important pillar of the economy. This momentum, combined with technology trends and market opportunities, offers a rare chance to change the existing trajectory — and give the United States a powerful driver for economic recovery, inclusive growth, resilience, and the capabilities of the future.”
This blog first appeared September 4 here.