Can Insourcing Be A Major Source of Job Creation?

Can insourcing  be a major source of job creation for the U.S.?  The answer is yes, with a caveat. Widespread insourcing–or import recapture, as I like to call it–won’t happen without some help from government policy.  In particular, the main role of the government is to provide better data about the relative cost of insourcing vs outsourcing.

Why would better statistics help create new jobs in the U.S. and accelerate insourcing?  The reason is hysteresis. Hysteresis is defined as  a “lag in response”  when the forces acting on a situation have changed.  Originally hysteresis worked in favor of keeping jobs in this country, because businesses didn’t want to switch their production to a country thousands of miles away, even if it might be cheaper.But now, with production firmly established in China, India, Mexico, and other low-cost countries,  hysteresis is working against the U.S.

As a result,  even if production costs have converged, there are three big obstacles to bringing  jobs back to the U.S.

First, it is expensive to switch suppliers, especially for noncommodity purchases. Contracts have to be negotiated, the quality of the product has to be checked,  suppliers have to be integrated into a supply chain.  Wal-mart would rather work with suppliers that it already has been doing business with.

Second,  it may be expensive and time-consuming to recreate a production ecosystem here in the U.S., especially if an industry has been hollowed out.   That is,  if you want to start making shoes in the U.S.,  it’s easier if you have a repairman in the area who knows have to fix shoe manufacturing machinery.

Third, it may be expensive for small and medium-size companies to determine if switching suppliers will raise or lower costs. That’s especially true if all of their current suppliers are in one country.   Big multinationals can afford to run studies on relative costs of the different countries, but small and medium businesses cannot.

One cheap way of boost insourcing is for the Bureau of Labor Statistics to provide better data about the relative costs of production in the U.S. versus production overseas. The BLS already collects information on import prices and domestic production prices, but it doesn’t compare the two.

Assuming that production costs really are converging,  better information would make it easier for companies to justify the decision to bring jobs back to this country. Right now the safe decision for executives is to continue sourcing from China and India, since they are generally accepted to be ‘low-cost’ countries.  It’s like they used to say, you can’t get fired for buying from IBM.  It’s the same today–execs can’t get fired for buying from China and India, because everyone assumes that prices are lower there.

In November 2011 PPI proposed a Competitiveness Audit, to be done by the BLS, to help boost insourcing of jobs.  For each industry, the Competitiveness Audit would compare import and domestic prices, and give a sense about the size of the gap and whether it was widening or narrowing.  This information would be crucial for identifyng the industries where insourcing makes sense. The Competitiveness Audit would also give executives a sense of security that they were making the right decision by bringing back jobs.

A Competitiveness Audit is a good way of accelerating the rate of insourcing. The goal here is to overcome hysteresis and inertia, and create a sort of bandwagon effect of jobs moving back to this country.  Better information is essential to create new jobs.

Reihan Salam on German Productivity

Germany has been held up as a model for the United States by David Leonhardt and others. Reihan Salam  correctly observes that German offshoring to Eastern Europe has been an essential part of Germany’s apparent success. He also  points out that:

The fall of communism was, as Marin suggests, a positive exogenous shock that proved a tremendous boon the German economy. A 20% increase in productivity is nothing to sneeze at, and I don’t think that David Leonhardt gave the role of offshoring its due in explaining the virtues of the German model.

Of course, the Houseman-Mandel thesis also tell us that German productivity gains, like U.S. productivity gains, might offer less than meets the eye.

Reihan raises a very interesting point which I hadn’t considered. Remember that our recent paper, “Not all productivity gains are the same. Here’s why”, we divided measured productivity growth into three types:

  • Improvements in domestic production processes
  • Gains in global supply chain efficiency
  • Productivity gains at foreign suppliers.

As we noted in the paper, these different types of productivity growth cannot be told apart in the conventional economic statistics. However, the type of productivity growth matters for domestic wages and jobs. For example,  productivity gains from improvements in domestic production processes are more likely to result in rising real wages for domestic factory workers.

We made our argument in terms of the U.S., but it potentially applies to other countries as well. I hadn’t considered Germany until Reihan raised the point, but in fact Germany appears to use a similar import price methodology as the U.S. (see for example Silver 2007) with the potential for similar problems, though I need to take a closer look to make sure.

Here’s something to think about: In a global economy, measured productivity growth in an industrialized country potentially may not measure only the strength of that country’s domestic economy, but also its ability to successfully offshore production to cheaper countries, with implications for domestic wages and jobs.

New Manufacturing Data Show Weaker Factory Recovery, Deeper Recession

There’s been a lot of happy talk recently about the revival of U.S. manufacturing .  According to an article in the New York Times,  “manufacturing has been one of the surprising pillars of the recovery. “  In a column entitled “Manufacturing Stages A Comeback,”  well-known geographer Joel Kotkin talks about “the revival of the country’s long distressed industrial sector.”  The Economist writes that “against all the odds, American factories are coming back to life.”* 

Truly, I’d like to believe in the revival of manufacturing as much as the next person. Manufacturing, in the broadest sense,  is an essential part of the U.S. economy, and any good news would be welcome.  

Unfortunately,  the latest figures do not back up the cheerful rhetoric.

Newly-released data suggest that the manufacturing recession was deeper than previously thought, and the factory recovery has been weaker. On May 13 the Census Bureau issued revised numbers for factory shipments,  incorporating the results of the 2009 Annual Survey of Manufacturers.  The chart belows shows the comparison between the original data and the revised data (three-month moving averages):

 The decline in shipments from the second quarter of 2008 to the second quarter of 2009 is now 25%, rather than 22%. And the current level of shipments in the first quarter of 2011 is now 9% below the second quarter of 2008, rather than only 5%. In other words, the new data shows that factory shipments, in dollars, are still well below their peak level.

The manufacturing recovery looks even more  tepid when we adjust shipments for changes in price.   Here are real shipments in manufacturing, deflated by the appropriate producer price indexes.**

Now that hardly looks like a recovery at all, does it?  Real shipments plummeted 22% from the peak in the fourth quarter of 2007 to the second quarter of 2009.  As of the first quarter of 2011, real shipments are still 15% below their peak.  To put it another way,  manufacturers have made back only about one-third of the decline from the financial crisis.

And while U.S. manufacturers have struggled, imports have coming roaring back.  Here’s a comparison of real imports (data taken directly from this Census table) and real U.S. factory shipments (my construction, using Census and BLS data).

This chart shows that imports have recovered far faster and more completely than domestic manufacturing.   Goods imports, adjusted  for inflation, are only about 1% below their peak.  That’s according to the official data. If we factored in the import price bias, we would see that real imports are likely above their peak (I’ll do that in a different post).

In other words,   this so-called  ‘revival of U.S. manufacturing’ seems to involve losing even more ground to imports.  That doesn’t strike me as much of a revival.

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Import Recapture Strategy

From the NYT, on rising Chinese export prices:

Markups of 20 to 50 percent on products like leather shoes and polo shirts have sent Western buyers scrambling for alternate suppliers…..Already, the slowdown in American orders has forced some container shipping lines to cancel up to a quarter of their trips to the United States this spring from Hong Kong and other Chinese ports.

It’s time for state and local economic development agencies to start honing their import recapture strategies.  By ‘import recapture strategy’, I mean the judicious use of loans and other aid to help rebuild and restart manufacturing production and jobs that were lost to foreign factories.*

Yes, I know that sounds weird after all the manufacturing jobs that have been lost.  Anecdotally, the price differential between China and the U.S. was on the order of 35%.  Given the price jumps in the pipeline, all of a sudden the cost of U.S. production might be in spitting distance for some industries.That’s especially true since domestic manufacturers have the advantage of being close and flexible.

I’m talking here both high- and low-tech production here. The question is which industries are ripe for import recapture, and how many jobs could be created. Here I’m going to tell you an important  little secret–you cannot rely on the BLS import price data to tell you where the gap has closed between import and domestic prices.  Two reasons:

* The BLS does not measure the difference between the price of imports and the price of the comparable domestic goods.   Just doesn’t.  Never has. It’s a gaping hole in the data.

*The BLS  does measure changes in import prices–but very very badly (see here and the conference proceedings here). To understand how badly, take a look at this chart, which supposedly tracks the price of Chinese imports.

If you believe this data, the price of Chinese imports into the U.S. has been effectively flat (plus or minus no more than 4%) for the past seven years, through the biggest import boom in U.S. history, the biggest financial crisis in75 years, and a 25% appreciation of the Chinese yuan against the dollar.  As the saying goes, “this does not make sense.”  

Back again. I’m currently figuring out  how to develop a database of import-domestic price gaps, so we can assess where an import recapture strategy makes sense. If you are interested in working with me on this, drop me a note at