Will Tax Breaks Bring Manufacturing Jobs Back to the US?

In his State of the Union address last night, President Obama spoke of a possible manufacturing renaissance popping up right here in the United States. With the right tax policies in place, over time, Mr. Obama believes that this potential renaissance could be a reality.  Is there something to this argument?

The Case

While manufacturing a product is currently cheaper in many parts of Asia (where labor costs are low and workers are more malleable), productivity gains and potential tax benefits here at home could be enough to close the wage gap and make US manufacturing competitive again.

Let’s consider the US versus China. In 2000, Chinese manufacturing workers were paid on average around 50 cents an hour while American manufacturing workers were being paid on average around $16.60 an hour. That means labor costs in China were 3% of that in the United States. In addition, the Chinese currency (the Renminbi or Yuan) was artificially cheap compared to the US dollar, making the disparity even greater in real terms. Chinese workers, while generally not as skilled as American workers, were reliable enough to get the job done, so many US companies relocated there — some enticed by Chinese government subsidies. From 2001 to 2004, US imports from China grew at a rate of around 20% a year.

But that growth rate started to slow around 2005, and by 2010 it had fallen to just 4%. Americans were still consuming plenty of Chinese-made products, but they were starting to get full. Meanwhile, in China, wage inflation started to take hold as people got richer. The average Chinese worker is now projected to earn around $4.50 an hour by 2014, nine times more than s/he earned in 2000, according to an analysis by the Boston Consulting Group. To put that in perspective, if the American manufacturing worker experienced the same rate of wage growth, s/he would have a salary of around $150 an hour by 2014.

The Wage Gap is Closing

Of course, the American manufacturing worker shouldn’t expect their wages to jump by a factor of nine. By 2014, the average hourly rate for an American is expected to be around $26.10. While there is still a major wage gap compared with that of a Chinese worker, it will now be up to 17% of the American worker.

That is still a big enough incentive for many companies to keep their manufacturing in China. But it isn’t always just about the money. It turns out that US workers are far more productive compared to their Chinese counterparts. When you factor in productivity, that Chinese worker is really costing $15.03 an hour compared to $24.81 for a worker in the Southern US, according to BCG. That might still seem like a big gap, but once you factor in duties and shipping, it starts to make sense for manufacturers to do the work at home versus abroad.

But there is one major flaw in this reasoning worth noting. Labor costs, especially for high tech products, aren’t the only reason why companies choose to relocate to China. It also has to do with supply-chain management and access to raw materials. China has built massive manufacturing hubs around the Pearl River Delta that can make almost anything in a flash. Chinese factories can be retooled and producing custom products in a matter of days, while a similar change would take weeks in the US. Measuring productivity per person as BCG did in their study may not be the best way to compare China and US labor costs. The Chinese work in collectives and with the full support of the government’s centrally-planned economy — a strong force to beat.

The Proposed Tax Breaks

President Obama proposed that Congress give American companies tax breaks if they manufacture their products at home and take away tax breaks that give them the incentive to go abroad. He proposed doubling the tax break for high-tech companies. That will help close the labor and collective productivity gap that China holds over the US, but it still may not be enough for some companies to come around to the idea of manufacturing their products in Alabama over Shenzhen. So the President also said he would create a special task force to ensure that Chinese made goods bound for the US did not receive unfair government subsidies. Removing that advantage might just put US manufacturing on an equal footing with China.

Now, the chances that Democrats and Republicans unite in an election year to pass any of these tax breaks seems unlikely given all the acrimony in Washington these days. Until then, there are still a growing number of American companies, including Master Lock and General Motors, which have decided to take the plunge and move their manufacturing plants back to the US. One day, they could be rewarded for the efforts with a big ol’ tax break — and more manufacturing jobs might follow.