Fighting with Our Hands TiedHow Structural Costs Imposed on U.S. Manufacturers Threaten Competitiveness

Presented by Jeremy LeonardEconomic ConsultantManufacturers Alliance/MAPI, Inc.

Tauber Manufacturing InstituteMarch 26, 2004

Background

Emerson Electric approached MAPI and NAM in summer 2003 on the burden of “overhead” costs.

Research carried out in fall 2003; final study released in December.

Analysis reflects input from MAPI, NAM and Emerson.

Manufacturing costs closely related to “offshoring” at the center of current political debate.

Key findings of study

U.S. manufacturing renaissance since early 1980s.

Increasing competition from emerging markets, notably China and Mexico.

Nonproduction costs outside of manufacturers’ direct control have spiraled, with disastrous consequences: Total manufacturing costs are HIGHER than for our industrial trading

partners. U.S. nonproduction costs are almost as high as TOTAL manufacturing

costs in China. Soft pricing environment = ↓ cash flow, ↓ investment, ↓ jobs

The U.S. is shooting itself in the foot by not adopting policies to rein in these costs.

Renaissance inU.S. manufacturing

Manufacturing accounted for 22 percent of GDP growth in 1990s expansion, more than its share of output.

Annual trend productivity growth accelerated to more than 4 percent, higher than any post-WWII expansion.

An engine of innovation: 90 percent of patent approvals and 75 percent of R&D in manufacturing and allied industries.

Innovation and investment fanned out to other sectors of the economy, helping double productivity growth in nonmanufacturing industries.

U.S. material living standards began to pull away from Canada, Western Europe and Japan.

Shift in global competitionsince 1990

Geographic distribution of trade (percent of total)

Exports Imports

1990 2002 1990 2002

Canada 21.1 24.6 18.1 19.1

European Union 26.3 22.0 20.0 20.6

Japan 12.3 7.9 18.2 11.1

Other advanced 3.4 3.2 2.4 2.0

TOTAL ADVANCED 63.1 57.6 58.7 52.7

Mexico 7.2 14.9 6.0 12.3

China 1.2 3.4 3.1 11.4

Southeast Asia 9.4 11.1 15.8 13.8

Other developing 12.0 7.6 11.3 4.3

TOTAL DEVELOPING 29.9 37.0 36.1 41.7

Unclassified 7.0 5.4 5.2 5.6

Majority of trade is with advanced economies, though share declining.

Mexico and China have become major players in US market.

Some imports from Japan and SE Asia have migrated to China.

Note: Southeast Asia includes Taiwan, South Korea, Hong Kong, Singapore, Malaysia, Philippines, Thailand and Indonesia

Emerging markets have moved

into high-value goodsImports from emerging markets by product type (% total)

Mexico China Korea Taiwan

Office machines and telecom equipment

17.4 23.6 30.9 33.6

Electrical machinery 12.6 8.2 14.6 16.6

Transportation equipment

19.8 1.5 20.9 4.4

Textiles, apparel, footwear and handbags

7.2 20.0 9.3 7.9

Miscellaneous manufacturing

2.5 18.8 3.0 7.8

Industrial machinery 7.6 3.6 6.0 7.4

Fabricated metal products

3.8 4.7 4.4 8.7

Furniture 2.8 5.6 0.2 2.5

TOTAL OF ABOVE 73.6 86.0 89.4 88.9

Office machines and telecom are the most important main category.

China is making inroads in other higher-value industries.

“Traditional” labor-intensive industries are becoming less important.

Note: Miscellaneous manufacturing includes toys, sporting goods, and other small consumer goods

Manufacturing cost pressures areeroding productivity gains

Growth since 1997

Productivity (2003Q2) 27.3

Employer-paid health care premiums (2003Q2)

34.2

Employer-paid pension premiums (2003Q2) 15.2

Regulatory compliance costs1 11.4

Tort and litigation costs (2001) 32.9

1. Regulatory compliance costs reflect growth from 1992 to 1997 and likely understate more recent growth

Excess burden of U.S. nonproduction costs is heavy

0

5

10

15

20

25

30

U.S. Industrializedpartners

Middle-incomepartners

Mexico China

energy costs ($0.10)

regulatory compliance ($0.88)

tort litigation ($0.80)

employee benefits ($1.41)

corporate tax rate (1.43)

raw cost index

Total manufacturing costs, U.S. dollars per hour

U.S. manufacturing costs are higher than all trading partners; without EXCESS nonproduction costs, they would be lower than industrialized partners.

Dollar value of U.S. excess costs almost as large as TOTAL production costs in China.

Implications of high and escalating nonproduction costs

Manufacturers cannot compete internationally (trade deficit is more than a currency problem).

Relocation of operations offshore becomes more attractive option.

In a soft pricing environment, escalating costs reduce cash flow (manufacturing CF declining since 1997).

Declining cash flow discourages hiring, investment and R&D.

Manufacturing nonproduction costs: THE BIG 4

Corporate taxation.

Employee health benefits.

Tort litigation.

Regulatory compliance.

The burden of HIGH ENERGY COSTS is much in the news but is much smaller than these in quantitative terms.

Statutory corporate tax rates going south everywhere but here

0

10

20

30

40

50

60

70

UnitedStates

Canada Mexico Japan China Germany UnitedKingdom

SouthKorea

Taiwan France

1997 2003

percent

Statutory rates not the only tax problem

Until JGTRRA in 2003, no deductibility of dividends from US individual income tax (unique among trading partners).

Partial dividend exclusion scheduled to sunset in 2008.

Treatment of foreign-source income very unfavorable relative to countries with value-added taxes; costs manufacturers $60 billion annually.

Foreign sales corporations, the tool to compensate for VAT rebating, have been ruled illegal by WTO.

US health care costs areout of control

0

2

4

6

8

10

12

14

16

UnitedStates

Canada Mexico Japan China Germany UnitedKingdom

SouthKorea

Taiwan France

publicly-funded privately-funded

2001, percent of GDP

US businesses shoulder a much larger share of health care costs than their international counterparts.Businesses typically pay ¾ of employee premiums, a share that has risen since early 1990s.

Tort litigation

US tort system notorious for its high cost ($230 billion in 2002), inefficiency with regard to compensating plaintiffs, and inability to link damages to negligent behavior.

Proportionally, US manufacturers bear an actual litigation burden that is three times heavier than most of its major trading partners.

Threatened litigation can at best increase product safety requirements and at worst discourage new product development.

Looming asbestos crisis ($275 billion in potential damages across the industrial spectrum?) urgently needs resolution.

Regulatory compliance: the silent killer of competitiveness

Most expensive in terms of direct costs are environmental; other main categories are workplace safety, tax compliance, and economic.

Rarely pass basic cost-benefit hurdles and often stay on the books long after their useful life is over.

Total compliance cost to US manufacturers: $160 billion, equivalent to a 12 percent excise tax.

Sarbanes-Oxley and related corporate governance changes will add a yet unknown amount to this.

Well-designed regulatory measures can reach intended goals at a much lower cost.

International comparisons: pollution abatement

Manufacturing pollution abatement costs

(% of mfg output)

United States 7.6

Canada 4.8

Mexico 3.1

Japan 5.3

China 1.61

Germany 5.2

United Kingdom 4.7

South Korea 4.3

Taiwan 1.61

France 6.1

Trade-weighted average of trading partners

4.1

Pollution abatement costs are higher for US manufacturers than ALL major trading partners, even so-called “green” economies of W. Europe.

Why? US pollution regs are toughest in the world and still rely too much on command-and-control.

If international data existed, similar story might be told for workplace and product safety.

1. Data for China and Taiwan are not available. This analysis assumes that manufacturers in these countries bear a pollution abatement burden equal to half that of Mexico, the lowest value.

Conclusions and implications

Current debates about offshoring U.S. jobs skirt the fundamental issue of overall cost.

Manufacturers doing their part: ↑ investment, ↑ innovation, ↑ productivity has lowered unit costs since 1990.

Nonproduction costs outside of manufacturers’ direct control have spiraled, mainly as a result of benign neglect on the part of government policies.

Commerce Department manufacturing report provides good blueprint for policy action on the “Big 4” nonproduction cost drivers.

Our mission: take this message to Washington and the state capitals.