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An end to outsourcing?

Wednesday, May 18, 2011
by Tom White

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Could ‘Made in the UK’ start making a comeback?  According to The Economist, American multinational manufacturers are moving back to home, as building factories offshore becomes less and less attractive.  Might the same thing happen in the UK?

Falling transport and communication costs over the last 40-50 years have presented businesses with a dilemma.  Why not produce items in the lowest cost location and ship them to market?  For years, in practical terms this has meant locating factories outside high cost Europe, America and Japan and shifting them to low wage destinations – which has usually meant South and East Asia.  But according to the article, the economics of globalisation are changing fast.  When American firms are looking to build factories to serve American customers, the advice is increasingly likely to suggest that they stay at home.

What about those low wages abroad?  As emerging economies boom, wages there are rising. Pay for factory workers in China, for example, soared by 69% between 2005 and 2010. So the gains from lower pay overseas are starting to shrink, in some cases to the point of irrelevance, according to a new study by the Boston Consulting Group.  “Sometime around 2015, manufacturers will be indifferent between locating in America or China for production for consumption in America,” says BCG.

The year 2015 is not far off. Factories take time to build, and can carry on operating for years. So firms planning today for production tomorrow are increasingly looking close to home. There is a long list of US companies moving home – but it isn’t a stampede.  At the moment it’s perhaps more a case of not creating many new jobs overseas, but keeping jobs that might otherwise have been exported.

A lot of this is closely related to the economics of exchange rates.  It isn‘t surprising that big falls in the value of the £ and $ in recent years have made both British and American firms more inclined to find that home production is cheaper, and operating abroad is relatively more expensive.

However, a growing number of rich country multinationals are starting to see the benefits of keeping more of their operations close to home. For many products, labour is a small and diminishing fraction of total costs. And long, complex supply chains turn out to be riskier than many firms realised. When oil prices soar, transport grows dearer. When an earthquake hits Japan, supply chains are disrupted. Firms are trying to shorten supply chains and reduce their stock holding costs. Importing from China to the United States or Europe may require a company to hold 100 days of stock. That burden can be handily reduced if the goods are made nearer home.

But even if wages in China explode upwards, many UK and US firms will find it hard to bring many jobs home because they no longer have the necessary supplier base or infrastructure. That’s a bit of a worry for government. Firms did not realise when they shifted operations to low-wage countries that some moves would be almost irreversible. And many multinationals will continue to build most of their new factories in emerging markets, not to export stuff back home but because that is where demand is growing fastest.

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