Reindustrialization in USA - Euler Hermes

no. 1187Special ReportThe Reindustrializationof the United StatesEuler Hermes Economic Research DepartmentEconomic Outlookwww.eulerhermes.com | no. 1187

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesContentsn° 1187Special ReportThe Reindustrialization of the United StatesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEditorialpage 3page 4 u Overview – Like a phoenix rising from the ashes page 4page 6 u It’s the (macro)economy stupid! page 6• Falling over the ‘fiscal cliff’: why the short-term outlook is worrying page 7• Which favorable market conditions support a full-fledged U.S. recovery? page 8• Another positive sign for the industrial fabric: insolvencies on the decrease page 9page 10 u Manufacturing: the cornerstone of the reindustrialization of the U.S. page 10• 2000-2010: important but losing momentum and restructuring massively page 11• Over-performing in the aftermath of the crisis to regain higher ground page 13• The guest stars of reindustrialization page 14page 16 u Reason #1: Lower labor costs page 16• Competitiveness: Advantage U.S.A. page 16• A new era of manufacturing: “on-shoring” page 17• Focus on… the Southern draw page 18page 21 u Reason #2: The gas bonanza page 21• The (positive) double price effect in the short-run page 21• Chemicals and primary metals industries to benefit most from the low energy costs page 24• Focus on... Texas, the power plant page 25Economic Outlookseriespage 36page 28 u Reason #3: The commitment to a conducive business climate page 28• Objective: Innovation page 29• Cash hoard instinct: debunking the myth page 31• Focus on... California, the innovation incubator page 32Euler Hermes Economic outlook is issued ten times a year by the Economic research department of Euler Hermes. It is also available on subscription for other businessesand organisations. Reproduction is authorised, so long as mention of source is made. © Publication Director and Chief Economist: Ludovic Subran • MacroeconomicResearch: Maxime Lemerle (Manager), Mahamoud Islam (Economist), Ana Boata (Economist), Romeo Grill (Economist Germany), Dan North (Economist USA), ClémentBouillet (Intern) • Sector Research: Yann Lacroix (Manager), Bruno Goutard, Marc Livinec, Didier Moizo (Sector Economists) • Country Risk Research: David Atkinson(Manager), Andrew Atkinson, Manfred Stamer (Economists) • Graphic Design: Claire Mabille • Editors: Martine Benhadj • Support: Jaclyn Schneider, Alix McCabe • Forfurther information, contact: the Economic Research Department of Euler Hermes at 1, place des Saisons 92‐048 Paris La Défense Cedex – Tel.: +33 (0) 1‐84‐11‐53‐77 u EulerHermes is a limited company with a Directoire and Supervisory Board, with a capital of 14,451,032.64‐euros, RCS Paris B 388‐236‐853 • Photoengraving: Evreux Compo,Evreux, France – Permit november‐2012—Bull 1176; ISSN 1‐162 – 2‐881 © 25 January 20132

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler HermesEditorialAn alignment of the stars?With the post-presidential election fever now gone, the immediate shift of theU.S. focus is squarely on the economy. Surely, the road to recovery looks likethe Labors of Hercules. Of course no economic environment will ever be perfect, butthe current uncertainty surrounding the fiscal situation and the ongoing debt crisis inEurope are the two largest headwinds currently affecting the U.S. economy. Beyond thetumult in the short run, there are some positive macro- and micro-economic factorsthat have caused us to look more thoroughly to what the ‘new normal’ could look like forthe U.S. Here begins a quest to better understand what underlying trends and dramaticregime changes may support a robust long-term growth in the U.S.The potential key to America’s long-term growth lies in the very heart of the country, itsmanufacturing sector. Bullied throughout the last decade, its resilience and malleability,further tested by the most too recent crisis, may actually demonstrate why it nowappears to be the backbone of the U.S. recovery. There are several determinants to thisbold assumption which we analyze in this report:• unit labor costs are among the lowest in the industrialized world;• energy costs are low thanks to the gas bonanza;• the cost of capital is very low given the Fed’s ultra-accommodativemonetary policy;• the weak dollar makes U.S. exports very competitive in the majority of U.S.export markets; and• the housing market is slowly rebounding.If you add to this a conducive policy environment and the definite commitment tocontinue to improve it, there are better days ahead for the U.S. and its private sector.After the perfect storm (the commodity, financial and jobs crises), now would be thetime for an alignment of the stars. Manufacturing could lead the U.S. economy out ofimmobilism, and is poised to be a major contributor going forward.What needs to be done to maintain the momentum? The private sector in the U.S.continues to be relatively self-reinventing without much intervention. But like a goodgardener, the government may want to occasionally water the flowers. In this report,we outline several actions necessary to catalyze this rebirth.Of course, we will continue to monitor this reindustrialization phenomenon andaccompany our clients on the still bumpy road ahead. It is all about good ‘ol production,key industries such as the energy and chemicals sector and the agri-food businesses,and growth markets: the South, Texas, and California. If supported, the real economyshould indeed regain its strength. _ Ludovic Subran3

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesOverviewLike a PhoenixRising from the AshesA turning point?Ever since the Industrial Revolution began in the1800s, the U.S. manufacturing sector has alwaysbeen of vital economic importance. It has often beenthe engine of growth, historically providing strongcontributions to Gross Domestic Product (GDP).During the nineteenth and twentieth centuries economicindustrial concentrations developed across theU.S. In the South, proximity to cotton growers helpedbuild the textile industry. From the Northeast to thecentral Midwest, steel and iron products emergedand as a result the automobile industry arose in theMidwest. In the Southwest, an abundance of oil andnatural gas shaped the energy industry. And in theWest, high technology emerged during and afterWWII as a product of the defense industry.However this robust manufacturing economy cameunder intense pressures in the latter half of thetwentieth century from the development of theglobal economy. Countries such as Japan, Mexicoand China emerged with enormous supplies of peoplewho were willing to work for a fraction of U.S.wages, while concurrently, American consumersdeveloped a thirst for inexpensive goods from overseas.American businesses could not resist the lure ofmuch lower manufacturing costs available in thesecountries and began to send U.S jobs overseas, decimatingmany industries such as appliances, furniture,heavy equipment, shipbuilding, steel, textiles, andmany others. As a result of this shift, the U.S. manufacturingindustry shrank drastically as a percentage4

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler Hermesof the entire economy and millions of manufacturingjobs were lost.But this trend is now on the cusp of reversal for severalreasons. U.S. manufacturing productivity hasgrown at a relatively high rate compared to otherindustrialized nations, making U.S. unit labor coststhe lowest in the industrialized world. Highly skilledAmerican workers can more reliably produce highervalue-added goods. Costs such as transportation,inventory and lag time are lower while tax incentivesand cheap energy make manufacturing in the U.S.even more attractive.As a result, U.S. manufacturing is enjoying a renaissanceand recently led the country out of the mostsevere recession since the Great Depression, contributingmuch more to GDP growth than one wouldexpect given its weight in the economy. In fact, afterthe recession, the only job growth outside the servicessector was in manufacturing. Of course theoutlook is brighter for some industries and regionsthan it is for others, but the business environmentsuggests that conditions going forward will continueto be favorable, even in a world of uncertainty.Short-lived effect or durable trends?Beyond positive macroeconomic factors such ascredit availability and low interest rates, the threedeterminants of this reindustrialization are:• lower labor costs, especially in the southernstates;• lower cost of energy resulting from the shalegas bonanza; and• the ability to steer the economic environmentto leverage the positive cost reductions fromwhich companies have been benefitting.Another factor is the new awareness of operatingvulnerability created by an over-stretched supplychain. In 2011, the localized production disruptionsin Japan following an earthquake and a tsunami, andin Thailand from flooding, disrupted industrial operationsall around the world. The incidents highlightedhow dangerous exposure to foreign supply chainscould be and how a lack of preparedness for theserisks causes difficulty in implementing risk managementprotocols for what were previously thought tobe unthinkable events.Going forward, and when examining specific U.S.industry dynamics, it seems important to selectivelysupport:• The “shining” industries mentioned above, inorder to identify more specifically the growingsubsectors (agriculture, construction/mining,machinery, medical equipment, petroleum-relatedproducts, semiconductor-related products)and examine their dynamics. The automotive sectoralso seems to be reviving from its ashes;• A conducive business climate with a clear emphasison innovation. The new era in the businessenvironment (tightening gap between Chineseand American wages, appreciation of the yuan,access to cheap energy in the U.S., structural highoil prices, mounting awareness of the vulnerabilitycaused by an over-stretched supply chain) couldhelp U.S. manufacturing sustain this momentum.U.S. computer/electronic product manufacturing,machinery, furniture and miscellaneous productmanufacturing are expected to take advantageof the falling Chinese wage competitiveness.Chemicals and primary metal sectors should gainground thanks to cheap shale gas; and• Regional strengths make the efficient specializationof the individual states feasible. The dynamicsin the South, Texas, and California - particularlywith niche sectors, incentives, and opportunities- are particularly important as they appear to bethe renewed growth centers of the U.S.This degree of industrial investment demands thatthe U.S. economy present sound, reliable growthprospects and that the financial system (banks andbond markets) support these capital intensive projects.It also requires a confidence injection for theprivate sector to continue to re-shore and invest inthe economy. Finally, the path to industrial rebirth willrequire a highly skilled workforce. ©5

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesIt is the (macro)economy, stupid!With the deceleration of the global economyand prolonged limbo of the euro zone, the U.S.economy appears to be particularly central toglobal recovery. However, domestically, severalsteps need to be taken to limit the damage of thefiscal situation, curb unemployment figures, andbenefit fully from the aggressive monetary policystance chosen by the Fed. It will also be necessary tocontinue to unleash growth drivers: consumption,private sector investments, and exports to offset thegradual withdrawal of the post-crisis governmentspending, without causing damage. Is this feasible?We argue that there are some green shoots whichcould lead to a favorable macroeconomic backdrop,against which what we call the “Reindustrializationof the U.S.” is possible.A. Macroeconomic Forecasts for the U.S.U.S.A. share 2011 2012 2013 2014GDP 100% 1.8 2.2 1.9 2.5Consumer Spending 71% 2.5 2.0 2.2 2.6Public Spending 19% -3.1 -1.9 -1.4 -1.3Investment 13% 6.6 7.8 3.9 7.2Construction 2% -1.4 11.6 9.5 10,3Equipment 10% 8.6 6.9 2.4 6.5Stocks* 0% -0.2 0.1 0.1 0,0Exports 13% 6.7 3.6 4.3 6.5Imports 16% 4.8 2.8 3.5 6.5Net exports * ‐3% 0.1 0.0 -0.0 -0.2Current account ** ‐466 -508 -495 -477Current account (% of GDP) -3.1 -3.2 -3.0 -2.8Employment 0.6 1.7 1.1 1.5Unemployment rate 8.9 8.1 7.7 7.1Wages 2.0 1.5 1.9 2.2Inflation 3.3 2.2 2.0 2.1General government balance ** -1250 -1129 -1039 -981General government balance (% of GDP) -8.3 -7.2 -6.4 -5.8Public debt (% of GDP) 101.0 104.8 108.1 110.1Nominal GDP ** 15 076 15 684 16 230 16 909Change over the period, unless otherwise indicated: * contribution to GDP growth ** U.S.D billionsSource : IHS Global Insight, Euler Hermes6

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler HermesFalling over the ‘fiscal cliff’:why the short-term outlook is worryingThe U.S. economy still faces significantheadwinds resulting in expectationsof sub-par GDP growth and elevatedunemployment for 2013. The FederalReserve has started another roundof quantitative easing (QE3) to helpstimulate the housing market and thebroader economy. However, QE3 islikely to have a very limited effect anduncertainty surrounding the fiscalsituation is likely to contribute to theweakness.u Recent DevelopmentsThe U.S. economy lost 9 million jobs in the recessionand as of August 2012, more than three years since therecession ended, it has only recovered about half thatamount. The unemployment rate, despite a recentdecline, has remained above 8% for three and one halfyears and the labor participation rate is the lowest ithas been in 30 years. GDP has been correspondinglyweak, growing only 2.1% over the past four quarters.Manufacturing, which helped lead the economy outof recession, has been stumbling for several months,and while consumers have enjoyed some recentgains in income, consumption still remains weak.Positives have included surprisingly strong auto sales,a firming housing market, and falling insolvencies.u Mixed perspectives for 2013Looming events will make for yet another year ofsub-par GDP growth in 2013 - around 2% - withunemployment most likely remaining near 8%. Theuncertainty of the fiscal situation at the beginning of2013 is weighing on the economy. Even if a plan isdevised to reduce the country’s debt, it will probablynot have much effect until the middle of 2013 at theearliest. Fiscal Contraction could push the economyinto recession. However, the most likely scenario isthat most of the fiscal contraction will be avoided sinceboth Republicans and Democrats believe that such arapid fiscal withdrawal would be politically dangerousand a serious blow to the economy. Yet uncertaintyremains as the fiscal situation issues may not beaddressed entirely by the new session of Congress.On the monetary side, while QE3 is intended to boostthe housing sector by lowering mortgage rates, theplan is unlikely to help much since mortgage ratesare already near historical lows. Risk-averse bankershave slowed the mortgage market, not high interestrates. Nonetheless, there has been some firming inseveral housing market measures such as prices andunit sales, but it is premature to call a bottom. On anupbeat note, insolvencies are expected to fall 8% in2013 due to positive, albeit weak GDP growth.• • •Estimating the impact of the fiscal situationu What: A combination of higher taxes and reducedspending at the start of 2013.u How much: Fiscal tightening would amount to a good4% of GDP in 2013 (5% of GDP, if changes in revenues andspending unlinked to specific policies are included). Ifthe automatic spending cuts (across-the-board spendingcuts) under the Budget Control Act are avoided,fiscal tightening would be reduced to between 1.8% ofGDP and 2.7% of GDP, respectively. Applying an overallfiscal multiplier of 0.75, the drag on GDP growth wouldamount to between 1.4% and 2%, respectively.u To put 2013 fiscal tightening into perspective: Generalgovernment net borrowing amounted to 8.7% of GDP inH1 2012, down from 10.25% of GDP in 2011.7

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United States• • •Which favorable market conditions support a full-fledged U.S. recovery?The favorable economic environment in the short-runfor private sector development is a product of distinctlyunfavorable conditions which actually started well beforethe Great Recession. Accommodating monetarypolicy, credit availability, lower cost of capital and the(timid) rebound in the housing market are some ofthe major positive contributors to this.In the late ‘90s and early 2000s, the Federal Reservekept monetary policy too loose for too long. When thehousing bubble burst in 2006, it destroyed billions ofdollars of wealth and wreaked havoc on the economy.As a result, the subprime mortgage crisis developedin 2007, impairing the financial markets. In 2008oil prices rose to a record high creating yet anotherhuge drag on the economy. As the financial crisisreached its height in the Fall of 2008, credit marketscame to a virtual standstill, paralyzing the economy.To counteract the chaos, the Federal Reserve droveshort-term interest rates virtually down to 0%, andthen injected $1.4 trillion of liquidity into the financialsystem, more than doubling its balance sheet in justa few weeks. Congress and the President passed the$700 billion Troubled Asset Relief Program (TARP) tokeep impaired banks functioning, and in early 2009,an $800 billion stimulus package was passed in anattempt to jump-start the economy. By this time theeconomy was losing over 700,000 jobs per month, thefastest rate in over 60 years (Figure 1). Although therecession technically ended in June of 2009, only abouthalf of the total jobs lost have been recovered, and GDPhas averaged a mere 2.2% annualized growth ratesince then, well below the long-term average of 3.3%..Yet this chaotic backdrop helped set the stage for aneconomic recovery, which although tepid, was idealfor a manufacturing rebound. The deep recessionhad caused manufacturers to cut employment to thebone, so after the recovery began they were able tooperate with minimal labor costs using highly productive,motivated workers. Unit labor costs plungedin the manufacturing industry, particularly in somesouthern states. At the same time that labor costs werefalling, so were the costs of capital. The Fed had drivenshort-term rates virtually to zero, which was an openinvitation for investment. Starting in the fourth quarterof 2009, the investment component of GDP set a blisteringpace over four quarters, growing at annualizedrates of 41%, 20%, 15% and 16% respectively - whilethe economy as a whole grew less than 3%. Creditconditions eased substantially and commercial andindustrial loans have grown more than 10% annuallysince the Fall of 2010 versus a long-term average of6% (Figure 2).In addition, high credit quality manufacturers are alsoable to tap the corporate bond market at historicallylow rates. The Fed’s QE programs further lowered thecost of capital by boosting stock prices. Energy costsfor manufacturers have also fallen, due in part to theemergence of very cheap shale gas. The housingmarket is now firming (Figure 3), setting the stagefor a rebound in manufacturers of home buildingmaterials and appliances.Approximately three quarters of U.S. manufacturing issold domestically, where conditions are very good, yetthe export markets are also in surprisingly good condition.Canada is the largest market for U.S. exports, consumingapproximately 19% of all U.S. exports. WhileCanadian GDP has experienced slow growth recentlyand is expected to grow only about 2% in 2013, theCanadian economy is in much better fiscal and monetarycondition than most industrialized nations, and1. Jobs Created and the Unemployment Rate2. Commercial and Industrial Loansquaterly annualized % change3. US Housing MarketFundamental Measures, Seasonally Adjusted Annualized Rates9005000600400Non farm payroll jobscreated (000’s) (left scale)1098508004800460020075044000870042004000-20076503800-400Unemploymentrate (right scale)66003600-6005503400-80055003200-10002002 2003 2004 2005 2006Source: Bureau of Labor Statistics2007200820092010201142012Source: Federal Reserve45020082009Permits (left scale)Starts(left scale)20102011Existing 1-FamilyHome sales ( right scale)Source: National Association of Realtors, Census300020128

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler Hermestherefore offers some stability to U.S. exports. Mexicois the next largest importer of U.S. goods, consumingabout 14% of all U.S. exports. Unlike much of the worldsince the recession ended in 2009 Mexico has enjoyedsteady and strong growth, with robust annual GDPgrowth of 4.6% versus a long-term average of 2.7%,clearly boding well for future U.S. exports. Centraland South America absorb 11% of U.S. exports, andprospects for continued strength in these emergingeconomies are good. China absorbs 7% of U.S. exports,and the long-term growth of the Chinese economy isexpected to remain very strong, despite a recent softpatch. Asia (ex-China and ex-Japan) consumes 13%of exports and like Latin America, growth in theseemerging economies is likely to be robust. Togetherthese major, strong markets buy 64% of U.S. exports.Europe is of course a weak spot and may be for sometime, but exports to the European Monetary Unioncomprise only 13% of total U.S. exports. Furthermore,the Fed’s quantitative easing policies have devaluedthe dollar, making export prices cheaper and boostingtheir competitiveness. Between the end of 2009 andAugust 2012, exports from the U.S. have risen 45%,a 15% annualized rate compared to the long-termaverage of 7.8%. ©Another positive sign for theindustrial fabric: insolvencieson the decreaseAs shown in Figures 4 and 5, business insolvencieshave overall been on a slightly downward trend overthe past decade. Insolvencies rose as the economydeteriorated through 2007, and increased furtherin 2008. Insolvencies often are a leading indicator,as they were when they fell sharply in 2009 as therecession came to an end. By that time, most of thevulnerable businesses had already failed, and thosethat survived had done so by:• reducing debt on their balance sheets,• becoming more risk-averse by not extending asmuch risky credit to other businesses, and• by reducing headcount.These factors allowed businesses to survive eventhough they put a weight on the economy which hasyet to be fully removed.4. Bankruptciesin millions300002500020000150001000050000198119831985198719891991Sources: Administrative Office of the U.S. Court, Euler Hermes1993199519971999200120032005Bankruptcies2007200920112013Looking at 2013, expectations are that the downwardtrend in insolvencies will continue. We expectthe decrease in insolvencies to be 10% in 2012 and6% in 2013. This will happen for two reasons: first,GDP growth in 2013 is forecast to be around 2%. Thisshould suffice to help decrease the number of insolvenciesin the economy. Secondly, businesses are stilloperating in the risk-averse manner which helpedthem survive the recession. They are carrying lowerdebt levels on their balance sheets, providing themmore of a cushion should there be another downturn.And they are still running in a very lean modeby keeping operational costs and payrolls as tight aspossible.5. Insolvencies to Decrease in the Manufacturing Sectorannual change, in %2.01.81.61.41.21.00.80.60.4Manufacturing tends to be more sensitive to thebusiness cycle as Figure 5 clearly shows, and as suchtends to be riskier as well. Manufacturing insolvenciesrose more sharply than the total economy in therecession and fell more sharply in the recovery, andwere higher than the total throughout virtually all ofthis time period. However, it is important to note thatafter the recent recession, manufacturing insolvenciesclosed the gap with the total economy becauseof the sector’s outperformance.0.20.02003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013Total Manufacturing ServicesSource: Euler HermesThe services sector is less sensitive to the businesscycle, as demonstrated by how much less insolvenciesfluctuated. Since it is less risky it also has an insolvencyrate lower than the total economy. ©9

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesManufacturing:the cornerstone of the reindustrialization of the U.S.For many years and even decades, the U.S.manufacturing sector has become synonymouswith economic decline, heavy job cuts, darkDickensian facilities and a hopeless outlookin collective minds. The three year-longmanufacturing revival marks an opportunity toreview these entrenched stereotypes. The lastdecade has reshaped the U.S. industrial landscapeand provided the foundations for this improvement,but since 2010 a handful of buoyant sectors haveaccomplished what had been inconceivable formany years: restoring faith in U.S. manufacturing.6. Manufacturing Employment Depending on ProductivityJobs (thousands)2000015000100002000 01Manufacturing employmentManufacturing employment - Productivity 2000Manufacturing employment - Output 2000020304Source: Bureau of Economic Analysis – Bureau of Labor Statistics05060708091010

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler Hermes2000-2010:momentum lost followed by massive restructuringu Limited role in the U.S. economy?During the previous decade, the manufacturingweight in the U.S. economy remained fairly steady,at 12.4% (real value added) of GDP in 2000 and 2010,with limited fluctuations over the period (high of 12.9%in 2007 / low of 11.5% in 2009). The growth yearswitnessed noticeable contributions from the manufacturingsector to the improvement of the economy- a bit higher than would have been expected given itsweight in the U.S. economy - but they were always lessthan the contributions from the services sector. Conversely,the significant drops in manufacturing value-add,which occurred during the recessions, werea significant drag on the U.S. economy and, generallyspeaking, were major downward economic drivers.u Sharp restructuring in manufacturingemploymentBetween 2000 and 2010, the manufacturing sectorlost 5.7 million jobs (-33%). In Figure 6, we comparethe actual employment in manufacturing from 2000-2010 and two scenarios estimated:• the Productivity 2000 scenario shows the numberof jobs needed to produce the actual outputwith productivity held constant;• the Output 2000 scenario shows the number ofjobs it would have taken to create that outputwith the actual productivity gains. This scenariomore closely matches what actually happened,suggesting that any drop in output during arecession had a smaller effect on employment.The analysis shows that manufacturers did not layoff workers because the economy was so bad, butbecause productivity was so good that they neededfewer workers. The main driver for manufacturingjob losses during the last decade was certainly productivitygains. The output decrease resulting fromthe recession, shipping jobs overseas, and the lowercompetitiveness of U.S. manufacturing in the globaleconomy contributed much less to the decline injobs. The impact of productivity improvement onjob losses was more than three times as high as theimpact of economic contraction.u Different goods, different stories?We carried out the same analysis for durable goodsmanufacturing, which posted a -35% decrease inemployment during the last decade – or 3.8 millionjobs. The impact on employment that productivityimprovements had, compared to the impact that therecession had, was only about two and a half timesgreater, as opposed to three times greater for allmanufacturing. The difference suggests that durablegoods manufacturing was more sensitive to economicconditions than overall manufacturing. Durablegoods meant to last three years or more - such asappliances, cars and planes - represent discretionarypurchases which can be more easily delayed thanthose for non-durables such as food.The computer and electronic manufacturing sectorwitnessed a sharper drop in employment (-40% orloss of 735,000 jobs). The dramatic decline in jobswas a result of the adverse effects of strong productivityimprovements (+79% over the period), whichwere only partially offset by jobs created due toincreasing activity.Between 2000 and 2010, the machinery sectordemonstrated better resistance to erosion as itsemployment dropped by a relatively smaller -32%(-467,000 jobs). Lower productivity enhancement(+27% during the decade) led to a lower adverseimpact on job losses.In 2010, non-durable goods manufacturing jobsdropped -30% from 2000 (-1.9 million jobs). Theimpact of productivity improvements was four timesas large as the impact of activity fluctuations duringthe last decade.• • •11

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United States• • •u Further sector concentration of the U.S.manufacturing landscapeFigure 7 shows industries plotted on the horizontalaxis of growth in value added, versus the verticalaxis of growth in total output, over the time period2000-2010. The strongest industries are seen in theupper right quadrant, with the computer and electronicsindustry the clear standout with real valueadded, growing +417% since 2000. The petroleumand coal industry was also a strong performer withother attractive industries including food and chemicals.In general, durable goods manufacturing, suchas machinery and “other transportation” (excludingautomotive), along with “miscellaneous others”performed quite well. The weaker industries are inthe lower left quadrant and are dominated by lowervalue-added, mature businesses such as apparel, furniture,textiles, and wood.Table B summarizes the most buoyant sectors for theperiod 2000-2010. A gap has widened between themand the lackluster group leading to a stronger concentrationin U.S. manufacturing. The contributionof the top five sectors to U.S. manufacturing valueadded has risen from 51% in 2000 to 59% in 2010.u Further sector concentration of the U.S.manufacturing landscapeU.S. manufacturing has expanded along with the worldmarket in terms of total sales, but has steadily lost marketshare of sales, contracting from 22% in 2000 to 17% in2011(estimated). On the other hand, U.S. manufacturinghas managed to preserve its position in global valueadded, with a market share sliding only slightly from 23%to 22% over the same period, increasing slightly in 2012.The data suggests two possible explanations. First, itcould be that U.S. manufacturing has shifted towardhigher value added activities and has deserted thosemanufacturing sub-industries with lower value added.This possibility corresponds with the notion that it hasproven difficult for the U.S. to compete with low laborcost countries. For example, simple goods can be madein China much more cheaply than in the U.S., driving U.S.manufacturers out of those markets. The huge influx ofsimple, cheap Chinese goods is a perfect example of thisphenomenon. Labor and capital displaced by lower costgoods will then be moved to higher value-added manufacturing.This condition is a perfect demonstrationof the uncomfortable notion of “creative destruction”which is often very necessary for an economy to growin the long run but which is so painful in the short run.In this case the data may actually indicate a positive phenomenon.A second explanation arises from the fact that the differencebetween sales and value added can be thoughtof conceptually as a proxy for profit margin. Thus, thedata might suggest that American manufacturers aretaking smaller profit margins in a global environmentof slow growth and low inflation creating very strongdownward pricing pressures. This second explanationdoes not indicate a flaw in U.S. manufacturing, sincemanufacturers around the world have to contend withthe same conditions.7. Production and Value Added Index Changes 2010/2000 (Real Terms)Output changes in %Source: Bureau of Economic Analysis – Bureau of Labor Statistics12B. Breakdown of the Manufacturing Value Added by SectorRanking Ranking Sector Weight manufacturing2010 2000 value added in 20101 1 Computer and electronic product mfg 15.6%2 3 Chemical mfg 13.3%3 2 Food, beverage and tobacco product mfg 12.2%4 12 Petroleum and coal product mfg 10.1%5 6 Machinery mfg 8.2%6 4 Fabricated metal product mfg 7.1%7 10 Miscellaneous mfg 5.2%8 7 Other transportation equipment mfg 4.2%9 7 Plastics and rubber products mfg 3.9%10 9 Paper mfg 3.3%11 5 Motor vehicle, body, trailer, and parts mfg 3.2%12 12 Electrical equipment, appliance and component mfg 2.6%13 11 Primary metal mfg 2.5%14 14 Non metallic mineral product mfg 2.1%15 15 Printing and related support activities 1.9%16 16 Furniture and related product mfg 1.7%17 17 Wood product mfg 1.3%18 17 Textile mills and textile product mills 0.9%19 19 Apparel and leather and allied product mfg 0.7%Source: Bureau of Economic Analysis

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler HermesOver-performing in the aftermath of the crisis to regainhigher groundu Manufacturing rebound in the aftermath of thecrisisBy the end of 2011, U.S. GDP had recovered to levelsjust before the recession started in the fourthquarter of 2007. This recovery has been boosted bya substantial contribution from the manufacturingsector. As demonstrated in Table C, in 2010, manufacturingwas only 12.4% of the economy, yet itaccounted for 44.6% of its growth. In 2011, thosesame proportions were 12.8% and 37.2%. From thisperspective, manufacturing indeed led the economyout of the severe recession of 2008 and 2009.Furthermore, as shown in Figure 8, the only sectorto provide slightly more growth in 2010 and 2011was the entire services sector, which is six to seventimes larger than the manufacturing sector.ing the recession and how rapidly it has reboundedsince. Manufacturing has dramatically outpaced servicesfor the last two years and has fully demonstratedits role as the engine of the economic recovery. Theonly sector to fall more steeply than manufacturingwas construction, which plummeted as a result of theburst housing bubble, and has still yet to fully recover.In the wake of the decline caused by the economiccrisis, the manufacturing sector has been a modestcontributor to the improvement of the employmentscenario. However, this tepid increase of manufacturingemployment also signaled the end of a continueddecline which has been ongoing for decades.• • •Figure 9 demonstrates that since 2001 the U.S. manufacturingsector has shown higher sensitivity to theeconomic environment than the services sector has.It displays the annual increase in value added by sector,highlighting how much manufacturing fell dur‐C. Contribution of the Manufacturing Sector to US Economic Growth2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011Part in U.S. GDP (in %) 11.7% 11.8% 11.9% 12.4% 12.5% 12.7% 12.9% 12.2% 11.5% 12.4% 12.8%Manufacturing partin economic growth (43,2%) 17.1% 17.4% 30.8% 15.5% 19.7% 25.9% (108,3%) (28,8%) 44.6% 37.2%GDP in real value; ( ): negativeSource: Bureau of Economic Analysis8. Contribution to U.S. GDP Changes by Sector4%3%2%1%0%-1%9. Annual Change in Real Value Added12%9%6%3%0%-3%-2%Service-6%-3%-4%-5%2001MiningConstructionManufacturingAgriculture2002 2003 2004 2005200620072008200920102011-9%-12%-15%2001ManufacturingServicesConstruction2002 2003 2004 2005200620072008200920102011Source: Bureau of Economic AnalysisSource: Bureau of Economic Analysis13

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United States• • •u Broad improvement of the manufacturingsectorAs shown in Figure 10, while manufacturing productionis still 4.5% below its 2007 peak, it steadilyrebounded during 2010 and 2011, and continuedto grow in the first half 2012. Manufacturing productivityhas dramatically improved over the lastdecade (+45% in the first half of 2012 comparedto 2000) despite slowing somewhat during therecession. This improvement in productivity is aresult of a 6% increase in output from 2000 to2012, while the workforce shrunk by more than30% over the same period. U.S. manufacturingoperating profitability bounced back dramaticallyin 2010/2011, and has so far stabilized at thehighest level in a decade despite previous periodsof more robust economic growth. Unit laborcosts in manufacturing have fallen below their2000 level, with much of the downturn comingafter the recession. Manufacturing employmentbottomed out in 2010 and has started to slowlyregain ground after two decades of deterioration.Exports of manufactured goods have jumped formuch of the last decade and displayed recordgrowth in 2010 into 2011. ©10. Manufacturing ProductionIndex basis 100 =‐2000200150ExportsProductivityOperating profitabilityProductionUnit labor costEmploymentThe guest stars of reindustrializationu The “shining” manufacturing sectors during the2010/2011 rebound and afterwardU.S. manufacturing has continued along the pathbegun in the previous decade and the aforementionedleading sectors have played a crucial role inthe dramatic 2010 and 2011 growth. Let’s considermore precisely the underlying factors which contributedto these improvements amid the most buoyantsectors.u Computer and electronic productsmanufacturingThis sector has retained its leadership and evenstrengthened its weight within the U.S. manufacturingsector during the last decade. For the last threeyears, two segments have especially outperformed,demonstrated by current outputs higher than theirpre-recession levels:• Semiconductor and other electronic equipmentmanufacturing has proven to be a powerful engineof growth as its output skyrocketed more than fourfoldbetween 2000 and 2012. For the last five years(except for 2009), the sharp expansion of newmarkets fuelled by the emergence of electronicdevices, such as smartphones, tablets and e-readers,has continued to drive production (+32.7% and+12.0% in 2010 and 2011 respectively). Nevertheless,2012 saw a slowdown caused by less favorablesector and economic environments.• Navigational, measuring, electro medical andcontrol instruments manufacturing also helpedthe sector expand during the last decade andrebound in the wake of the crisis. While shrinkingin 2009, the segment posted 6.5% and nearly 11%growth in 2010 and 2011 respectively. Boosted byits markets (aerospace, automotive, machinery,semiconductor manufacturing), 2012 also saw afairly robust increase for this subsector.100502000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012Sources: Bureau of Economic Analysis – Federal Reserve Bank – Bureau of Labor StatisticsAnother notable segment, computer and peripheralequipment production hit a landmark in 2008,punctuating a six year increase with an all-time high.But since then, lackluster PC and notebook salescontracted, with the first half of 2012 experiencing aslower rate of decline.14

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler HermesA final segment of note, communication equipmentproduction has been lagging far below its 2007 leveldespite a rebound in 2010.The 2012 output increase is expected to slow dramatically(estimated at +3.5%) because the two maingrowth drivers appear to have paused in their ascent.2013 will follow this downward trend (+1.5%).u MachineryThis sector contributed strongly to U.S. manufacturingoutput expansion with double digit growthin 2010 and in 2011. It is also expected to regain itspre-recession average annual production. All the subsectorshave posted significant production increasesduring this period following a rebound in investmentin the aftermath of the crisis. Two sub-sectors havebeen significant growth drivers and showed higherlevels of production in 2012 than in 2007/2008:• Mining, oil field and gas field machinery (output:+2.6%in 2010 and +21.3% in 2011 and+14.9% (estimated) in 2012). This segment hasthrived in the wake of the surges in oil industryextraction capacity and that of the shale gasindustry in the U.S., driven by the development ofnew technologies.• Engine, turbine and power transmission equipment(output: +9.7% in 2010 and +22.6% in 2011and +18.5% (estimated) in 2012). The noticeabledevelopment of the renewable energy sector hasfostered growth in this segment.The construction and metalworking machinery sectorsalso have fared reasonably well in 2012. Theunderlying conditions which stimulated machinerysector growth over the recent years - including11. Industrial Production Index:the “shining” manufacturing sectorsIndex basis 100 =‐2007among others, booming investments in fossil andrenewable energy, strong global economics favorableto U.S. exports - are likely to fade in 2013 withthe current fiscal/budget uncertainty weighing itsprospects down dramatically. The expectation is thatthe output growth of the machinery sector should berather limited (+3%).u Petroleum and coal product manufacturingThis sector has reclaimed its pre-recession benchmarkdue to momentum posted by the “paving, roofingand other petroleum and coal products” sector,which increased its production by 8.6%, 15.1% and13.1% (estimated) in 2010, 2011 and 2012 respectively.This momentum was due in large part to thefederal stimulus package aimed at boosting the U.S.economy and included $36.2 billion for transportation(highway infrastructure, high-speed rail corridors)and $30.0 billion for infrastructure. In 2013, thepetroleum and coal product manufacturing sectorwon’t be able to rely on such public support and islikely to suffer from this less favorable environment.u What about the car industry?Despite uneven global economic performance,including weakness in Europe, many global automakershave reported rising sales and profitability,driven by growth in emerging markets and China inparticular. In the U.S., auto sales posted a second yearof growth due to easier credit, low interest rates, andpent-up demand resulting from the recent recessionand an aging vehicle fleet. North American auto suppliersare benefiting from rising automotive productionand leaner cost structures. Many are now moreprofitable than before the downturn. The outlook forboth the automotive manufacturers and suppliers ispositive, reflecting expectations for rising demand inthe U.S. In addition, emerging markets led by Chinashould drive global demand, despite slowing regionaleconomic growth and debt issues affecting Europeandemand. The U.S. automotive market is still strengthening:it grew an estimated 12% to 14.8 million vehiclesin 2012 and we expect it to grow 5% more to 15.5million vehicles in 2013. That will still be 1.5 millionvehicles short of the pre-crisis benchmark.©Source: Federal Reserve Bank15

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesReason #1Lower labor costsThe combination of high output, productivityand profitability, and low unit labor costs lays asolid foundation for continued strength in theU.S. manufacturing sector. This section analyzesthe positive contribution of falling labor coststo U.S. competitiveness. We argue that thiscontinuing trend will be a major determinant of thereindustrialization momentum. This performancerelative to China and Europe, for instance, must becultivated. However, a too conservative U.S. wagepolicy and low labor pricing could eventually capproductivity gains and human capital accumulation,especially for niche industries.Competitiveness: advantage U.S.A.u As shown in Figures 12 and 13 below, comparingU.S. trends regarding manufacturing productivityand unit labor cost with the other leading industrializedcountries underscores America’s enviable position.Indeed, U.S. manufacturing has dramaticallyreinforced its productivity over the last decade andcut its unit labor costs by more than 10% (on U.S.$basis). In contrast sharply with its global competitors,it should be noted that the falling U.S. dollar versusthe euro may have contributed to the difference.Additionally, from 2000-2010 manufacturing productivityin the U.S. has grown at an annual rate of5.2%, greater than most industrialized nations exceptfor the rapidly emerging economies of Taiwan, theCzech Republic, and South Korea. At the same time,the U.S. has been one of only two major countrieswhere manufacturing unit labor costs have actuallyfallen. While this is a significant competitive advantage,it arises from the fact that productivity hasgrown sharply while real wages have hardly changedat all.12. Manufacturing Labor ProductivityIndex basis 100 = 200213. Manufacturing Labor CostsIndex basis 100 = 200216Source: Bureau of Labor Statistics, Euler HermesSource: Bureau of Labor Statistics, Euler Hermes

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler HermesA new era of manufacturing: “on-shoring”The Chinese competitive edge in laborcosts has been so overwhelming that itoften eclipsed all other parameters in theeconomic and strategic equation. Therefreshed set of parameters of “Made inAmerica” (cheap energy, supply chain riskmanagement, etc.), are major advantagesto on-shoring. Other factors includequality, easier communication, faster timeto market and cheaper inventory costs.u While real American labor costs have barelychanged over the past decade, the dramatic increasein Chinese wages has resulted in a steady erosion ofthe gap between American and Chinese wages. Forthe previous two decades this gap had been a crucialincentive for U.S. manufacturers to relocate industrialfacilities to China. Although there is no doubtthat the Chinese competitive edge is likely to remainsignificant for a while, the recent years have markeda tipping point in the industrial relationship betweenthe two countries wherein the wage gap will shrinkenough to become less important.Figure 14 below points to a sharp increase in Chinesewages, fueled by buoyant economic growth despitethe determination to keep inflation low, resulting ina sharp closing of the wage gap. Combined with thedepreciation of the U.S. dollar versus the Chineseyuan, the supremacy of China as the best locationto manufacture is likely to be weakened in any case.The current and foreseeable global environment maypave the way toward the on-shoring of industrialcapacities in the U.S. We assume the on-shoring ofmanufacturing capacities will mainly affect produc‐tion currently based in China but aimed at the U.S.market. This trend does not imply that the U.S. companieswill automatically scale back their operationsin China.The sectors expected to be the most proactive inon-shoring in the short and medium term can becharacterized by two conditions:• high exposure to labor costs in their coststructure; and• the ability to absorb higher labor costs by havinga lower labor cost component of value-added.Table D and Figure 15 below summarize the first andsecond tier of sectors which would initially participateand contribute to on-shoring. The activity potentiallyaffected by on-shoring these industries from China tothe U.S. would be equal to the current exports to theU.S. from China in these two industries. This amountis estimated to be $282 billion annually. ©D. The Candidates for On-shoringTier 1: Four sectors representing 56% of the U.S.imports from ChinaComputer and electronic product manufacturingU.S. import from China (in 2011)MachineryFurnitureMiscellaneous product manufacturingTier 2: The ChallengersFabricated metal product manufacturingElectrical equipment and appliancePlastic and rubber productsNon-metallic mineral productsSource: Bureau of Economic Analysis, Euler Hermes$146bn$21bn$15bn$36bn$17bn$29bn$12bn$6bn14. Effective Manufacturing Wage Gap302520$7USChina15. Part of labor costs in total operating costs and part of the value consumed by thelabor costs for each manufacturing sector in 2011, in %0.70.60.50.40.31510$170.20.100 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 150200620072008200920102011assumptions:wages and yuan grow at historical rate 2006-19US worker 3.4X as productiveSource: Federal Reserve, Bureau of Labor Statistics, Ministry of Labor andSocial Security of China, Boston Consulting Group and Euler Hermes2012201320142015Wood product Non-metallic product Primary metalFabricated metal productMachineryComputer andElectrical equipment Motor vehicleelectronicOther transportationequipmentFurnitureMiscellaneousmanufacturingFood and beverageTextileApparel Paper PrintingPetroleum andcoal productChemical Plastics and rubber Linchpin (median)Source: Bureau of Economic Analysis, Euler Hermes17

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesFocus on… The Southern Drawu The Southern U.S. enjoys significantcompensation, productivity and unit labor costadvantages compared to the rest of the country.These advantages caused an influx of foreign automakersand are expected to continue. Additionally,exports are providing a boost to southern state economieswhile the expansion of the Panama Canal in2014 is likely to contribute to economic activity inthe region.The South has outperformed the U.S. in terms ofGDP growth in ten of the past twelve years (Figure16). And while the U.S., as a whole, had two negativeyears of growth in 2008 and 2009, the moreresilient South actually grew in 2008. More recently,the South grew more than twice as fast as the U.S. in2011, and expectations are that this outperformancewill continue.u Total compensation, which includes wages andbenefits, are lowest in the South as shown in Figure17 below.Total employment in the South has more than doubledover the past 50 years with an average growthrate 35% higher than the U.S. as a whole. Much ofthis job growth relative to the rest of the country canbe attributed to the South’s lower labor costs, whichin turn are due to its slower transition from an agriculturaleconomy and to the lesser role of organizedlabor.16. Real GDP Growthu Productivity and unit labor cost statistics arenot available by state or region, but proxies can beestimated using other data.The result of our analysis (see Table E) shows thatfour of the top six states in terms of productivity areSouthern: Louisiana, Texas, North Carolina and NewMexico. When it comes to unit labor costs, five of thetop eight are Southern.u The auto industryOne sector that has benefitted from this reindustrializationwave is the auto industry, as summarizedin Table F. It is noteworthy that the list is comprisedonly of foreign automakers and none of the U.S.“Big Three” of Chrysler, Ford, and General Motors.Expansion of the Big Three into the South has beenhampered by labor unions which have vehementlyopposed moving production to “right-to-work*”states in the South. By contrast, foreign automakershave taken advantage of this situation and movedproduction to the U.S. South where they could avoidelevated union wages and high legacy costs. Theirlower costs, in turn, make the total cost of manufacturingcars in the South lower than manufacturingoverseas and shipping to the U.S. In addition to theBig Three, the U.S. auto industry now has a secondconcentration in the seven Southern states of Alabama,Georgia, Kentucky, Mississippi, South Carolina,17. Employer CostsContinued page 20• • •6%5%4%3530$20.25$20.25$30.03$27.923%2%1%2520$8.53$10.17$8.76$8.51$26.16$7.54BenefitsWages and salaries0%-1%-2%1510$20.25 $22.81 $21.16 $19.42 $18.7118-3%U.S.South-4%2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011Note: The South includes Alabama, Arizona, Arkansas, Florida, Georgia,Kentucky, Louisiana, Mississippi, New Mexico, North Carolina, Oklahoma,South Carolina, Tennessee, Texas, Virginia, and West Virginia.Source: Bureau of Economic Analysis50United StatesNortheastWestMidwestSouthNote: The sum of individual items may not equal totals due to rounding.Source : Bureau of Labor Statistics

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler HermesANADAThe Southern Draw…Pacific OceanSeatleOlympiaWASHINGTONPortlandSalemOREGONSacramentoSan FranciscoNEVADACALIFORNIACarson CityLos AngelesBoiseIDAHOARIZONAPhoenixUTAHHelenaSalt Lake CityMONTANAWYOMINGTop 10 States CANADA in AmericaCheyenneDenverCOLORADOSanta FeNEW MEXICOMEXICONORTH DAKOTAAustinHoustonMontpellierVERMONTProvidenceAugustaBismarck MINNESOTAAlbanyWISCONSINSOUTH DAKOTAMICHIGANNEW YORKSt. PaulMadison LansingNew YorkSioux FallsPENNSYLVANIADetroitIOWAHarrisburgChicagoNEBRASKAILLINOISColumbus WashingtonDes MoinesIndianapolisOHIOWESTLincolnSpringfieldVIRGINIAINDIANACharlestonTopeka Jefferson CityRichmondFrankfortKANSASMISSOURIKENTUCKYNashvilleRaleighOKLAHOMA ARKANSASTENNESSEELittle RockColumbiaOklahoma CityALABAMA AtlantaMISSISSIPPIGEORGIATEXASDallas LOUISIANAJacksonMontgomeryBaton RougeNew OrleansTallahasseeFLORIDAMAINEConcordDetroitRHODE ISLANDCONNECTICUTHartfortNEW JERSEYPhiladelphiaTrentonVIRGINIANORTH CAROLINASOUTH CAROLINAMiamiAtlantic OceanMASSACHUSETTSE. Top 10 StatesGSP Rank GSP Rank Combined/Employee Hour /Compensation Rank2011 2010Louisiana 209.3 1 5.0 1 1Oregon 163.4 2 4.1 2 2Wyoming 139.5 3 3.3 3 3North Carolina 93.0 5 2.8 5 5Texas 102.3 4 2.6 7 6Alaska 83.9 8 2.8 4 6New Mexico 92.7 6 2.7 6 6Delaware 82.2 10 2.3 9 10Virginia 81.2 11 2.4 8 10Source: Euler HermesMethodological Note:A proxy for productivity by state can be calculated as follows:• Gross State Product (GSP) in the manufacturing sector is known and canbe divided into 52 weeks;• then the number of employees and the average number of weekly hourscan be multiplied to determine the total number of “employee-hours/week”;• when this number is divided into GSP/week, the result is GSP/employee-hour.Conceptually, this is the dollar amount of output created by oneworker in one hour. A proxy for Unit Labor Costs can be derived madesimply by dividing GSP by total compensation (wages and benefits), effectivelyshowing how many dollars of GSP are created by each dollar of totalcompensation. The combined ranking is the simple average of the productivityand cost ranks.F. Auto Plants in the SoutheastOpened Company Location Employees Annual production capacity1983 Nissan Smyrna, Tenn. 6,000 550,0001986 Toyota Georgetown, KY 7,000 n/a1994 BMW Greer, South Carolina n/a n/a1997 Nissan Decherd, Tenn. 1,250 n/a1997 Mercedes-Benz Vance, Ala. 2,800 174,0002001 Toyota Huntsville, Ala. 768 n/a2001 Honda Lincoln, Ala. 4,000 300,0002003 Nissan Canton, Miss. 4,500 400,0002005 Hyundai Montgomery, Ala. 2,500 300,0002010 Kia West Point, Ga. 3,000 300,000b2011 Volkswagen Chattanooga, Tenn. 2,000c 150,000Fall 2011* Toyota Blue Springs, Miss. 2,000 150,000Notes: *projected to be 360,000 in 2012; projected to be 2,300 by fall 2011; projected opening dateSource: Individual companies, Congressional Research Service, Chambers of Commerce*A right-to-work state is one where employees are not required tojoin a union if one is in place, with the general effect of keeping totalcompensation lower than that in states where union labor dominates19

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United States• • • Continued from page 18“Even though these new Southern employerspay well below average for the U.S.automotive industry, they still pay wellabove average for manufacturing jobs in theSouth. The story is similar for other capitalintensiveindustries, such as aerospace andpharmaceutical manufacturing. Lookingbeyond the current business cycle, prospectsfor manufacturing in the South appearpromising. The transition to more advancedindustrial growth in countries such as Chinaand India is far from complete, so demandfor the South’s more advanced manufacturedgoods is likely to continue for some time. Newcapital investments should continue to reducecosts and increase productivity…”Jeffrey LackerThe Future of Manufacturing in the SouthTennessee, and Texas. In recent times these stateshave launched into bidding wars to attract automakers,offering generous tax breaks and subsidieswhich reduce the positive economic impact of newfactories.A major cornerstone to the continued comparativeadvantage of the Southern states in the reindustrializationprocess will be the development of the necessaryworkforce skills including more technical andvocational schooling rather than traditional four-yearcolleges. On the downside, it should be noted thatdurable goods manufacturing is particularly sensitiveto the business cycle. As a result, the recessionhit much of the South harder than the rest of thecountry, but it has also recovered somewhat faster.u The Southern export routes revisitedTotal U.S. exports have grown faster than the restof the economy in twelve of the past thirteen quarters.In 2011 when nominal GDP grew 4.0% over theentire year, exports grew 13.5%. And in the Southeast,the export growth rate was even stronger, over20%. According to the Federal Reserve, “Exportshave become an increasingly significant part of theregion’s economy. The Southeast’s globally interconnectedeconomy—with its fortuitous location andplentiful ports and coastline—is contributing to surging,if surprising, exports, such as the flood of internationaltravelers whose Southeastern expendituresconstitute a major export.” Commerce Departmentdata showing the top exports and their markets fromthe Southeast are listed in Table G. It would appearthat the Southern strength in auto manufacturing forthe domestic market has also contributed to strongexports for transportation equipment.u Finally, in 2014 a planned expansion of the PanamaCanal should be completed, allowing wider anddeeper vessels to transit the canal.Currently, most goods from Asia are unloaded at thecountry’s two largest ports, Los Angeles and LongBeach, and are then shipped by rail or truck to the restof the U.S. The expansion of the canal will establishan alternate competing route sending Asian goodsthrough the Panama Canal to U.S. ports closer tothe concentration of U.S. population. In preparation,southeastern ports such as Savannah, GA, Gulfport,MS, and New Orleans, LA, among others, have undertakenlarge-scale projects to upgrade their facilities.These preparations are likely to continue to boostmanufacturing in the South, while an increase inport activity from the new Panama Canal trade route,including both imports and exports, will contribute toeven more economic activity. ©G. Exports: Top Sector, Top DestinationsTop exports from the Southeast (2011)Transportation Equipment $31BChemicals $29BPetroleum & Coal Prods. $24BComputer and Electronic Prods. $23BAgricultural Prods. $21BTop export markets for the Southeast ( 2011)Canada $26BChina $17BMexico $17BBrazil $10BJapan $9B20Source: Department of Commerce

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler HermesThe (positive) double price effectin the short-runReason #2The gas bonanzau As shown below in Figure 18, net U.S. imports offoreign oil have been falling as domestic productionhas been increasing over the past several years. Asa result, imported oil, as a percentage of all oil producedand imported, dropped from a high of over68% in 2005 to 58% in 2012, in part because the priceof crude oil doubled over that same period. This dramaticshift will reduce America’s significant dependencerisk on foreign oil. It may also lead to lower costsand increased reindustrialization since, as shown inFigure 19, a glut of West Texas Intermediate (WTI)oil in the U.S. led to prices significantly below that ofthe global price of Brent crude.The energy factor has been particularly favorable to thereindustrialization of the U.S. and this trend should beconfirmed in the short run for two main factors. First, inspite of global oil price increases, and the subsequentstabilization at historical highs (expected to linger),U.S. domestic oil prices have been $15-$20 below theglobal price for almost two years. This has boosted therelative performance of U.S. companies, just as it hitthe operating profitability of foreign manufacturingand drove shipping costs up. Second, an abundanceof shale gas on the American market, resulting frommore intensive production has triggered downwardpressure on domestic gas prices and providedAmerican companies with access to a cheap energysupply. The main risks to this positive contribution are:• the effective potential of the shale gas reservesboth in terms of volume and usage for differentsectors of the economy; and• should prices continue to decrease, incentives forthe extractors (and their profitability) would fall,causing instability in the value chain.u In addition, prices for natural gas have plummeteddue to rapid developments in drilling technologiesincluding horizontal drilling and hydraulic fracturing,or “fracking.” Fracking is a technique in which water,sand and chemicals are injected thousands of feetbelow the surface under very high pressure to breakup rock formations, thereby releasing trapped naturalgas. These techniques have revealed dramaticamounts of new reserves over the past few years,particularly in the Marcellus shale which extendsfrom New York through Pennsylvania and into WestVirginia, and the Bakken shale in North Dakota andMontana. • • •18. U.S. Crude Oil Production and Net Imports000 bbl/mo19. Oil Prices$/bbl350000Domestic Net import productionNet imports150300000250000Production120BrentMar $125Oct$11020000090WTIMar$106Oct$901500006010000050000197274 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12Source: Department of Energy30Oct-07Jan-08Apr-08Jul-08Oct-07Jan-09Apr-09Jul-09Oct-09Jan-10Apr-10Jul-10Oct-10Jan-11Apr-11Jul-11Oct-11Jan-12Apr-12Jul-12Oct-12Source: World Bank21

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United States• • •As shown in Figures 20 and 21 below, the result isthat natural gas production and storage have risensharply while prices have plummeted. Regardingreserves, the Energy Information Agency now estimatesthat "…there are 2,214 trillion cubic feet (Tcf)of natural gas that is technically recoverable in theUnited States. Of the total, an estimated 273 Tcf areproven reserves, which includes 60 Tcf of shale gas.At the rate of U.S. natural gas consumption in 2010of about 24 Tcf per year, 2,214 Tcf of natural gas isenough to last about 92 years*."Furthermore, the substantial natural gas price differentialthe U.S. enjoys will add to its industrial competitiveness,specifically in manufacturing. In the U.S.,one million BTU costs $4.01 (in Canada, $3.47). Comparatively,costs are twice as much in the UK ($9.03)and Europe ($10.61), and more than three times asmuch in Japan (LNG is at $14.73). UBS estimates thatthe boost to U.S. manufacturing could add 0.5% toGDP growth in each of the next five years.u The potential for substitution.The greatly reduced price and greatly increased supplycould be strong contributors to the reindustrializationof the U.S. As shown in Figure 22, U.S. dependenceon foreign oil is largely due to the transportationsector. Thirty seven percent of all energy supplied tothe U.S. comes from petroleum and most of that, seventytwo percent, goes straight into transportation,mostly to gasoline for passenger cars, then diesel fortrucks and trains, and finally to jet fuel.Note that the industrial, commercial and residentialand electrical power sectors each consume aboutone-third of the current natural gas supply. In theelectric power sector, as older coal plants go offline,they are quite likely to be replaced with gas-firedplants. The industrial sector currently sources 44% ofits energy from petroleum; natural gas could beginreplacing that over time. Finally, in addition to beinga source of energy, natural gas is used as a feedstockin the production of many chemicals, plastics, andfertilizers. As a result, these industries are likely toreturn some production from overseas back to theU.S., taking advantage of the low price of natural gas.The development of shale gas extraction has createda glut of natural gas and near record low prices. Thediscovery of vast new reserves, bringing the total upto around 100 years, is paving the way for the futurereindustrialization of the U.S. ©* Questions remain about the environmental damage fracking mightcause, including the consumption of large amounts of water, disposal ofwastewater, seismic tremors, and possible contamination of groundwater.These concerns have led to some temporary restrictions in exploration andproduction in the U.S., but in Europe fears over fracking could prove to bemuch bigger hurdles to its use in that region.20. Natural Gas ProductionBil. Cubic feet21. Natural Gas Prices$/million BTUs, Henry Hub, Louisiana2200Total US Production Bill.Cubic Feet (left scale)Natural Gas storage:United States (SA, end ofWk, Bil.Cu.Ft) (right scale)500045001512200040003500918003000250061600200031500221400100094 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12Sources: Oil and Gas Journal, Energy Intelligence094 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12Source: Wall Street Journal

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler Hermes22. Use of Energy Sources by SectorSupply SourcesPetroleum37%Percent of Source722251Percent of Sector9433Demand SectorTransportation28%Natural Gas25%Coal21%Renewables8%Nuclear9%3327

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesChemicals and primary metals industries to benefit mostfrom the low energy costsCould cheap energy increase foreign directinvestments to the U.S.?u The competitive edge provided by a cheapenergy supply and a growing U.S. market (atleast from a demographic point of view) wouldrepresent potent incentives for investmentfrom overseas companies, which may beplagued with lackluster or even contractingdomestic markets and structural impedimentsdarkening their prospects. For example,Japanese companies that are grappling witha declining domestic environment, mountingenergy costs and ongoing appreciation of theYen/USD, could see several reasons whichwould favor the location of new or additionalindustrial capacities in the U.S. These includeproximity to growth driver markets and toraw materials, ease of logistics, and lowercosts of energy and labor. The protractedeconomic doldrums in Europe may alsoprompt local manufacturing players there toconsider increasing their U.S. presence. Thesecompetitive advantages may be emergingeven now. The U.S. has already regainedtraction in foreign direct investment inmanufacturing since the recession (US $100billion in 2011), and is on the path to reach thepre-recession peaks.u The U.S. shale gas supply is a game-changing factorfor American industries all across the board, asmanufacturers may now:• access lower energy prices as many electric powersuppliers have been shifting their coal-fired plantsto gas-fired plants;• switch their energy supply from oil to gas; and• switch their feedstock supply from oil to gas.These developments will help reinforce the ongoingimprovement of the competitive position of U.S.manufacturers, especially in comparison to Europeanand Japanese counterparts. Beyond the strengtheningof operating profitability, the foreseeable outcomeof this growing competitive edge is that U.S.manufacturers will regain ground in global trade,expanding exports and putting downward pressureon imports. The sector which is first in line to takeadvantage of cheaper energy is chemicals, especiallybasic chemicals and fertilizers, since these industrieswill benefit from both cheaper energy and cheaperfeedstock supplies. This competitive advantage islikely to filter to downstream sectors such as agriculture,coatings, manufacturing, paint, and plastics.Considering the size of the trade and the characteristicsof the sector, the primary metals industry couldalso be a significant winner, improving its competitiveadvantage and gaining global market share. Asshown, Table H displays the relevant metrics by sector.In the short/intermediate run, these trends mayalso fuel substantial investments in these sectors tokeep pace with probable production increases. Playersin the chemicals sector have already planned toinvest $16 billion in the next five years. ©H. Top Sectors Benefitting from a Decrease in Energy PricesManufacturing 3%Part of energy Part in U.S. Imports Exportscosts in sector manufacturing energy ($Bn) ($Bn)input cost (%) input costs (%) 2011 2011Nonmetallic mineral products 11% 6% 17.7 10.7Paper products 10% 12% 21.9 25.7Primary metals 8% 16% 103.5 76.5Wood products 5% 2% 11.3 5.9Chemicals 5% 22% 201.8* 197.1*Textile mills and textile product mills 4% 1% 24.4 12.6Plastics and rubber products 3% 3% 40.2 29.1Food/beverage and tobacco products 3% 18% 67.9 66.7Apparel/leather and allied products 3% ~0% 116.4 9.024* $108.7Bn and $149.2Bn excluding pharmaceuticalsSource: Bureau of Economic Analysis – International Trade Administration

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler HermesFED. DE RUSSIE (Russia)ALASKAFocus on… Texas, the power plantAnchorageCANADA1/2TexasThe second largest state economy in the U.S.CANADAAugustaSeatleMontpellierMAINEOlympiaVERMONTWASHINGTONConcordNORTH DAKOTAProvidencePortlandHelenaDetroit MASSACHUSETTSSalemBismarck MINNESOTAAlbanyMONTANAWISCONSINOREGONBoiseSOUTH DAKOTAMICHIGANNEW YORKRHODE ISLANDSt. PaulCONNECTICUTMadison LansingNew YorkSioux FallsPENNSYLVANIAHartfortIDAHOWYOMINGDetroitIOWAHarrisburgChicagoNEW JERSEYCheyenneNEBRASKAILLINOISColumbus WashingtonCarson CityDes MoinesIndianapolisOHIOWESTPhiladelphiaSalt Lake CitySacramentoLincolnSpringfieldVIRGINIATrentonINDIANASan FranciscoCharlestonTopeka Jefferson CityRichmondVIRGINIANEVADADenverFrankfortUTAHKENTUCKYCALIFORNIACOLORADOKANSASMISSOURIRaleighNashvilleOKLAHOMATENNESSEEARKANSASNORTH CAROLINALos AngelesARIZONALittle RockColumbiaSanta FeOklahoma CityALABAMA AtlantaSOUTH CAROLINAPhoenixNEW MEXICOMISSISSIPPIGEORGIADallas LOUISIANAMontgomeryJacksonTEXASBaton RougeAustinFLORIDA Atlantic OceanPacific OceanHoustonTallahasseeMiamiNew OrleansMEXICOTexas is the second largest state economy in theU.S. after California, comprising 8.8% of U.S. GDPin 2011. The Texas economy has grown faster thanthe rest of the U.S. in nine of the past 12 years asshown below in Figure 23.Texas is also the second largest employer with 8.8%of all U.S. jobs, and through most of 2011 and 2012outperformed the rest of the U.S. in job growth asshown below in Figure 24. In fact, of all the 2.6 millionjobs created between January 2000 and August 2012,1.8 million, or 70%, were created in Texas. Forecastsfor 2013 Texas GDP and job growth are expected tosignificantly outperform the U.S. as a whole. Texascomprises 7.1% of all U.S. manufacturing jobs.One outstanding feature of the Texas economy is thehousing market, which was relatively resilient comparedto the entire U.S. From the period just beforethe housing bubble burst, January 2006 to May 2012,housing prices in Dallas fell only 2.7%, the least of anyof the 20 major cities nationwide measured by theCase-Shiller home price index. The average housingloss for the 20 cities nationwide over that time periodwas a remarkable 31%. Median single-family homeprices in Texas were up 5% in August 2012 comparedto the previous year. Sales of existing single-familyhomes over the same time period were up 17%compared to a nationwide average of 10%. Permitswere up 36% versus 24% nationwide. The strength inthe housing market will provide a boost to the entirestate economy and a robust environment for manufacturersof building materials going forward.• • •23. Real GDP Growth24. Manufacturing Employment6%5%4%3%6%3%0%USTexasUS2%1%0USTexas-3%-6%-1%-9%-2%-3%-12%-4%20000102030405060708091011-15%Aug-01Aug-02Aug-03Aug-04Aug-05Aug-06Aug-07Aug-08Aug-09Aug-10Aug-11Aug-12Source: Bureau of Economic AnalysisSource: Bureau of Labor Statistics25

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United States• • • u Sector opportunitiesManufacturing industry GDP in Texas is $192 billionor 10% of all U.S. manufacturing. The concentrationof industries within Texas manufacturing is shown inTable I below. The first column in the table indicatesthat petroleum and coal products comprise 26% ofall manufacturing in Texas. Along with chemicalsat 20%, these top two industries are responsible fornearly half of the manufacturing output of Texas.There are significant contributions from computerand electronic products and machinery as well. Thesecond column indicates that of all the petroleumand coal product manufacturing in the U.S., 26% ofit is performed in Texas. Texas also produces 15% ofall U.S. chemical products. Once again, there are significantcontributions from computer and electronicproducts and machinery.I. Texas ‘ ID Card% of Texas % of total USmanufacturing in TexasManufacturing 100% 10%Petroleum and coal products 26% 26%Chemicals 20% 15%Computers and electronic products 14% 9%Machinery 10% 12%Fabricated metal products 6% 9%Food, beverage and tabacco products 6% 5%Other transportationequipment 3% 3%Plastics and rubber products 3% 7%Source: Bureau of Economic Analysisu PetroleumThe Texas economy has long been dominated by theenergy sector. Texas is the number one producer ofcrude oil, natural gas and total energy in the U.S., witha 15.3% share of total U.S. energy production. It has24% of U.S. crude reserves, 31% of its production, andis the number one consumer. Texas also has 29% ofU.S. dry natural gas reserves, 30% of its productionand is the number one consumer.In 2011, its 26 refineries accounted for 27% of all U.S.refining capacity. The refinery business is likely to seesteady growth going forward as demand from thechemical industry will be ramped up by cheap naturalgas. Several of the largest oil companies in the worldare headquartered in Texas, including Exxon-Mobiland ConocoPhillips. It has nine major sea ports forexporting and importing petroleum products. WestTexas Intermediate (WTI) remains the benchmarkgrade for crude oil in the U.S. and its price is currentlybetween $15 and $20 per barrel less than the globalbenchmark, Brent crude, because the U.S. currentlyhas a glut of WTI. High production combined withlimited pipeline capacity to transport to refineries hascontributed to the excess. While Texas is the numberone producer of crude oil in the U.S., output has fallento less than one third of its peak in 1972.Although there is no doubt that crude productionwill remain a robust industry for decades to come,growth prospects may be limited. By contrast, naturalgas production is on the rebound. Huge new reservesof shale gas have become recoverable because ofdevelopments in fracking and horizontal drilling.Much of the natural gas production goes directly toelectricity production, which will likely be a growthindustry for the foreseeable future. Texas is the numberone producer and consumer of electricity in theU.S. Another significant source of demand is fromchemical manufacturers who use natural gas as afeedstock. The adoption of natural gas as a fuel forvehicles also offers great promise in the long run.Texas also leads the country in coal consumption withthe majority of its supplies coming from Wyoming.Coal mining and consumption is likely to be a weakerindustry in the long run because of its emissions andbecause of competition from cheap natural gas. Onebright spot in the coal industry is increasing demandfrom China, which is the world’s largest consumerand importer of coal.26Despite being an economy heavily dependent onfossil fuels, Texas is also the nationwide leader inwind power. There are over 2,000 turbines in westTexas alone, and the largest wind energy facility in the

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler Hermesworld is located in central Texas. While crude oil productionand refining are likely to be in high demandgoing forward, it would appear that true growthopportunities in Texas energy lie more in natural gasand renewables.u ChemicalsAs in the petroleum industry, Texas is the leader inU.S. chemical production with over 200 chemicalplants. The industry provides employment for over70,000 workers at an average salary of over $85,000per year. The state’s abundant supply of natural gasand its large refining capacity are the main contributorsto the strong presence of the chemical industryin Texas. But unlike crude oil production and refining,the chemicals industry is set for strong growth, dueto the emergence of very cheap natural gas. Naturalgas is used as a “feedstock” or basic raw material inthe production of many chemicals, so its precipitousfall in price is also lowering prices for many goodsdownstream. There are thousands of productswhich use chemicals extensively for their manufacturing:apparel, auto parts, clothes, fertilizer, packaging,paints, pharmaceuticals, rubber, and all theplastic products which make up so many everydayitems such as appliances, furniture, and the seeminglyendless array of consumer electronics such aspersonal computers, tablets, smartphones, TVs andmany others.• The Texas Emerging Technology Fund is designedto attract R&D to the state; and• The Texas Enterprise Fund also provides financingto worthy projects. Recently the Fund providedapproximately $1million each to chemical manufacturersDow Chemical and Kuraray America tohelp finance their expansions.As far as exports are concerned, like in so many othermeasures, Texas is number one in the nation, exporting$250 billion in 2011 with a 17% share of all U.S.exports. Exports grew in 2011 over 2010 at a blistering21% rate. Over 20% of Texas exports were refinedpetroleum products, followed by coal, chemicals,computer and electronic products, non-electricalmachinery, and transportation equipment. The topexport markets were Mexico with a 35% share, followedby Canada at 8%, and China at 4%. These topthree countries buy almost half of Texas’ exports. Asignificant portion of exports to Mexico is likely to begoods which are then assembled or modified in Mexicoand re-exported to the U.S. ©The drop in natural gas prices along with lower unitlabor costs now make the U.S. one of the cheapestchemical producers in the world. According to PricewaterhouseCoopers, “U.S. chemical manufacturersnow have a 50-to-1 price advantage over foreigncompetitors forced to rely on much more expensivepetroleum products. Shale gas represents a oncein-a-centurychange in the competitive balanceworldwide." This change is likely to move significantnumbers of jobs back onshore. As a result, at least adozen major chemical plants are rapidly expandingin Texas, and expectations are that these projects willentail $15 billion in investments, and create as manyas 20,000 new jobs. Clearly the chemicals industry inTexas is poised for strong growth.u Public incentives and export routes arecontributing to this favorable outlook in TexasTexas offers a number of government incentives topromote growth:• Economic Development Corporations helpfinance both new and existing businesses;• Value Limitation tax credits are available forjob-creating construction projects;27

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesReason #3The commitmentto a conducive business climateAs we have seen from the response to the financialcrisis, policy responses including the stimuluspackage, have been a decisive factor in shapingthe U.S. recovery. Going forward, the questionis how can the policy environment help sustainthe positive first signs of a reindustrialization ofthe U.S.? What hampers the realization of its fullpotential? Is corporate cash hoarding a reality?How did the private sector organize to cope withnew challenges and an uncertain economicenvironment? Confidence and forward visibility arekey as uncertainties, and still cloud the decisionmakingof entrepreneurs. Are there other options?25. GDP Growth VS. R&D Growthaveraged annualized rates 1987-200910%9%8%7%6%5%4%3%U.K. France CanadaU.S.ItalyGermanyJapanKoreaSpainAustraliaChina2%0% 5% 10% 15% 20%Source: Organisation for Economic Co-operation and Development28

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler HermesObjective: InnovationResearch and Development (R&D)is critical to competitiveness andinnovation, and the U.S. needs to boostefforts in this sector. For example, theU.S. is beginning to fall behind its globalcompetitors in patent generation.Patents represent the end-product ofR&D efforts, which can then be used forcommercial purposes and competitiveadvantage.u The benefits of a strong national R&D programand the resulting growth in the number of patentsgranted are obvious. Figure 25 demonstrates thatfrom 1995 to 2012, nations that had a higher averageannualized growth rate in the number of patentsgranted tended to also have a higher growth rate ofGDP. Clearly the growth rate of patent issuance in theU.S. at under 5% is insufficient to contribute to robustGDP growth. By contrast, China’s R&D programs aregrowing the number of patents issued there by aremarkable 22%, resulting in an equally remarkableGDP growth of 10% annually. U.S. industry needs totake this competitive threat seriously if it expects tocontinue on the path of reindustrialization.u The threat appears in other measures of innovationas well, such as the absolute number of patentsgranted in each country. Note in Figure 26 below thatthe U.S. and Japan lead this measure with about thesame number of patents granted in 2010. But moreimportantly, the chart clearly shows the rise of China’sR&D programs and to a lesser extent those ofSouth Korea. These countries are rapidly closing thegap with the U.S. and eroding its competitive advantage.Even after patent applications are made, the U.S.stumbles. Figure 27 shows the increase or decreasesince 1993 in the length of time required for patentapproval, by country. Here the U.S. is a serious laggardas well. It took more than twice as much time toapprove a patent in the U.S. in 2009 as it did in 1993.By comparison, the approval time in South Korea hasfallen 40%, and in Japan 20%. U.S. manufacturingand the economy in general would be well served byimprovements in the process of approving patents.u The composition of the increase in patents showsthreats and opportunities as well. Table J shows thepercentage contribution of each industry to thegrowth in patents between 1995 and 2008. Thefirst columns show the contribution to total patentsgranted worldwide, and as might be expected, sevenof the top 10 industries are related to electronics,with computers and electrical machinery taking thetop spots. The remaining columns show the industrybreakout by country. The U.S. contribution by industryis the most highly concentrated with a full 19% incomputers. Computer technology is also in the topthree in Japan and South Korea, representing significantcompetition from those countries. The positiveview here is that the U.S. has focused on the highestgrowth industry since 1995, and its lead may make itwell-suited for further competitive gains.• • •26. Patents Granted27. Change in TimeRequired for Patent Approval25000020000015000010000050000080828486889092949698000204060810U.S.JapanKoreaEuropeChinaSource: World Intellectual Property Organization (WIPO)Source: World Intellectual Property Organization (WIPO):29

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United States• • •u However, the concentration in one industry israther risky to U.S. manufacturing as a whole. An offsetto that risk is that the second largest U.S. concentrationis in medical technology; none of the othermajor economies have that in their top three, representinga competitive U.S. advantage in this industry.Similarly, the third largest U.S. industry concentration– pharmaceuticals - appears in only one other country’slist: China. Other countries show concentrationrisk. Over 40% of Japan’s increase in new patents isrelated to computers or electronics. This situation isespecially dangerous given that Japan’s once dominantelectronics manufacturers are now strugglingto survive in the global marketplace. South Korea isless concentrated with only about 16% in high technology.China however is the most diverse, suggestingthat the Chinese leadership is fostering developmentacross many industries as the country seeks tosupport its rapid growth rate.than half of China’s. Clearly the U.S. needs to increaseits dedication and funding to R&D to compete in thefuture global economy. The last column in the tableshows how effective a country’s R&D program is bycomparing how many patent applications are maderelative to the amount of R&D spending. Once again,South Korea, Japan, and China far outpaced the U.S.in 2010.u Finally, Figure 28 below shows two measures ofR&D activity, averaged from 2000-2012. The U.S. performsreasonably well by these measures. For example,Japan and the U.S. have the largest number ofresearch workers per 1,000 total workers. But whileU.S. R&D spending as a percentage of GDP exceedsthe average for the OECD countries, it still lags behindJapan, Korea, and Switzerland. ©uAnother measure of a country’s innovation comparesthe number of patent applications to its GDP,as shown below in Table K in the first column. Thismeasure conceptually shows a country’s commitmentto its R&D efforts, and by this measure U.S.dedication to R&D is very weak at only a fraction ofthat of South Korea’s and Japan’s and only a bit more28. Research and Development, Averages 2000-20101210Researchers/1000 workers8R&D as a % of GDPJ. Contribution of Fields of Technology to the Change in Volume of Filings Between 1995 and 2008TotalComputer technology 10.5Electrical machinery, apparatus 7.0Pharmaceuticals 6.6Digital communication 6.4Medical technology 5.6Semiconductors 5.4Measurement 4.6Audio-visual technology 4.3Transport 3.8Telecommunications 3.8Others (25 fields) 41.8Total 100Source: World Intellectual Property Organization (WIPO)30USComputer technology 19.0Medical technology 9.7Pharmaceuticals 8.8JapanElectrical machinery, energy 15.9Semiconductors 14.8Computer technology 11.6ChinaDigital communication 7.5Electrical machinery, energy 6.9Pharmaceuticals 6.5Korea6420JapanUSAustraliaCanadaFranceKoreaUKOECDGermanyRussianSwitzerlandSpainItalyChinaMexicoSource: Organisation for Economic Co-operation and DevelopmentSemiconductors 8.9Computer technology 7.5Electrical machinery, energy 7.3GermanyTransport 12.7Semiconductors 9.0Electrical machinery, energy 8.5Note: Total refers to the world total. The IPCtechnologyconcordance table (availableat: www.wipo.int/ipstats/en) was used toconvert IPC symbols into corresponding fieldsof technology. Data include both first andsubsequent filings.K. 2010 Measures of InnovationApplicationApplication toBusiness sectorCountry to GDP ratio R&D ratioKorea 99.8 4.1Japan 73.7 3.0China 32.2 2.8US 18.4 0.8Germany 17.2 0.9Source: World Intellectual Property Organization(WIPO)

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler HermesCash hoard instinct: debunking the mythClearly the U.S. is falling behind incritical R&D programs. So how will theU.S. increase its investment in R&Dspending? What policies can the federalgovernment undertake to encouragethis effort? An examination of currentbusiness practices reveals somepossibilities.u U.S. manufacturers have grown their profits rapidlyover the past decade, largely due to increasedproductivity. Yet over the same period, manufacturershave increased investment much more slowly,and employment has actually fallen in the sector.Clearly, U.S. manufacturers need to resume a fasterpace of investment to become more competitive inthe global marketplace. Profits need to be re-distributedto promote investment.Figure 29 below shows the growth in corporateand non-corporate business profits as a percentageof total assets. The rising profits are clearly evidenthere also, but this chart breaks the profits down intodividends and undistributed profits. It is evident thatover the past decade, manufacturers have paid outdividends at approximately the same rate, but theyhave more than tripled the portion of profits whichremain undistributed. Where have the undistributedprofits been allocated on balance sheets?u Figure 30 below shows the composition of thebalance sheet of all corporate and non-corporatebusinesses. As shown by the blue line, contrary topopular belief, corporations are not hoarding cashand other liquid assets on their balance sheets. Theproportion of liquid assets as a percentage of totalassets has barely budged from a low of 5.8% to ahigh of 7.3% to the current value of 6.4%. Instead, theundistributed profits went to pay down liabilities andto increase net worth. These efforts have occurred intwo distinct periods. After the tech bubble burst andequity values plummeted, businesses began rebuildingnet worth and paring down liabilities. Then thefinancial crisis started to emerge in 2007, drasticallymarking down the value of financial assets, loweringnet worth and increasing liabilities. After 2009, businessesonce again undertook the task of restoringfiscal prudence to their balance sheets, reducing liabilities,and rebuilding net worth. The financial crisisand the great recession pushed businesses into the“risk aversion” mode to rebuild their balance sheetsand make investment a secondary priority.u The good news is that although this risk aversionstrategy is still in place, it has been easing. Bankshave started to make commercial and industrialloans again. Consumer confidence is on the rise. Thehousing market may have bottomed, and employmenthas firmed in recent months, although it is wellbelow the rate of job creation needed to bolster theanemic recovery. Expectations are that all of thesetrends will continue and that businesses will start toincrease their risk appetite such that profits will beused less to bolster the balance sheet and more toincrease investment. • • •29. Distribution of Profits as a % of Assets30. Net Worth, Liabilities, and Liquid Assets as a % of Total Assets6%profits6%trying to buildnet worth....financial crisis drovenet worth down...trying to buildnet worth again...net worth5%5%Liabilities4%undistributed profits4%liabilities tryingto de-lever ...financial crisis droveasset values down...trying tode-lever again...3%3%2%dividends2%1%1%5.8% liquid asset - no cash hoar 7.3% 6.4%liquid assets0%2000 01 02 03 04 05Source: Federal Reserve060708091011Q1 2012Q2 20120%2000 01 02 03 04 05Source: Federal Reserve060708091011Q1 2012Q2 201231

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United States• • •But the federal government could do more to stimulateincreased R&D spending. First, the corporate taxcode should be reformed. At the moment, U.S. corporationsare holding large amounts of accumulatedearnings overseas which would be taxed if they wererepatriated. This tax structure obviously impedes theflow of capital back into domestic operations, constraininginvestment. If that money could be repatriateduntaxed, there would most likely be a flood ofnew capital coming in to stimulate investment andcreate the new jobs which the U.S. desperately needs.The government could also spur investment by creatinga less uncertain business environment. Specifically,Congress should resolve the fiscal situationas quickly as possible. The details of the resolutionare less important than actually doing it. Continueddeadlock in Congress, or some sort of temporary fixwill only extend the uncertainty, impeding investmentand job growth.Surprisingly though, the U.S. does have one advantagein this regard compared to the European MonetaryUnion (EMU); it has one federal government,not 17. This structure has allowed for a rapid andconcerted U.S. crisis response before. For example,during the meltdown of the housing market, thefinancial crisis, and the resulting recession, the Presidency,the Congress, and the Federal Reserve all tookextraordinary measures to mitigate the damage.But in Europe, there has been little real progress increating a coherent plan to deal with the sovereigndebt crisis which is approaching its fourth year. Andthe largest E.U. impediment is that there are 17countries, the International Monetary Fund, and theEuropean Central Bank (the troika) all involved. Whileovercoming deadlock in Washington may be very difficult,it is not nearly as challenging as trying to mounta singular effort in Europe.When Washington has acted in concert, there werepositive results. For example, the American Recoveryand Reinvestment Act (ARRA) allocated almost $70billion to the construction industry, which significantlyslowed the rate of job loss. Similar targetedstimulus in the manufacturing industry could helpspur new R&D spending, more investment, andmore employment. One logical target would be theindustry with the highest value-added but one whichis exposed to increasing global competitive pressures- the computer and electronic products manufacturing.California is the center of this industry. ©Focus on… California, the innovationincubatorWhile California has suffered significant joblosses in manufacturing over the past decade,conditions are ripe for improvement. Californiais by far the largest state in terms of nominal GDPat $1.96 trillion in 2011, which is 13% of the entireU.S. economy. California alone is the world’s ninthlargest economy, and is larger than Russian, India,Canada, Spain, and Australia. As shown in Figure31, California’s GDP growth rate has usually outperformedthe U.S. as a whole and was ranked 10thamong all states in 2011.u California is also the largest employer in the U.S.with 16.4 million jobs at the end of 2011, or 12% ofall 132 million U.S. jobs. California has recently ledthe nation in job creation. Perhaps more importantly,job growth in California is expected to outpace therest of the U.S. over the next two years. Accordingto a University of California at Los Angeles (UCLA)Anderson Business School forecast, jobs in Californiaare expected to grow in 2013 by 1.9% vs. 1.5% for allof the U.S., and in 2014 the numbers are 2.5% vs. 1.6%respectively. In addition, while the unemploymentrate is among the highest in the nation, it appearsthat it may be due to an increasing labor force, suggestingthat relatively fewer workers are becomingdiscouraged and leaving the labor force.31. Real GDP Growth8%7%6%5%4%3%2%1%0%-1%-2%-3%-4%USCalifornia-5%2000010203040506070809101132Source: Bureau of Economic Analysis

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler HermesCANADACaliforniaCANADAAugustaThe largest state economy in the U.S.SeatleMontpellierMAINEOlympiaVERMONTWASHINGTONConcordNORTH DAKOTAProvidencePortlandHelenaDetroit MASSACHUSETTSSalemBismarck MINNESOTAAlbanyMONTANAWISCONSINOREGONBoiseSOUTH DAKOTAMICHIGANNEW YORKRHODE ISLANDSt. PaulCONNECTICUTMadison LansingNew YorkSioux FallsPENNSYLVANIAHartfortIDAHOWYOMINGDetroitIOWAHarrisburgChicagoNEW JERSEYCheyenneNEBRASKAILLINOISColumbus WashingtonCarson CityDes MoinesIndianapolisOHIOWESTPhiladelphiaSalt Lake CitySacramentoLincolnSpringfieldVIRGINIATrentonINDIANACharlestonSan FranciscoTopeka Jefferson CityRichmondVIRGINIANEVADADenverFrankfortUTAHKENTUCKYCOLORADOKANSASCALIFORNIAMISSOURIRaleighNashvilleOKLAHOMATENNESSEEARKANSASNORTH CAROLINALos AngelesARIZONALittle RockColumbiaSanta FeOklahoma CityALABAMA AtlantaSOUTH CAROLINAPhoenixNEW MEXICOMISSISSIPPIGEORGIADallas LOUISIANAMontgomeryJacksonTEXASBaton RougePacific OceanMEXICOAustinHoustonNew OrleansTallahasseeFLORIDAMiamiAtlantic OceanGDP for the manufacturing industry in California is$230 billion or 12% of all U.S. manufacturing. Theconcentration of industries within California manufacturingis shown in Table L. The first column indicatesthat computer and electronic products comprise31% of all the manufacturing in California, by farthe largest single industry. Along with petroleum andcoal product manufacturing, these top two industriesare responsible for nearly half of the manufacturingoutput of California. There are significant contributionsfrom food, beverage and tobacco, and chemicalsas well.The second column indicates that of all the computerand electronic products manufactured in the U.S.,25% is made in California. California also produces21% of all the U.S. petroleum and coal products. Andonce again there are significant contributions fromfood, beverage and tobacco, and chemicals as well.u Computer and Electronic ProductsManufacturingThe computer industry is clearly the shining star inCalifornia manufacturing. The industry is heavily concentratedin the Silicon Valley region surrounding SanFrancisco. Corporations such as Apple, Cisco, Facebook,Google, Intel, and others have added tens ofthousands of jobs and created billions in wealth overthe past decade. The development of the industry issomething of a random historical accident, largelyemerging from innovations at Stanford University.As the industry blossomed in the 1980s, a secondaryindustry of venture capital formed in the region,helping to fuel growth. California’s share of total venturecapital funding in the U.S. is approximately 50%,the majority of which has gone into hi-tech industries.Part of the remarkable growth surrounding theindustry is due to the multiplier effect where one newjob creates other related jobs, as in venture capital.The Milken Institute estimates that in the computermanufacturing industry one new job may create asmany as 16 others.L. California’s ID Card% of California % of total USmanufacturing in CaliforniaManufacturing 100% 13%Computers and electronic products 31% 25%Petroleum and coal products 17% 21%Food, beverage and tabacco products 10% 10%Chemicals 9% 9%Miscellaneous 7% 17%Fabricated metal products 5% 9%Machinery 4% 7%Other transportation equipment 5% 12%Plastics and rubber products 2% 7%Source: Bureau of Economic AnalysisThese fast-growing businesses do require a highlyeducated and highly paid workforce. The San FranciscoBay area has the highest percentage of collegegraduates in the U.S. workforce; 44% vs. 28% nationwide.This is a hallmark of industries where the U.S.does not have to compete on labor costs; rather theycompete on high quality, high value-added production.Maintaining competitive advantage in this industryis critical, and the federal government should helpin this effort. Educational standards in science, math,and engineering must be raised. Legal immigrationmust be promoted to keep talented workers on these• • •33

Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United States• • • shores after college graduation, instead of sendingthem away to compete against the U.S. Taxes onrepatriated capital should be removed.The overwhelming success this industry enjoys is dueto insatiable global demand for its products such aspersonal computers, smart phones, and tablets.Competition and continuous innovation have createddemand for products unimagined just a fewyears ago. Yet this same competition continuouslydrives prices down due to increased productivity,automation, off-shoring, and continuous improvementin semiconductor design. The industry is furthercharacterized by a convergence of features onnew products, such as cameras, web browsers andemail on phones. Research and Design (R&D) spendingis critical in this industry.Globally the consumer electronics industry grewsomewhat more slowly in 2012 than previously anticipated,around 2.5%. The industry probably exceeded$1 trillion in added value in 2012. Much of the growthis due to emerging markets which are not yet fullypenetrated. In the U.S. in 2013 however, consumerelectronics revenues are expected to grow 4.5% andexceed $215 billion, according to the ConsumerElectronics Association (CEA). Smartphone saleswill comprise the largest segment of revenue at $34billion but will only grow 24%. Tablet sales will skyrocketover 80% higher to almost $30 billion. Personalcomputers have slowed due to cannibalization fromtablets, but ultrabook laptop sales are still expectedto reach $15 billion. The Manufacturers Alliance forProductivity and Innovation (MAPI) forecasts hightechindustrial production (computers and electronicproducts) to grow by 5.7% in 2013 in the U.S. Highergrowth in production vs. revenues is to be expectedin this industry with ever-falling prices.u PetroleumCalifornia has large crude oil reserves and is the thirdlargest producer of crude in the nation. Much of thedemand for this crude comes from within the stateitself and this demand is not expected to drop off inthe foreseeable future. Of all the states, California hasby far the most vehicles. There are 20 million cars inCalifornia, 15% of the nation’s total of 135 million. Thenext closest state, Texas, has a little more than halfthat many. Including trucks, buses and commercialvehicles, there are a total of 33 million vehicles in California,or 14% of the nation’s total. The vast majorityof these vehicles run on gasoline, followed by dieselfuel, and natural gas. Forty percent of all energy consumedin California is for transportation.California has always been at the vanguard of environmentalprotection and as such it has uniquerequirements for the gasoline that can be used there.As a result, California refineries are ranked third incapacity nationwide and are basically the only oneswhich produce these blends. The refineries run atalmost 100% capacity to meet demand. Furthermore,California refineries have no competition from outsideof the state and are not expected to soon. Thesepresent very good conditions for business going forward– unquenchable demand and no competitors.California is also the 12th largest producer of naturalgas and, again, demand is built-in within the state.Over 57% of the state’s electricity is derived fromnatural-gas fired plants. And as the price of naturalgas fallen, the cost advantages for running vehicleson this fuel will become more apparent. Municipalbusses, commercial trucks, and other vehicles arealready making the switch. Building the infrastructureto support the growing use of natural gas is likelyto be a significant industry going forward as there arevery few filling stations available.Despite its somewhat spotty record, renewableenergy is making strong inroads in California andwill certainly be a growth industry going forward. Forinstance, California ranks first in electricity productionfrom renewables such as biomass and geothermalenergy. Given the state’s propensity to take thelead on improving energy efficiency, California willlikely be the premier market for the developmentof renewable energy. For example California haspassed a global warming bill which, according to thestate, “establishes a first-in-the-world comprehensiveprogram to achieve cost-effective reductions ingreenhouse gases through energy conservation andrenewable energy production, effectively makingCalifornia a hotbed of renewable energy and energy34

Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler Hermesefficiency innovations.” The state has also establishedthe California “million solar roofs initiative” aiming tocreate one million solar roofs in California by 2018.u Other incentivesCalifornia is trying to lure manufacturing jobs back tothe states with many different programs. One sucheffort is the “Innovation Hub,” which according tothe state government “seeks to improve the state'snational and global competitiveness by stimulatingpartnerships, economic development and job creationaround specific research clusters throughout thestate. Innovation Hubs target young, innovative companiesthat have been in business for less than eightyears in a technology cluster…” Other efforts includeIndustrial Development Bonds and Small BusinessLoan Guarantees.u ExportsTo support exports, the state has twelve cargo airportsand eleven cargo seaports including the two largest inthe nation, the ports of Los Angeles and Long Beach. Thestate’s 17 Foreign Trade Zones (FTZ) are intended to promoteexports by delaying, or even foregoing export orimport taxes and duties. The computer and electronicsmanufacturing industry is of course well represented inexports, comprising 29% of the state’s total. California’s topexport markets include the stable Canadian economy andthe more rapidly growing economies of Mexico, China andSouth Korea. ©The state government is currently providing a menuof tax incentives to lure manufacturing to Californiaas well. These include a Research and DevelopmentTax Credit, a Film and TV Production Tax Credit, aWork Opportunity Tax Credit, a Net Operating LossCarryover provision and finally, in an attempt to furtherpromote “green energy”, the state is offeringSales & Use Tax Exemptions for Clean Tech Manufacturing.35

Economic Outlookseries…N° 1173 u Global Sectors ReviewGlobal economic recovery continues, but new threats are arising.N° 1174 u Business insolvency in France (only available in French)The decline ininsolvencies remains modest overall and stillvery uneven, with a high number of cases.The French economic environment - the slowdown continues.N° 1175 u Global Macroeconomic PerspectivesThe slowdown is confirmed, the weaknesses remain, the risks endure.N° 1176 u Special DossierGreen Economy.N° 1177-1178 u Macroeconomic, Risk and Insolvency OutlookOn the edge.N° 1179 u Global Sectors ReviewLooking for growth where it can be found.N° 1180 u Business insolvency in France (only available in French)The overall decrease in French insolvencies hides several weaknesses.N° 1181 u Macroeconomic, Risk and Insolvency OutlookA fog cannot be dispelled by a fan.N° 1182 u Special DossierPayment periods in Europe: wide gaps.N° 1183-84 u Macroeconomic, Risk and Insolvency OutlookN° 1185 u Global Sectors OutlookEconomic sectors put to the test.N° 1186 u Macroeconomic, Risk and Insolvency OutlookIn 2013, we take the same and start again.N° 1187 u Special ReportThe Reindustrialization of the United StatesTo come:N° 1188 u Special ReportTransport: a two-speed worldEuler Hermes North America Insurance Company800 Red Brook Blvd, Owings Mills, MD 211171-877-883-3224 | www.eulerhermes.us36This document reflects the opinion of the Economic Research Department of Euler Hermes.The information, analyses and forecasts contained herein are based on the Department's current hypothesesand viewpoints and are of a prospective nature. In this regard, the Economic Research Department of EulerHermes has no responsibility for the consequences hereof and no liability. Moreover, these analyses are subjectto modification at any time.