Reindustrialization in USA - Euler Hermes

Reindustrialization in USA - Euler Hermes

Reindustrialization in USA - Euler Hermes


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no. 1187Special ReportThe <strong>Re<strong>in</strong>dustrialization</strong>of the United States<strong>Euler</strong> <strong>Hermes</strong> Economic Research DepartmentEconomic Outlookwww.eulerhermes.com | no. 1187

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United StatesContentsn° 1187Special ReportThe <strong>Re<strong>in</strong>dustrialization</strong> of the United StatesEconomic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United StatesEditorialpage 3page 4 u Overview – Like a phoenix ris<strong>in</strong>g from the ashes page 4page 6 u It’s the (macro)economy stupid! page 6• Fall<strong>in</strong>g over the ‘fiscal cliff’: why the short-term outlook is worry<strong>in</strong>g page 7• Which favorable market conditions support a full-fledged U.S. recovery? page 8• Another positive sign for the <strong>in</strong>dustrial fabric: <strong>in</strong>solvencies on the decrease page 9page 10 u Manufactur<strong>in</strong>g: the cornerstone of the re<strong>in</strong>dustrialization of the U.S. page 10• 2000-2010: important but los<strong>in</strong>g momentum and restructur<strong>in</strong>g massively page 11• Over-perform<strong>in</strong>g <strong>in</strong> the aftermath of the crisis to rega<strong>in</strong> higher ground page 13• The guest stars of re<strong>in</strong>dustrialization page 14page 16 u Reason #1: Lower labor costs page 16• Competitiveness: Advantage U.S.A. page 16• A new era of manufactur<strong>in</strong>g: “on-shor<strong>in</strong>g” page 17• Focus on… the Southern draw page 18page 21 u Reason #2: The gas bonanza page 21• The (positive) double price effect <strong>in</strong> the short-run page 21• Chemicals and primary metals <strong>in</strong>dustries 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 bus<strong>in</strong>ess climate page 28• Objective: Innovation page 29• Cash hoard <strong>in</strong>st<strong>in</strong>ct: debunk<strong>in</strong>g the myth page 31• Focus on... California, the <strong>in</strong>novation <strong>in</strong>cubator page 32<strong>Euler</strong> <strong>Hermes</strong> Economic outlook is issued ten times a year by the Economic research department of <strong>Euler</strong> <strong>Hermes</strong>. It is also available on subscription for other bus<strong>in</strong>essesand 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 <strong>USA</strong>), ClémentBouillet (Intern) • Sector Research: Yann Lacroix (Manager), Bruno Goutard, Marc Liv<strong>in</strong>ec, Didier Moizo (Sector Economists) • Country Risk Research: David Atk<strong>in</strong>son(Manager), Andrew Atk<strong>in</strong>son, Manfred Stamer (Economists) • Graphic Design: Claire Mabille • Editors: Mart<strong>in</strong>e Benhadj • Support: Jaclyn Schneider, Alix McCabe • Forfurther <strong>in</strong>formation, contact: the Economic Research Department of <strong>Euler</strong> <strong>Hermes</strong> at 1, place des Saisons 92‐048 Paris La Défense Cedex – Tel.: +33 (0) 1‐84‐11‐53‐77 u <strong>Euler</strong><strong>Hermes</strong> 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 • Photoengrav<strong>in</strong>g: Evreux Compo,Evreux, France – Permit november‐2012—Bull 1176; ISSN 1‐162 – 2‐881 © 25 January 20132

Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>EditorialAn 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 uncerta<strong>in</strong>ty surround<strong>in</strong>g the fiscal situation and the ongo<strong>in</strong>g debt crisis <strong>in</strong>Europe are the two largest headw<strong>in</strong>ds currently affect<strong>in</strong>g the U.S. economy. Beyond thetumult <strong>in</strong> 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 beg<strong>in</strong>s a quest to better understand what underly<strong>in</strong>g trends and dramaticregime changes may support a robust long-term growth <strong>in</strong> the U.S.The potential key to America’s long-term growth lies <strong>in</strong> the very heart of the country, itsmanufactur<strong>in</strong>g 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 determ<strong>in</strong>ants to thisbold assumption which we analyze <strong>in</strong> this report:• unit labor costs are among the lowest <strong>in</strong> the <strong>in</strong>dustrialized 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 <strong>in</strong> the majority of U.S.export markets; and• the hous<strong>in</strong>g market is slowly rebound<strong>in</strong>g.If you add to this a conducive policy environment and the def<strong>in</strong>ite commitment tocont<strong>in</strong>ue to improve it, there are better days ahead for the U.S. and its private sector.After the perfect storm (the commodity, f<strong>in</strong>ancial and jobs crises), now would be thetime for an alignment of the stars. Manufactur<strong>in</strong>g could lead the U.S. economy out ofimmobilism, and is poised to be a major contributor go<strong>in</strong>g forward.What needs to be done to ma<strong>in</strong>ta<strong>in</strong> the momentum? The private sector <strong>in</strong> the U.S.cont<strong>in</strong>ues to be relatively self-re<strong>in</strong>vent<strong>in</strong>g without much <strong>in</strong>tervention. But like a goodgardener, the government may want to occasionally water the flowers. In this report,we outl<strong>in</strong>e several actions necessary to catalyze this rebirth.Of course, we will cont<strong>in</strong>ue to monitor this re<strong>in</strong>dustrialization phenomenon andaccompany our clients on the still bumpy road ahead. It is all about good ‘ol production,key <strong>in</strong>dustries such as the energy and chemicals sector and the agri-food bus<strong>in</strong>esses,and growth markets: the South, Texas, and California. If supported, the real economyshould <strong>in</strong>deed rega<strong>in</strong> its strength. _ Ludovic Subran3

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United StatesOverviewLike a PhoenixRis<strong>in</strong>g from the AshesA turn<strong>in</strong>g po<strong>in</strong>t?Ever s<strong>in</strong>ce the Industrial Revolution began <strong>in</strong> the1800s, the U.S. manufactur<strong>in</strong>g sector has alwaysbeen of vital economic importance. It has often beenthe eng<strong>in</strong>e of growth, historically provid<strong>in</strong>g strongcontributions to Gross Domestic Product (GDP).Dur<strong>in</strong>g the n<strong>in</strong>eteenth and twentieth centuries economic<strong>in</strong>dustrial concentrations developed across theU.S. In the South, proximity to cotton growers helpedbuild the textile <strong>in</strong>dustry. From the Northeast to thecentral Midwest, steel and iron products emergedand as a result the automobile <strong>in</strong>dustry arose <strong>in</strong> theMidwest. In the Southwest, an abundance of oil andnatural gas shaped the energy <strong>in</strong>dustry. And <strong>in</strong> theWest, high technology emerged dur<strong>in</strong>g and afterWWII as a product of the defense <strong>in</strong>dustry.However this robust manufactur<strong>in</strong>g economy cameunder <strong>in</strong>tense pressures <strong>in</strong> the latter half of thetwentieth century from the development of theglobal economy. Countries such as Japan, Mexicoand Ch<strong>in</strong>a emerged with enormous supplies of peoplewho were will<strong>in</strong>g to work for a fraction of U.S.wages, while concurrently, American consumersdeveloped a thirst for <strong>in</strong>expensive goods from overseas.American bus<strong>in</strong>esses could not resist the lure ofmuch lower manufactur<strong>in</strong>g costs available <strong>in</strong> thesecountries and began to send U.S jobs overseas, decimat<strong>in</strong>gmany <strong>in</strong>dustries such as appliances, furniture,heavy equipment, shipbuild<strong>in</strong>g, steel, textiles, andmany others. As a result of this shift, the U.S. manufactur<strong>in</strong>g<strong>in</strong>dustry shrank drastically as a percentage4

Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>of the entire economy and millions of manufactur<strong>in</strong>gjobs were lost.But this trend is now on the cusp of reversal for severalreasons. U.S. manufactur<strong>in</strong>g productivity hasgrown at a relatively high rate compared to other<strong>in</strong>dustrialized nations, mak<strong>in</strong>g U.S. unit labor coststhe lowest <strong>in</strong> the <strong>in</strong>dustrialized world. Highly skilledAmerican workers can more reliably produce highervalue-added goods. Costs such as transportation,<strong>in</strong>ventory and lag time are lower while tax <strong>in</strong>centivesand cheap energy make manufactur<strong>in</strong>g <strong>in</strong> the U.S.even more attractive.As a result, U.S. manufactur<strong>in</strong>g is enjoy<strong>in</strong>g a renaissanceand recently led the country out of the mostsevere recession s<strong>in</strong>ce the Great Depression, contribut<strong>in</strong>gmuch more to GDP growth than one wouldexpect given its weight <strong>in</strong> the economy. In fact, afterthe recession, the only job growth outside the servicessector was <strong>in</strong> manufactur<strong>in</strong>g. Of course theoutlook is brighter for some <strong>in</strong>dustries and regionsthan it is for others, but the bus<strong>in</strong>ess environmentsuggests that conditions go<strong>in</strong>g forward will cont<strong>in</strong>ueto be favorable, even <strong>in</strong> a world of uncerta<strong>in</strong>ty.Short-lived effect or durable trends?Beyond positive macroeconomic factors such ascredit availability and low <strong>in</strong>terest rates, the threedeterm<strong>in</strong>ants of this re<strong>in</strong>dustrialization are:• lower labor costs, especially <strong>in</strong> the southernstates;• lower cost of energy result<strong>in</strong>g from the shalegas bonanza; and• the ability to steer the economic environmentto leverage the positive cost reductions fromwhich companies have been benefitt<strong>in</strong>g.Another factor is the new awareness of operat<strong>in</strong>gvulnerability created by an over-stretched supplycha<strong>in</strong>. In 2011, the localized production disruptions<strong>in</strong> Japan follow<strong>in</strong>g an earthquake and a tsunami, and<strong>in</strong> Thailand from flood<strong>in</strong>g, disrupted <strong>in</strong>dustrial operationsall around the world. The <strong>in</strong>cidents highlightedhow dangerous exposure to foreign supply cha<strong>in</strong>scould be and how a lack of preparedness for theserisks causes difficulty <strong>in</strong> implement<strong>in</strong>g risk managementprotocols for what were previously thought tobe unth<strong>in</strong>kable events.Go<strong>in</strong>g forward, and when exam<strong>in</strong><strong>in</strong>g specific U.S.<strong>in</strong>dustry dynamics, it seems important to selectivelysupport:• The “sh<strong>in</strong><strong>in</strong>g” <strong>in</strong>dustries mentioned above, <strong>in</strong>order to identify more specifically the grow<strong>in</strong>gsubsectors (agriculture, construction/m<strong>in</strong><strong>in</strong>g,mach<strong>in</strong>ery, medical equipment, petroleum-relatedproducts, semiconductor-related products)and exam<strong>in</strong>e their dynamics. The automotive sectoralso seems to be reviv<strong>in</strong>g from its ashes;• A conducive bus<strong>in</strong>ess climate with a clear emphasison <strong>in</strong>novation. The new era <strong>in</strong> the bus<strong>in</strong>essenvironment (tighten<strong>in</strong>g gap between Ch<strong>in</strong>eseand American wages, appreciation of the yuan,access to cheap energy <strong>in</strong> the U.S., structural highoil prices, mount<strong>in</strong>g awareness of the vulnerabilitycaused by an over-stretched supply cha<strong>in</strong>) couldhelp U.S. manufactur<strong>in</strong>g susta<strong>in</strong> this momentum.U.S. computer/electronic product manufactur<strong>in</strong>g,mach<strong>in</strong>ery, furniture and miscellaneous productmanufactur<strong>in</strong>g are expected to take advantageof the fall<strong>in</strong>g Ch<strong>in</strong>ese wage competitiveness.Chemicals and primary metal sectors should ga<strong>in</strong>ground thanks to cheap shale gas; and• Regional strengths make the efficient specializationof the <strong>in</strong>dividual states feasible. The dynamics<strong>in</strong> the South, Texas, and California - particularlywith niche sectors, <strong>in</strong>centives, and opportunities- are particularly important as they appear to bethe renewed growth centers of the U.S.This degree of <strong>in</strong>dustrial <strong>in</strong>vestment demands thatthe U.S. economy present sound, reliable growthprospects and that the f<strong>in</strong>ancial system (banks andbond markets) support these capital <strong>in</strong>tensive projects.It also requires a confidence <strong>in</strong>jection for theprivate sector to cont<strong>in</strong>ue to re-shore and <strong>in</strong>vest <strong>in</strong>the economy. F<strong>in</strong>ally, the path to <strong>in</strong>dustrial rebirth willrequire a highly skilled workforce. ©5

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> 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 tocont<strong>in</strong>ue to unleash growth drivers: consumption,private sector <strong>in</strong>vestments, and exports to offset thegradual withdrawal of the post-crisis governmentspend<strong>in</strong>g, without caus<strong>in</strong>g damage. Is this feasible?We argue that there are some green shoots whichcould lead to a favorable macroeconomic backdrop,aga<strong>in</strong>st which what we call the “<strong>Re<strong>in</strong>dustrialization</strong>of 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 Spend<strong>in</strong>g 71% 2.5 2.0 2.2 2.6Public Spend<strong>in</strong>g 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) 101.0 104.8 108.1 110.1Nom<strong>in</strong>al GDP ** 15 076 15 684 16 230 16 909Change over the period, unless otherwise <strong>in</strong>dicated: * contribution to GDP growth ** U.S.D billionsSource : IHS Global Insight, <strong>Euler</strong> <strong>Hermes</strong>6

Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>Fall<strong>in</strong>g over the ‘fiscal cliff’:why the short-term outlook is worry<strong>in</strong>gThe U.S. economy still faces significantheadw<strong>in</strong>ds result<strong>in</strong>g <strong>in</strong> expectationsof sub-par GDP growth and elevatedunemployment for 2013. The FederalReserve has started another roundof quantitative eas<strong>in</strong>g (QE3) to helpstimulate the hous<strong>in</strong>g market and thebroader economy. However, QE3 islikely to have a very limited effect anduncerta<strong>in</strong>ty surround<strong>in</strong>g the fiscalsituation is likely to contribute to theweakness.u Recent DevelopmentsThe U.S. economy lost 9 million jobs <strong>in</strong> the recessionand as of August 2012, more than three years s<strong>in</strong>ce therecession ended, it has only recovered about half thatamount. The unemployment rate, despite a recentdecl<strong>in</strong>e, has rema<strong>in</strong>ed above 8% for three and one halfyears and the labor participation rate is the lowest ithas been <strong>in</strong> 30 years. GDP has been correspond<strong>in</strong>glyweak, grow<strong>in</strong>g only 2.1% over the past four quarters.Manufactur<strong>in</strong>g, which helped lead the economy outof recession, has been stumbl<strong>in</strong>g for several months,and while consumers have enjoyed some recentga<strong>in</strong>s <strong>in</strong> <strong>in</strong>come, consumption still rema<strong>in</strong>s weak.Positives have <strong>in</strong>cluded surpris<strong>in</strong>gly strong auto sales,a firm<strong>in</strong>g hous<strong>in</strong>g market, and fall<strong>in</strong>g <strong>in</strong>solvencies.u Mixed perspectives for 2013Loom<strong>in</strong>g events will make for yet another year ofsub-par GDP growth <strong>in</strong> 2013 - around 2% - withunemployment most likely rema<strong>in</strong><strong>in</strong>g near 8%. Theuncerta<strong>in</strong>ty of the fiscal situation at the beg<strong>in</strong>n<strong>in</strong>g of2013 is weigh<strong>in</strong>g 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 economy<strong>in</strong>to recession. However, the most likely scenario isthat most of the fiscal contraction will be avoided s<strong>in</strong>ceboth Republicans and Democrats believe that such arapid fiscal withdrawal would be politically dangerousand a serious blow to the economy. Yet uncerta<strong>in</strong>tyrema<strong>in</strong>s as the fiscal situation issues may not beaddressed entirely by the new session of Congress.On the monetary side, while QE3 is <strong>in</strong>tended to boostthe hous<strong>in</strong>g sector by lower<strong>in</strong>g mortgage rates, theplan is unlikely to help much s<strong>in</strong>ce mortgage ratesare already near historical lows. Risk-averse bankershave slowed the mortgage market, not high <strong>in</strong>terestrates. Nonetheless, there has been some firm<strong>in</strong>g <strong>in</strong>several hous<strong>in</strong>g market measures such as prices andunit sales, but it is premature to call a bottom. On anupbeat note, <strong>in</strong>solvencies are expected to fall 8% <strong>in</strong>2013 due to positive, albeit weak GDP growth.• • •Estimat<strong>in</strong>g the impact of the fiscal situationu What: A comb<strong>in</strong>ation of higher taxes and reducedspend<strong>in</strong>g at the start of 2013.u How much: Fiscal tighten<strong>in</strong>g would amount to a good4% of GDP <strong>in</strong> 2013 (5% of GDP, if changes <strong>in</strong> revenues andspend<strong>in</strong>g unl<strong>in</strong>ked to specific policies are <strong>in</strong>cluded). Ifthe automatic spend<strong>in</strong>g cuts (across-the-board spend<strong>in</strong>gcuts) under the Budget Control Act are avoided,fiscal tighten<strong>in</strong>g would be reduced to between 1.8% ofGDP and 2.7% of GDP, respectively. Apply<strong>in</strong>g an overallfiscal multiplier of 0.75, the drag on GDP growth wouldamount to between 1.4% and 2%, respectively.u To put 2013 fiscal tighten<strong>in</strong>g <strong>in</strong>to perspective: Generalgovernment net borrow<strong>in</strong>g amounted to 8.7% of GDP <strong>in</strong>H1 2012, down from 10.25% of GDP <strong>in</strong> 2011.7

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States• • •Which favorable market conditions support a full-fledged U.S. recovery?The favorable economic environment <strong>in</strong> the short-runfor private sector development is a product of dist<strong>in</strong>ctlyunfavorable conditions which actually started well beforethe Great Recession. Accommodat<strong>in</strong>g monetarypolicy, credit availability, lower cost of capital and the(timid) rebound <strong>in</strong> the hous<strong>in</strong>g 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 thehous<strong>in</strong>g bubble burst <strong>in</strong> 2006, it destroyed billions ofdollars of wealth and wreaked havoc on the economy.As a result, the subprime mortgage crisis developed<strong>in</strong> 2007, impair<strong>in</strong>g the f<strong>in</strong>ancial markets. In 2008oil prices rose to a record high creat<strong>in</strong>g yet anotherhuge drag on the economy. As the f<strong>in</strong>ancial crisisreached its height <strong>in</strong> the Fall of 2008, credit marketscame to a virtual standstill, paralyz<strong>in</strong>g the economy.To counteract the chaos, the Federal Reserve droveshort-term <strong>in</strong>terest rates virtually down to 0%, andthen <strong>in</strong>jected $1.4 trillion of liquidity <strong>in</strong>to the f<strong>in</strong>ancialsystem, more than doubl<strong>in</strong>g its balance sheet <strong>in</strong> justa few weeks. Congress and the President passed the$700 billion Troubled Asset Relief Program (TARP) tokeep impaired banks function<strong>in</strong>g, and <strong>in</strong> early 2009,an $800 billion stimulus package was passed <strong>in</strong> anattempt to jump-start the economy. By this time theeconomy was los<strong>in</strong>g over 700,000 jobs per month, thefastest rate <strong>in</strong> over 60 years (Figure 1). Although therecession technically ended <strong>in</strong> June of 2009, only abouthalf of the total jobs lost have been recovered, and GDPhas averaged a mere 2.2% annualized growth rates<strong>in</strong>ce 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 manufactur<strong>in</strong>g rebound. The deep recessionhad caused manufacturers to cut employment to thebone, so after the recovery began they were able tooperate with m<strong>in</strong>imal labor costs us<strong>in</strong>g highly productive,motivated workers. Unit labor costs plunged<strong>in</strong> the manufactur<strong>in</strong>g <strong>in</strong>dustry, particularly <strong>in</strong> somesouthern states. At the same time that labor costs werefall<strong>in</strong>g, so were the costs of capital. The Fed had drivenshort-term rates virtually to zero, which was an open<strong>in</strong>vitation for <strong>in</strong>vestment. Start<strong>in</strong>g <strong>in</strong> the fourth quarterof 2009, the <strong>in</strong>vestment component of GDP set a blister<strong>in</strong>gpace over four quarters, grow<strong>in</strong>g at annualizedrates of 41%, 20%, 15% and 16% respectively - whilethe economy as a whole grew less than 3%. Creditconditions eased substantially and commercial and<strong>in</strong>dustrial loans have grown more than 10% annuallys<strong>in</strong>ce 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 boost<strong>in</strong>g stock prices. Energy costsfor manufacturers have also fallen, due <strong>in</strong> part to theemergence of very cheap shale gas. The hous<strong>in</strong>gmarket is now firm<strong>in</strong>g (Figure 3), sett<strong>in</strong>g the stagefor a rebound <strong>in</strong> manufacturers of home build<strong>in</strong>gmaterials and appliances.Approximately three quarters of U.S. manufactur<strong>in</strong>g issold domestically, where conditions are very good, yetthe export markets are also <strong>in</strong> surpris<strong>in</strong>gly good condition.Canada is the largest market for U.S. exports, consum<strong>in</strong>gapproximately 19% of all U.S. exports. WhileCanadian GDP has experienced slow growth recentlyand is expected to grow only about 2% <strong>in</strong> 2013, theCanadian economy is <strong>in</strong> much better fiscal and monetarycondition than most <strong>in</strong>dustrialized nations, and1. Jobs Created and the Unemployment Rate2. Commercial and Industrial Loansquaterly annualized % change3. US Hous<strong>in</strong>g 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)20102011Exist<strong>in</strong>g 1-FamilyHome sales ( right scale)Source: National Association of Realtors, Census300020128

Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>therefore offers some stability to U.S. exports. Mexicois the next largest importer of U.S. goods, consum<strong>in</strong>gabout 14% of all U.S. exports. Unlike much of the worlds<strong>in</strong>ce the recession ended <strong>in</strong> 2009 Mexico has enjoyedsteady and strong growth, with robust annual GDPgrowth of 4.6% versus a long-term average of 2.7%,clearly bod<strong>in</strong>g well for future U.S. exports. Centraland South America absorb 11% of U.S. exports, andprospects for cont<strong>in</strong>ued strength <strong>in</strong> these emerg<strong>in</strong>geconomies are good. Ch<strong>in</strong>a absorbs 7% of U.S. exports,and the long-term growth of the Ch<strong>in</strong>ese economy isexpected to rema<strong>in</strong> very strong, despite a recent softpatch. Asia (ex-Ch<strong>in</strong>a and ex-Japan) consumes 13%of exports and like Lat<strong>in</strong> America, growth <strong>in</strong> theseemerg<strong>in</strong>g 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 eas<strong>in</strong>g policies have devaluedthe dollar, mak<strong>in</strong>g export prices cheaper and boost<strong>in</strong>gtheir 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 the<strong>in</strong>dustrial fabric: <strong>in</strong>solvencieson the decreaseAs shown <strong>in</strong> Figures 4 and 5, bus<strong>in</strong>ess <strong>in</strong>solvencieshave overall been on a slightly downward trend overthe past decade. Insolvencies rose as the economydeteriorated through 2007, and <strong>in</strong>creased further<strong>in</strong> 2008. Insolvencies often are a lead<strong>in</strong>g <strong>in</strong>dicator,as they were when they fell sharply <strong>in</strong> 2009 as therecession came to an end. By that time, most of thevulnerable bus<strong>in</strong>esses had already failed, and thosethat survived had done so by:• reduc<strong>in</strong>g debt on their balance sheets,• becom<strong>in</strong>g more risk-averse by not extend<strong>in</strong>g asmuch risky credit to other bus<strong>in</strong>esses, and• by reduc<strong>in</strong>g headcount.These factors allowed bus<strong>in</strong>esses to survive eventhough they put a weight on the economy which hasyet to be fully removed.4. Bankruptcies<strong>in</strong> millions300002500020000150001000050000198119831985198719891991Sources: Adm<strong>in</strong>istrative Office of the U.S. Court, <strong>Euler</strong> <strong>Hermes</strong>1993199519971999200120032005Bankruptcies2007200920112013Look<strong>in</strong>g at 2013, expectations are that the downwardtrend <strong>in</strong> <strong>in</strong>solvencies will cont<strong>in</strong>ue. We expectthe decrease <strong>in</strong> <strong>in</strong>solvencies to be 10% <strong>in</strong> 2012 and6% <strong>in</strong> 2013. This will happen for two reasons: first,GDP growth <strong>in</strong> 2013 is forecast to be around 2%. Thisshould suffice to help decrease the number of <strong>in</strong>solvencies<strong>in</strong> the economy. Secondly, bus<strong>in</strong>esses are stilloperat<strong>in</strong>g <strong>in</strong> the risk-averse manner which helpedthem survive the recession. They are carry<strong>in</strong>g lowerdebt levels on their balance sheets, provid<strong>in</strong>g themmore of a cushion should there be another downturn.And they are still runn<strong>in</strong>g <strong>in</strong> a very lean modeby keep<strong>in</strong>g operational costs and payrolls as tight aspossible.5. Insolvencies to Decrease <strong>in</strong> the Manufactur<strong>in</strong>g Sectorannual change, <strong>in</strong> %<strong>in</strong>g tends to be more sensitive to thebus<strong>in</strong>ess cycle as Figure 5 clearly shows, and as suchtends to be riskier as well. Manufactur<strong>in</strong>g <strong>in</strong>solvenciesrose more sharply than the total economy <strong>in</strong> therecession and fell more sharply <strong>in</strong> the recovery, andwere higher than the total throughout virtually all ofthis time period. However, it is important to note thatafter the recent recession, manufactur<strong>in</strong>g <strong>in</strong>solvenciesclosed the gap with the total economy becauseof the sector’s outperformance.0.20.02003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013Total Manufactur<strong>in</strong>g ServicesSource: <strong>Euler</strong> <strong>Hermes</strong>The services sector is less sensitive to the bus<strong>in</strong>esscycle, as demonstrated by how much less <strong>in</strong>solvenciesfluctuated. S<strong>in</strong>ce it is less risky it also has an <strong>in</strong>solvencyrate lower than the total economy. ©9

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United StatesManufactur<strong>in</strong>g:the cornerstone of the re<strong>in</strong>dustrialization of the U.S.For many years and even decades, the U.S.manufactur<strong>in</strong>g sector has become synonymouswith economic decl<strong>in</strong>e, heavy job cuts, darkDickensian facilities and a hopeless outlook<strong>in</strong> collective m<strong>in</strong>ds. The three year-longmanufactur<strong>in</strong>g revival marks an opportunity toreview these entrenched stereotypes. The lastdecade has reshaped the U.S. <strong>in</strong>dustrial landscapeand provided the foundations for this improvement,but s<strong>in</strong>ce 2010 a handful of buoyant sectors haveaccomplished what had been <strong>in</strong>conceivable formany years: restor<strong>in</strong>g faith <strong>in</strong> U.S. manufactur<strong>in</strong>g.6. Manufactur<strong>in</strong>g Employment Depend<strong>in</strong>g on ProductivityJobs (thousands)2000015000100002000 01Manufactur<strong>in</strong>g employmentManufactur<strong>in</strong>g employment - Productivity 2000Manufactur<strong>in</strong>g employment - Output 2000020304Source: Bureau of Economic Analysis – Bureau of Labor Statistics05060708091010

Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>2000-2010:momentum lost followed by massive restructur<strong>in</strong>gu Limited role <strong>in</strong> the U.S. economy?Dur<strong>in</strong>g the previous decade, the manufactur<strong>in</strong>gweight <strong>in</strong> the U.S. economy rema<strong>in</strong>ed fairly steady,at 12.4% (real value added) of GDP <strong>in</strong> 2000 and 2010,with limited fluctuations over the period (high of 12.9%<strong>in</strong> 2007 / low of 11.5% <strong>in</strong> 2009). The growth yearswitnessed noticeable contributions from the manufactur<strong>in</strong>gsector to the improvement of the economy- a bit higher than would have been expected given itsweight <strong>in</strong> the U.S. economy - but they were always lessthan the contributions from the services sector. Conversely,the significant drops <strong>in</strong> manufactur<strong>in</strong>g value-add,which occurred dur<strong>in</strong>g the recessions, werea significant drag on the U.S. economy and, generallyspeak<strong>in</strong>g, were major downward economic drivers.u Sharp restructur<strong>in</strong>g <strong>in</strong> manufactur<strong>in</strong>gemploymentBetween 2000 and 2010, the manufactur<strong>in</strong>g sectorlost 5.7 million jobs (-33%). In Figure 6, we comparethe actual employment <strong>in</strong> manufactur<strong>in</strong>g 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 ga<strong>in</strong>s. This scenariomore closely matches what actually happened,suggest<strong>in</strong>g that any drop <strong>in</strong> output dur<strong>in</strong>g 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 ma<strong>in</strong> driver for manufactur<strong>in</strong>gjob losses dur<strong>in</strong>g the last decade was certa<strong>in</strong>ly productivityga<strong>in</strong>s. The output decrease result<strong>in</strong>g fromthe recession, shipp<strong>in</strong>g jobs overseas, and the lowercompetitiveness of U.S. manufactur<strong>in</strong>g <strong>in</strong> the globaleconomy contributed much less to the decl<strong>in</strong>e <strong>in</strong>jobs. 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 goodsmanufactur<strong>in</strong>g, which posted a -35% decrease <strong>in</strong>employment dur<strong>in</strong>g 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 allmanufactur<strong>in</strong>g. The difference suggests that durablegoods manufactur<strong>in</strong>g was more sensitive to economicconditions than overall manufactur<strong>in</strong>g. 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 manufactur<strong>in</strong>g sectorwitnessed a sharper drop <strong>in</strong> employment (-40% orloss of 735,000 jobs). The dramatic decl<strong>in</strong>e <strong>in</strong> jobswas a result of the adverse effects of strong productivityimprovements (+79% over the period), whichwere only partially offset by jobs created due to<strong>in</strong>creas<strong>in</strong>g activity.Between 2000 and 2010, the mach<strong>in</strong>ery sectordemonstrated better resistance to erosion as itsemployment dropped by a relatively smaller -32%(-467,000 jobs). Lower productivity enhancement(+27% dur<strong>in</strong>g the decade) led to a lower adverseimpact on job losses.In 2010, non-durable goods manufactur<strong>in</strong>g jobsdropped -30% from 2000 (-1.9 million jobs). Theimpact of productivity improvements was four timesas large as the impact of activity fluctuations dur<strong>in</strong>gthe last decade.• • •11

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States• • •u Further sector concentration of the U.S.manufactur<strong>in</strong>g landscapeFigure 7 shows <strong>in</strong>dustries plotted on the horizontalaxis of growth <strong>in</strong> value added, versus the verticalaxis of growth <strong>in</strong> total output, over the time period2000-2010. The strongest <strong>in</strong>dustries are seen <strong>in</strong> theupper right quadrant, with the computer and electronics<strong>in</strong>dustry the clear standout with real valueadded, grow<strong>in</strong>g +417% s<strong>in</strong>ce 2000. The petroleumand coal <strong>in</strong>dustry was also a strong performer withother attractive <strong>in</strong>dustries <strong>in</strong>clud<strong>in</strong>g food and chemicals.In general, durable goods manufactur<strong>in</strong>g, suchas mach<strong>in</strong>ery and “other transportation” (exclud<strong>in</strong>gautomotive), along with “miscellaneous others”performed quite well. The weaker <strong>in</strong>dustries are <strong>in</strong>the lower left quadrant and are dom<strong>in</strong>ated by lowervalue-added, mature bus<strong>in</strong>esses 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 lead<strong>in</strong>g to a stronger concentration<strong>in</strong> U.S. manufactur<strong>in</strong>g. The contributionof the top five sectors to U.S. manufactur<strong>in</strong>g valueadded has risen from 51% <strong>in</strong> 2000 to 59% <strong>in</strong> 2010.u Further sector concentration of the U.S.manufactur<strong>in</strong>g landscapeU.S. manufactur<strong>in</strong>g has expanded along with the worldmarket <strong>in</strong> terms of total sales, but has steadily lost marketshare of sales, contract<strong>in</strong>g from 22% <strong>in</strong> 2000 to 17% <strong>in</strong>2011(estimated). On the other hand, U.S. manufactur<strong>in</strong>ghas managed to preserve its position <strong>in</strong> global valueadded, with a market share slid<strong>in</strong>g only slightly from 23%to 22% over the same period, <strong>in</strong>creas<strong>in</strong>g slightly <strong>in</strong> 2012.The data suggests two possible explanations. First, itcould be that U.S. manufactur<strong>in</strong>g has shifted towardhigher value added activities and has deserted thosemanufactur<strong>in</strong>g sub-<strong>in</strong>dustries 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 made<strong>in</strong> Ch<strong>in</strong>a much more cheaply than <strong>in</strong> the U.S., driv<strong>in</strong>g U.S.manufacturers out of those markets. The huge <strong>in</strong>flux ofsimple, cheap Ch<strong>in</strong>ese goods is a perfect example of thisphenomenon. Labor and capital displaced by lower costgoods will then be moved to higher value-added manufactur<strong>in</strong>g.This condition is a perfect demonstrationof the uncomfortable notion of “creative destruction”which is often very necessary for an economy to grow<strong>in</strong> the long run but which is so pa<strong>in</strong>ful <strong>in</strong> the short run.In this case the data may actually <strong>in</strong>dicate 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 marg<strong>in</strong>. Thus, thedata might suggest that American manufacturers aretak<strong>in</strong>g smaller profit marg<strong>in</strong>s <strong>in</strong> a global environmentof slow growth and low <strong>in</strong>flation creat<strong>in</strong>g very strongdownward pric<strong>in</strong>g pressures. This second explanationdoes not <strong>in</strong>dicate a flaw <strong>in</strong> U.S. manufactur<strong>in</strong>g, s<strong>in</strong>cemanufacturers around the world have to contend withthe same conditions.7. Production and Value Added Index Changes 2010/2000 (Real Terms)Output changes <strong>in</strong> %Source: Bureau of Economic Analysis – Bureau of Labor Statistics12B. Breakdown of the Manufactur<strong>in</strong>g Value Added by SectorRank<strong>in</strong>g Rank<strong>in</strong>g Sector Weight manufactur<strong>in</strong>g2010 2000 value added <strong>in</strong> 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 Mach<strong>in</strong>ery 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 m<strong>in</strong>eral product mfg 2.1%15 15 Pr<strong>in</strong>t<strong>in</strong>g 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 <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>Over-perform<strong>in</strong>g <strong>in</strong> the aftermath of the crisis to rega<strong>in</strong>higher groundu Manufactur<strong>in</strong>g rebound <strong>in</strong> the aftermath of thecrisisBy the end of 2011, U.S. GDP had recovered to levelsjust before the recession started <strong>in</strong> the fourthquarter of 2007. This recovery has been boosted bya substantial contribution from the manufactur<strong>in</strong>gsector. As demonstrated <strong>in</strong> Table C, <strong>in</strong> 2010, manufactur<strong>in</strong>gwas 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, manufactur<strong>in</strong>g <strong>in</strong>deed led the economyout of the severe recession of 2008 and 2009.Furthermore, as shown <strong>in</strong> Figure 8, the only sectorto provide slightly more growth <strong>in</strong> 2010 and 2011was the entire services sector, which is six to seventimes larger than the manufactur<strong>in</strong>g sector.<strong>in</strong>g the recession and how rapidly it has reboundeds<strong>in</strong>ce. Manufactur<strong>in</strong>g has dramatically outpaced servicesfor the last two years and has fully demonstratedits role as the eng<strong>in</strong>e of the economic recovery. Theonly sector to fall more steeply than manufactur<strong>in</strong>gwas construction, which plummeted as a result of theburst hous<strong>in</strong>g bubble, and has still yet to fully recover.In the wake of the decl<strong>in</strong>e caused by the economiccrisis, the manufactur<strong>in</strong>g sector has been a modestcontributor to the improvement of the employmentscenario. However, this tepid <strong>in</strong>crease of manufactur<strong>in</strong>gemployment also signaled the end of a cont<strong>in</strong>ueddecl<strong>in</strong>e which has been ongo<strong>in</strong>g for decades.• • •Figure 9 demonstrates that s<strong>in</strong>ce 2001 the U.S. manufactur<strong>in</strong>gsector has shown higher sensitivity to theeconomic environment than the services sector has.It displays the annual <strong>in</strong>crease <strong>in</strong> value added by sector,highlight<strong>in</strong>g how much manufactur<strong>in</strong>g fell dur‐C. Contribution of the Manufactur<strong>in</strong>g Sector to US Economic Growth2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011Part <strong>in</strong> U.S. GDP (<strong>in</strong> %) 11.7% 11.8% 11.9% 12.4% 12.5% 12.7% 12.9% 12.2% 11.5% 12.4% 12.8%Manufactur<strong>in</strong>g part<strong>in</strong> 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 <strong>in</strong> real value; ( ): negativeSource: Bureau of Economic Analysis8. Contribution to U.S. GDP Changes by Sector4%3%2%1%0%-1%9. Annual Change <strong>in</strong> Real Value Added12%9%6%3%0%-3%-2%Service-6%-3%-4%-5%2001M<strong>in</strong><strong>in</strong>gConstructionManufactur<strong>in</strong>gAgriculture2002 2003 2004 2005200620072008200920102011-9%-12%-15%2001Manufactur<strong>in</strong>gServicesConstruction2002 2003 2004 2005200620072008200920102011Source: Bureau of Economic AnalysisSource: Bureau of Economic Analysis13

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States• • •u Broad improvement of the manufactur<strong>in</strong>gsectorAs shown <strong>in</strong> Figure 10, while manufactur<strong>in</strong>g productionis still 4.5% below its 2007 peak, it steadilyrebounded dur<strong>in</strong>g 2010 and 2011, and cont<strong>in</strong>uedto grow <strong>in</strong> the first half 2012. Manufactur<strong>in</strong>g productivityhas dramatically improved over the lastdecade (+45% <strong>in</strong> the first half of 2012 comparedto 2000) despite slow<strong>in</strong>g somewhat dur<strong>in</strong>g therecession. This improvement <strong>in</strong> productivity is aresult of a 6% <strong>in</strong>crease <strong>in</strong> output from 2000 to2012, while the workforce shrunk by more than30% over the same period. U.S. manufactur<strong>in</strong>goperat<strong>in</strong>g profitability bounced back dramatically<strong>in</strong> 2010/2011, and has so far stabilized at thehighest level <strong>in</strong> a decade despite previous periodsof more robust economic growth. Unit laborcosts <strong>in</strong> manufactur<strong>in</strong>g have fallen below their2000 level, with much of the downturn com<strong>in</strong>gafter the recession. Manufactur<strong>in</strong>g employmentbottomed out <strong>in</strong> 2010 and has started to slowlyrega<strong>in</strong> ground after two decades of deterioration.Exports of manufactured goods have jumped formuch of the last decade and displayed recordgrowth <strong>in</strong> 2010 <strong>in</strong>to 2011. ©10. Manufactur<strong>in</strong>g ProductionIndex basis 100 =‐2000200150ExportsProductivityOperat<strong>in</strong>g profitabilityProductionUnit labor costEmploymentThe guest stars of re<strong>in</strong>dustrializationu The “sh<strong>in</strong><strong>in</strong>g” manufactur<strong>in</strong>g sectors dur<strong>in</strong>g the2010/2011 rebound and afterwardU.S. manufactur<strong>in</strong>g has cont<strong>in</strong>ued along the pathbegun <strong>in</strong> the previous decade and the aforementionedlead<strong>in</strong>g sectors have played a crucial role <strong>in</strong>the dramatic 2010 and 2011 growth. Let’s considermore precisely the underly<strong>in</strong>g factors which contributedto these improvements amid the most buoyantsectors.u Computer and electronic productsmanufactur<strong>in</strong>gThis sector has reta<strong>in</strong>ed its leadership and evenstrengthened its weight with<strong>in</strong> the U.S. manufactur<strong>in</strong>gsector dur<strong>in</strong>g 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 equipmentmanufactur<strong>in</strong>g has proven to be a powerful eng<strong>in</strong>eof 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 cont<strong>in</strong>ued to drive production (+32.7% and+12.0% <strong>in</strong> 2010 and 2011 respectively). Nevertheless,2012 saw a slowdown caused by less favorablesector and economic environments.• Navigational, measur<strong>in</strong>g, electro medical andcontrol <strong>in</strong>struments manufactur<strong>in</strong>g also helpedthe sector expand dur<strong>in</strong>g the last decade andrebound <strong>in</strong> the wake of the crisis. While shr<strong>in</strong>k<strong>in</strong>g<strong>in</strong> 2009, the segment posted 6.5% and nearly 11%growth <strong>in</strong> 2010 and 2011 respectively. Boosted byits markets (aerospace, automotive, mach<strong>in</strong>ery,semiconductor manufactur<strong>in</strong>g), 2012 also saw afairly robust <strong>in</strong>crease 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 <strong>in</strong> 2008,punctuat<strong>in</strong>g a six year <strong>in</strong>crease with an all-time high.But s<strong>in</strong>ce then, lackluster PC and notebook salescontracted, with the first half of 2012 experienc<strong>in</strong>g aslower rate of decl<strong>in</strong>e.14

Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>A f<strong>in</strong>al segment of note, communication equipmentproduction has been lagg<strong>in</strong>g far below its 2007 leveldespite a rebound <strong>in</strong> 2010.The 2012 output <strong>in</strong>crease is expected to slow dramatically(estimated at +3.5%) because the two ma<strong>in</strong>growth drivers appear to have paused <strong>in</strong> their ascent.2013 will follow this downward trend (+1.5%).u Mach<strong>in</strong>eryThis sector contributed strongly to U.S. manufactur<strong>in</strong>goutput expansion with double digit growth<strong>in</strong> 2010 and <strong>in</strong> 2011. It is also expected to rega<strong>in</strong> itspre-recession average annual production. All the subsectorshave posted significant production <strong>in</strong>creasesdur<strong>in</strong>g this period follow<strong>in</strong>g a rebound <strong>in</strong> <strong>in</strong>vestment<strong>in</strong> the aftermath of the crisis. Two sub-sectors havebeen significant growth drivers and showed higherlevels of production <strong>in</strong> 2012 than <strong>in</strong> 2007/2008:• M<strong>in</strong><strong>in</strong>g, oil field and gas field mach<strong>in</strong>ery (output:+2.6%<strong>in</strong> 2010 and +21.3% <strong>in</strong> 2011 and+14.9% (estimated) <strong>in</strong> 2012). This segment hasthrived <strong>in</strong> the wake of the surges <strong>in</strong> oil <strong>in</strong>dustryextraction capacity and that of the shale gas<strong>in</strong>dustry <strong>in</strong> the U.S., driven by the development ofnew technologies.• Eng<strong>in</strong>e, turb<strong>in</strong>e and power transmission equipment(output: +9.7% <strong>in</strong> 2010 and +22.6% <strong>in</strong> 2011and +18.5% (estimated) <strong>in</strong> 2012). The noticeabledevelopment of the renewable energy sector hasfostered growth <strong>in</strong> this segment.The construction and metalwork<strong>in</strong>g mach<strong>in</strong>ery sectorsalso have fared reasonably well <strong>in</strong> 2012. Theunderly<strong>in</strong>g conditions which stimulated mach<strong>in</strong>erysector growth over the recent years - <strong>in</strong>clud<strong>in</strong>g11. Industrial Production Index:the “sh<strong>in</strong><strong>in</strong>g” manufactur<strong>in</strong>g sectorsIndex basis 100 =‐2007among others, boom<strong>in</strong>g <strong>in</strong>vestments <strong>in</strong> fossil andrenewable energy, strong global economics favorableto U.S. exports - are likely to fade <strong>in</strong> 2013 withthe current fiscal/budget uncerta<strong>in</strong>ty weigh<strong>in</strong>g itsprospects down dramatically. The expectation is thatthe output growth of the mach<strong>in</strong>ery sector should berather limited (+3%).u Petroleum and coal product manufactur<strong>in</strong>gThis sector has reclaimed its pre-recession benchmarkdue to momentum posted by the “pav<strong>in</strong>g, roof<strong>in</strong>gand other petroleum and coal products” sector,which <strong>in</strong>creased its production by 8.6%, 15.1% and13.1% (estimated) <strong>in</strong> 2010, 2011 and 2012 respectively.This momentum was due <strong>in</strong> large part to thefederal stimulus package aimed at boost<strong>in</strong>g the U.S.economy and <strong>in</strong>cluded $36.2 billion for transportation(highway <strong>in</strong>frastructure, high-speed rail corridors)and $30.0 billion for <strong>in</strong>frastructure. In 2013, thepetroleum and coal product manufactur<strong>in</strong>g sectorwon’t be able to rely on such public support and islikely to suffer from this less favorable environment.u What about the car <strong>in</strong>dustry?Despite uneven global economic performance,<strong>in</strong>clud<strong>in</strong>g weakness <strong>in</strong> Europe, many global automakershave reported ris<strong>in</strong>g sales and profitability,driven by growth <strong>in</strong> emerg<strong>in</strong>g markets and Ch<strong>in</strong>a <strong>in</strong>particular. In the U.S., auto sales posted a second yearof growth due to easier credit, low <strong>in</strong>terest rates, andpent-up demand result<strong>in</strong>g from the recent recessionand an ag<strong>in</strong>g vehicle fleet. North American auto suppliersare benefit<strong>in</strong>g from ris<strong>in</strong>g automotive productionand leaner cost structures. Many are now moreprofitable than before the downturn. The outlook forboth the automotive manufacturers and suppliers ispositive, reflect<strong>in</strong>g expectations for ris<strong>in</strong>g demand <strong>in</strong>the U.S. In addition, emerg<strong>in</strong>g markets led by Ch<strong>in</strong>ashould drive global demand, despite slow<strong>in</strong>g regionaleconomic growth and debt issues affect<strong>in</strong>g Europeandemand. The U.S. automotive market is still strengthen<strong>in</strong>g:it grew an estimated 12% to 14.8 million vehicles<strong>in</strong> 2012 and we expect it to grow 5% more to 15.5million vehicles <strong>in</strong> 2013. That will still be 1.5 millionvehicles short of the pre-crisis benchmark.©Source: Federal Reserve Bank15

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United StatesReason #1Lower labor costsThe comb<strong>in</strong>ation of high output, productivityand profitability, and low unit labor costs lays asolid foundation for cont<strong>in</strong>ued strength <strong>in</strong> theU.S. manufactur<strong>in</strong>g sector. This section analyzesthe positive contribution of fall<strong>in</strong>g labor coststo U.S. competitiveness. We argue that thiscont<strong>in</strong>u<strong>in</strong>g trend will be a major determ<strong>in</strong>ant of there<strong>in</strong>dustrialization momentum. This performancerelative to Ch<strong>in</strong>a and Europe, for <strong>in</strong>stance, must becultivated. However, a too conservative U.S. wagepolicy and low labor pric<strong>in</strong>g could eventually capproductivity ga<strong>in</strong>s and human capital accumulation,especially for niche <strong>in</strong>dustries.Competitiveness: advantage U.S.A.u As shown <strong>in</strong> Figures 12 and 13 below, compar<strong>in</strong>gU.S. trends regard<strong>in</strong>g manufactur<strong>in</strong>g productivityand unit labor cost with the other lead<strong>in</strong>g <strong>in</strong>dustrializedcountries underscores America’s enviable position.Indeed, U.S. manufactur<strong>in</strong>g has dramaticallyre<strong>in</strong>forced 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 fall<strong>in</strong>g U.S. dollar versusthe euro may have contributed to the difference.Additionally, from 2000-2010 manufactur<strong>in</strong>g productivity<strong>in</strong> the U.S. has grown at an annual rate of5.2%, greater than most <strong>in</strong>dustrialized nations exceptfor the rapidly emerg<strong>in</strong>g economies of Taiwan, theCzech Republic, and South Korea. At the same time,the U.S. has been one of only two major countrieswhere manufactur<strong>in</strong>g 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. Manufactur<strong>in</strong>g Labor ProductivityIndex basis 100 = 200213. Manufactur<strong>in</strong>g Labor CostsIndex basis 100 = 200216Source: Bureau of Labor Statistics, <strong>Euler</strong> <strong>Hermes</strong>Source: Bureau of Labor Statistics, <strong>Euler</strong> <strong>Hermes</strong>

Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>A new era of manufactur<strong>in</strong>g: “on-shor<strong>in</strong>g”The Ch<strong>in</strong>ese competitive edge <strong>in</strong> laborcosts has been so overwhelm<strong>in</strong>g that itoften eclipsed all other parameters <strong>in</strong> theeconomic and strategic equation. Therefreshed set of parameters of “Made <strong>in</strong>America” (cheap energy, supply cha<strong>in</strong> riskmanagement, etc.), are major advantagesto on-shor<strong>in</strong>g. Other factors <strong>in</strong>cludequality, easier communication, faster timeto market and cheaper <strong>in</strong>ventory costs.u While real American labor costs have barelychanged over the past decade, the dramatic <strong>in</strong>crease<strong>in</strong> Ch<strong>in</strong>ese wages has resulted <strong>in</strong> a steady erosion ofthe gap between American and Ch<strong>in</strong>ese wages. Forthe previous two decades this gap had been a crucial<strong>in</strong>centive for U.S. manufacturers to relocate <strong>in</strong>dustrialfacilities to Ch<strong>in</strong>a. Although there is no doubtthat the Ch<strong>in</strong>ese competitive edge is likely to rema<strong>in</strong>significant for a while, the recent years have markeda tipp<strong>in</strong>g po<strong>in</strong>t <strong>in</strong> the <strong>in</strong>dustrial relationship betweenthe two countries where<strong>in</strong> the wage gap will shr<strong>in</strong>kenough to become less important.Figure 14 below po<strong>in</strong>ts to a sharp <strong>in</strong>crease <strong>in</strong> Ch<strong>in</strong>esewages, fueled by buoyant economic growth despitethe determ<strong>in</strong>ation to keep <strong>in</strong>flation low, result<strong>in</strong>g <strong>in</strong>a sharp clos<strong>in</strong>g of the wage gap. Comb<strong>in</strong>ed with thedepreciation of the U.S. dollar versus the Ch<strong>in</strong>eseyuan, the supremacy of Ch<strong>in</strong>a as the best locationto manufacture is likely to be weakened <strong>in</strong> any case.The current and foreseeable global environment maypave the way toward the on-shor<strong>in</strong>g of <strong>in</strong>dustrialcapacities <strong>in</strong> the U.S. We assume the on-shor<strong>in</strong>g ofmanufactur<strong>in</strong>g capacities will ma<strong>in</strong>ly affect produc‐tion currently based <strong>in</strong> Ch<strong>in</strong>a but aimed at the U.S.market. This trend does not imply that the U.S. companieswill automatically scale back their operations<strong>in</strong> Ch<strong>in</strong>a.The sectors expected to be the most proactive <strong>in</strong>on-shor<strong>in</strong>g <strong>in</strong> the short and medium term can becharacterized by two conditions:• high exposure to labor costs <strong>in</strong> their coststructure; and• the ability to absorb higher labor costs by hav<strong>in</strong>ga lower labor cost component of value-added.Table D and Figure 15 below summarize the first andsecond tier of sectors which would <strong>in</strong>itially participateand contribute to on-shor<strong>in</strong>g. The activity potentiallyaffected by on-shor<strong>in</strong>g these <strong>in</strong>dustries from Ch<strong>in</strong>a tothe U.S. would be equal to the current exports to theU.S. from Ch<strong>in</strong>a <strong>in</strong> these two <strong>in</strong>dustries. This amountis estimated to be $282 billion annually. ©D. The Candidates for On-shor<strong>in</strong>gTier 1: Four sectors represent<strong>in</strong>g 56% of the U.S.imports from Ch<strong>in</strong>aComputer and electronic product manufactur<strong>in</strong>gU.S. import from Ch<strong>in</strong>a (<strong>in</strong> 2011)Mach<strong>in</strong>eryFurnitureMiscellaneous product manufactur<strong>in</strong>gTier 2: The ChallengersFabricated metal product manufactur<strong>in</strong>gElectrical equipment and appliancePlastic and rubber productsNon-metallic m<strong>in</strong>eral productsSource: Bureau of Economic Analysis, <strong>Euler</strong> <strong>Hermes</strong>$146bn$21bn$15bn$36bn$17bn$29bn$12bn$6bn14. Effective Manufactur<strong>in</strong>g Wage Gap302520$7USCh<strong>in</strong>a15. Part of labor costs <strong>in</strong> total operat<strong>in</strong>g costs and part of the value consumed by thelabor costs for each manufactur<strong>in</strong>g sector <strong>in</strong> 2011, <strong>in</strong> %$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, M<strong>in</strong>istry of Labor andSocial Security of Ch<strong>in</strong>a, Boston Consult<strong>in</strong>g Group and <strong>Euler</strong> <strong>Hermes</strong>2012201320142015Wood product Non-metallic product Primary metalFabricated metal productMach<strong>in</strong>eryComputer andElectrical equipment Motor vehicleelectronicOther transportationequipmentFurnitureMiscellaneousmanufactur<strong>in</strong>gFood and beverageTextileApparel Paper Pr<strong>in</strong>t<strong>in</strong>gPetroleum andcoal productChemical Plastics and rubber L<strong>in</strong>chp<strong>in</strong> (median)Source: Bureau of Economic Analysis, <strong>Euler</strong> <strong>Hermes</strong>17

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> 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 <strong>in</strong>flux of foreign automakersand are expected to cont<strong>in</strong>ue. Additionally,exports are provid<strong>in</strong>g a boost to southern state economieswhile the expansion of the Panama Canal <strong>in</strong>2014 is likely to contribute to economic activity <strong>in</strong>the region.The South has outperformed the U.S. <strong>in</strong> terms ofGDP growth <strong>in</strong> ten of the past twelve years (Figure16). And while the U.S., as a whole, had two negativeyears of growth <strong>in</strong> 2008 and 2009, the moreresilient South actually grew <strong>in</strong> 2008. More recently,the South grew more than twice as fast as the U.S. <strong>in</strong>2011, and expectations are that this outperformancewill cont<strong>in</strong>ue.u Total compensation, which <strong>in</strong>cludes wages andbenefits, are lowest <strong>in</strong> the South as shown <strong>in</strong> Figure17 below.Total employment <strong>in</strong> 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, which<strong>in</strong> 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 us<strong>in</strong>g other data.The result of our analysis (see Table E) shows thatfour of the top six states <strong>in</strong> terms of productivity areSouthern: Louisiana, Texas, North Carol<strong>in</strong>a and NewMexico. When it comes to unit labor costs, five of thetop eight are Southern.u The auto <strong>in</strong>dustryOne sector that has benefitted from this re<strong>in</strong>dustrializationwave is the auto <strong>in</strong>dustry, as summarized<strong>in</strong> 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 <strong>in</strong>to the South has beenhampered by labor unions which have vehementlyopposed mov<strong>in</strong>g production to “right-to-work*”states <strong>in</strong> 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, <strong>in</strong> turn, make the total cost of manufactur<strong>in</strong>gcars <strong>in</strong> the South lower than manufactur<strong>in</strong>goverseas and shipp<strong>in</strong>g to the U.S. In addition to theBig Three, the U.S. auto <strong>in</strong>dustry now has a secondconcentration <strong>in</strong> the seven Southern states of Alabama,Georgia, Kentucky, Mississippi, South Carol<strong>in</strong>a,17. Employer CostsCont<strong>in</strong>ued 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 <strong>in</strong>cludes Alabama, Arizona, Arkansas, Florida, Georgia,Kentucky, Louisiana, Mississippi, New Mexico, North Carol<strong>in</strong>a, Oklahoma,South Carol<strong>in</strong>a, Tennessee, Texas, Virg<strong>in</strong>ia, and West Virg<strong>in</strong>ia.Source: Bureau of Economic Analysis50United StatesNortheastWestMidwestSouthNote: The sum of <strong>in</strong>dividual items may not equal totals due to round<strong>in</strong>g.Source : Bureau of Labor Statistics

Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>ANADAThe Southern Draw…Pacific OceanSeatleOlympiaWASHINGTONPortlandSalemOREGONSacramentoSan FranciscoNEVADACALIFORNIACarson CityLos AngelesBoiseIDAHOARIZONAPhoenixUTAHHelenaSalt Lake CityMONTANAWYOMINGTop 10 States CANADA <strong>in</strong> AmericaCheyenneDenverCOLORADOSanta FeNEW MEXICOMEXICONORTH DAKOTAAust<strong>in</strong>HoustonMontpellierVERMONTProvidenceAugustaBismarck MINNESOTAAlbanyWISCONSINSOUTH DAKOTAMICHIGANNEW YORKSt. PaulMadison Lans<strong>in</strong>gNew YorkSioux FallsPENNSYLVANIADetroitIOWAHarrisburgChicagoNEBRASKAILLINOISColumbus Wash<strong>in</strong>gtonDes Mo<strong>in</strong>esIndianapolisOHIOWESTL<strong>in</strong>colnSpr<strong>in</strong>gfieldVIRGINIAINDIANACharlestonTopeka Jefferson CityRichmondFrankfortKANSASMISSOURIKENTUCKYNashvilleRaleighOKLAHOMA ARKANSASTENNESSEELittle RockColumbiaOklahoma CityALABAMA AtlantaMISSISSIPPIGEORGIATEXASDallas LOUISIANAJacksonMontgomeryBaton RougeNew OrleansTallahasseeFLORIDAMAINEConcordDetroitRHODE ISLANDCONNECTICUTHartfortNEW JERSEYPhiladelphiaTrentonVIRGINIANORTH CAROLINASOUTH CAROLINAMiamiAtlantic OceanMASSACHUSETTSE. Top 10 StatesGSP Rank GSP Rank Comb<strong>in</strong>ed/Employee Hour /Compensation Rank2011 2010Louisiana 209.3 1 5.0 1 1Oregon 163.4 2 4.1 2 2Wyom<strong>in</strong>g 139.5 3 3.3 3 3North Carol<strong>in</strong>a 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 10Virg<strong>in</strong>ia 81.2 11 2.4 8 10Source: <strong>Euler</strong> <strong>Hermes</strong>Methodological Note:A proxy for productivity by state can be calculated as follows:• Gross State Product (GSP) <strong>in</strong> the manufactur<strong>in</strong>g sector is known and canbe divided <strong>in</strong>to 52 weeks;• then the number of employees and the average number of weekly hourscan be multiplied to determ<strong>in</strong>e the total number of “employee-hours/week”;• when this number is divided <strong>in</strong>to GSP/week, the result is GSP/employee-hour.Conceptually, this is the dollar amount of output created by oneworker <strong>in</strong> one hour. A proxy for Unit Labor Costs can be derived madesimply by divid<strong>in</strong>g GSP by total compensation (wages and benefits), effectivelyshow<strong>in</strong>g how many dollars of GSP are created by each dollar of totalcompensation. The comb<strong>in</strong>ed rank<strong>in</strong>g is the simple average of the productivityand cost ranks.F. Auto Plants <strong>in</strong> 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 Carol<strong>in</strong>a 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 L<strong>in</strong>coln, Ala. 4,000 300,0002003 Nissan Canton, Miss. 4,500 400,0002005 Hyundai Montgomery, Ala. 2,500 300,0002010 Kia West Po<strong>in</strong>t, Ga. 3,000 300,000b2011 Volkswagen Chattanooga, Tenn. 2,000c 150,000Fall 2011* Toyota Blue Spr<strong>in</strong>gs, Miss. 2,000 150,000Notes: *projected to be 360,000 <strong>in</strong> 2012; projected to be 2,300 by fall 2011; projected open<strong>in</strong>g dateSource: Individual companies, Congressional Research Service, Chambers of Commerce*A right-to-work state is one where employees are not required tojo<strong>in</strong> a union if one is <strong>in</strong> place, with the general effect of keep<strong>in</strong>g totalcompensation lower than that <strong>in</strong> states where union labor dom<strong>in</strong>ates19

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States• • • Cont<strong>in</strong>ued from page 18“Even though these new Southern employerspay well below average for the U.S.automotive <strong>in</strong>dustry, they still pay wellabove average for manufactur<strong>in</strong>g jobs <strong>in</strong> theSouth. The story is similar for other capital<strong>in</strong>tensive<strong>in</strong>dustries, such as aerospace andpharmaceutical manufactur<strong>in</strong>g. Look<strong>in</strong>gbeyond the current bus<strong>in</strong>ess cycle, prospectsfor manufactur<strong>in</strong>g <strong>in</strong> the South appearpromis<strong>in</strong>g. The transition to more advanced<strong>in</strong>dustrial growth <strong>in</strong> countries such as Ch<strong>in</strong>aand India is far from complete, so demandfor the South’s more advanced manufacturedgoods is likely to cont<strong>in</strong>ue for some time. Newcapital <strong>in</strong>vestments should cont<strong>in</strong>ue to reducecosts and <strong>in</strong>crease productivity…”Jeffrey LackerThe Future of Manufactur<strong>in</strong>g <strong>in</strong> the SouthTennessee, and Texas. In recent times these stateshave launched <strong>in</strong>to bidd<strong>in</strong>g wars to attract automakers,offer<strong>in</strong>g generous tax breaks and subsidieswhich reduce the positive economic impact of newfactories.A major cornerstone to the cont<strong>in</strong>ued comparativeadvantage of the Southern states <strong>in</strong> the re<strong>in</strong>dustrializationprocess will be the development of the necessaryworkforce skills <strong>in</strong>clud<strong>in</strong>g more technical andvocational school<strong>in</strong>g rather than traditional four-yearcolleges. On the downside, it should be noted thatdurable goods manufactur<strong>in</strong>g is particularly sensitiveto the bus<strong>in</strong>ess 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 <strong>in</strong> twelve of the past thirteen quarters.In 2011 when nom<strong>in</strong>al GDP grew 4.0% over theentire year, exports grew 13.5%. And <strong>in</strong> the Southeast,the export growth rate was even stronger, over20%. Accord<strong>in</strong>g to the Federal Reserve, “Exportshave become an <strong>in</strong>creas<strong>in</strong>gly significant part of theregion’s economy. The Southeast’s globally <strong>in</strong>terconnectedeconomy—with its fortuitous location andplentiful ports and coastl<strong>in</strong>e—is contribut<strong>in</strong>g to surg<strong>in</strong>g,if surpris<strong>in</strong>g, exports, such as the flood of <strong>in</strong>ternationaltravelers whose Southeastern expendituresconstitute a major export.” Commerce Departmentdata show<strong>in</strong>g the top exports and their markets fromthe Southeast are listed <strong>in</strong> Table G. It would appearthat the Southern strength <strong>in</strong> auto manufactur<strong>in</strong>g forthe domestic market has also contributed to strongexports for transportation equipment.u F<strong>in</strong>ally, <strong>in</strong> 2014 a planned expansion of the PanamaCanal should be completed, allow<strong>in</strong>g 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 compet<strong>in</strong>g route send<strong>in</strong>g 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 cont<strong>in</strong>ue to boostmanufactur<strong>in</strong>g <strong>in</strong> the South, while an <strong>in</strong>crease <strong>in</strong>port activity from the new Panama Canal trade route,<strong>in</strong>clud<strong>in</strong>g both imports and exports, will contribute toeven more economic activity. ©G. Exports: Top Sector, Top Dest<strong>in</strong>ationsTop 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 $26BCh<strong>in</strong>a $17BMexico $17BBrazil $10BJapan $9B20Source: Department of Commerce

Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>The (positive) double price effect<strong>in</strong> the short-runReason #2The gas bonanzau As shown below <strong>in</strong> Figure 18, net U.S. imports offoreign oil have been fall<strong>in</strong>g as domestic productionhas been <strong>in</strong>creas<strong>in</strong>g over the past several years. Asa result, imported oil, as a percentage of all oil producedand imported, dropped from a high of over68% <strong>in</strong> 2005 to 58% <strong>in</strong> 2012, <strong>in</strong> 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 <strong>in</strong>creased re<strong>in</strong>dustrialization s<strong>in</strong>ce, as shown <strong>in</strong>Figure 19, a glut of West Texas Intermediate (WTI)oil <strong>in</strong> the U.S. led to prices significantly below that ofthe global price of Brent crude.The energy factor has been particularly favorable to there<strong>in</strong>dustrialization of the U.S. and this trend should beconfirmed <strong>in</strong> the short run for two ma<strong>in</strong> factors. First, <strong>in</strong>spite of global oil price <strong>in</strong>creases, and the subsequentstabilization at historical highs (expected to l<strong>in</strong>ger),U.S. domestic oil prices have been $15-$20 below theglobal price for almost two years. This has boosted therelative performance of U.S. companies, just as it hitthe operat<strong>in</strong>g profitability of foreign manufactur<strong>in</strong>gand drove shipp<strong>in</strong>g costs up. Second, an abundanceof shale gas on the American market, result<strong>in</strong>g frommore <strong>in</strong>tensive production has triggered downwardpressure on domestic gas prices and providedAmerican companies with access to a cheap energysupply. The ma<strong>in</strong> risks to this positive contribution are:• the effective potential of the shale gas reservesboth <strong>in</strong> terms of volume and usage for differentsectors of the economy; and• should prices cont<strong>in</strong>ue to decrease, <strong>in</strong>centives forthe extractors (and their profitability) would fall,caus<strong>in</strong>g <strong>in</strong>stability <strong>in</strong> the value cha<strong>in</strong>.u In addition, prices for natural gas have plummeteddue to rapid developments <strong>in</strong> drill<strong>in</strong>g technologies<strong>in</strong>clud<strong>in</strong>g horizontal drill<strong>in</strong>g and hydraulic fractur<strong>in</strong>g,or “frack<strong>in</strong>g.” Frack<strong>in</strong>g is a technique <strong>in</strong> which water,sand and chemicals are <strong>in</strong>jected thousands of feetbelow the surface under very high pressure to breakup rock formations, thereby releas<strong>in</strong>g trapped naturalgas. These techniques have revealed dramaticamounts of new reserves over the past few years,particularly <strong>in</strong> the Marcellus shale which extendsfrom New York through Pennsylvania and <strong>in</strong>to WestVirg<strong>in</strong>ia, and the Bakken shale <strong>in</strong> North Dakota andMontana. • • •18. U.S. Crude Oil Production and Net Imports000 bbl/mo19. Oil Prices$/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

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States• • •As shown <strong>in</strong> Figures 20 and 21 below, the result isthat natural gas production and storage have risensharply while prices have plummeted. Regard<strong>in</strong>greserves, the Energy Information Agency now estimatesthat "…there are 2,214 trillion cubic feet (Tcf)of natural gas that is technically recoverable <strong>in</strong> theUnited States. Of the total, an estimated 273 Tcf areproven reserves, which <strong>in</strong>cludes 60 Tcf of shale gas.At the rate of U.S. natural gas consumption <strong>in</strong> 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 <strong>in</strong>dustrial competitiveness,specifically <strong>in</strong> manufactur<strong>in</strong>g. In the U.S.,one million BTU costs $4.01 (<strong>in</strong> Canada, $3.47). Comparatively,costs are twice as much <strong>in</strong> the UK ($9.03)and Europe ($10.61), and more than three times asmuch <strong>in</strong> Japan (LNG is at $14.73). UBS estimates thatthe boost to U.S. manufactur<strong>in</strong>g could add 0.5% toGDP growth <strong>in</strong> each of the next five years.u The potential for substitution.The greatly reduced price and greatly <strong>in</strong>creased supplycould be strong contributors to the re<strong>in</strong>dustrializationof the U.S. As shown <strong>in</strong> 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 <strong>in</strong>to transportation,mostly to gasol<strong>in</strong>e for passenger cars, then diesel fortrucks and tra<strong>in</strong>s, and f<strong>in</strong>ally to jet fuel.Note that the <strong>in</strong>dustrial, 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 offl<strong>in</strong>e,they are quite likely to be replaced with gas-firedplants. The <strong>in</strong>dustrial sector currently sources 44% ofits energy from petroleum; natural gas could beg<strong>in</strong>replac<strong>in</strong>g that over time. F<strong>in</strong>ally, <strong>in</strong> addition to be<strong>in</strong>ga source of energy, natural gas is used as a feedstock<strong>in</strong> the production of many chemicals, plastics, andfertilizers. As a result, these <strong>in</strong>dustries are likely toreturn some production from overseas back to theU.S., tak<strong>in</strong>g 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, br<strong>in</strong>g<strong>in</strong>g the total upto around 100 years, is pav<strong>in</strong>g the way for the futurere<strong>in</strong>dustrialization of the U.S. ©* Questions rema<strong>in</strong> about the environmental damage frack<strong>in</strong>g mightcause, <strong>in</strong>clud<strong>in</strong>g the consumption of large amounts of water, disposal ofwastewater, seismic tremors, and possible contam<strong>in</strong>ation of groundwater.These concerns have led to some temporary restrictions <strong>in</strong> exploration andproduction <strong>in</strong> the U.S., but <strong>in</strong> Europe fears over frack<strong>in</strong>g could prove to bemuch bigger hurdles to its use <strong>in</strong> 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 <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>22. Use of Energy Sources by SectorSupply SourcesPetroleum37%Percent of Source722251Percent of Sector9433Demand SectorTransportation28%Natural Gas25%Coal21%Renewables8%Nuclear9%3327

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United StatesChemicals and primary metals <strong>in</strong>dustries to benefit mostfrom the low energy costsCould cheap energy <strong>in</strong>crease foreign direct<strong>in</strong>vestments to the U.S.?u The competitive edge provided by a cheapenergy supply and a grow<strong>in</strong>g U.S. market (atleast from a demographic po<strong>in</strong>t of view) wouldrepresent potent <strong>in</strong>centives for <strong>in</strong>vestmentfrom overseas companies, which may beplagued with lackluster or even contract<strong>in</strong>gdomestic markets and structural impedimentsdarken<strong>in</strong>g their prospects. For example,Japanese companies that are grappl<strong>in</strong>g witha decl<strong>in</strong><strong>in</strong>g domestic environment, mount<strong>in</strong>genergy costs and ongo<strong>in</strong>g appreciation of theYen/USD, could see several reasons whichwould favor the location of new or additional<strong>in</strong>dustrial capacities <strong>in</strong> the U.S. These <strong>in</strong>cludeproximity to growth driver markets and toraw materials, ease of logistics, and lowercosts of energy and labor. The protractedeconomic doldrums <strong>in</strong> Europe may alsoprompt local manufactur<strong>in</strong>g players there toconsider <strong>in</strong>creas<strong>in</strong>g their U.S. presence. Thesecompetitive advantages may be emerg<strong>in</strong>geven now. The U.S. has already rega<strong>in</strong>edtraction <strong>in</strong> foreign direct <strong>in</strong>vestment <strong>in</strong>manufactur<strong>in</strong>g s<strong>in</strong>ce the recession (US $100billion <strong>in</strong> 2011), and is on the path to reach thepre-recession peaks.u The U.S. shale gas supply is a game-chang<strong>in</strong>g factorfor American <strong>in</strong>dustries all across the board, asmanufacturers may now:• access lower energy prices as many electric powersuppliers have been shift<strong>in</strong>g 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 re<strong>in</strong>force the ongo<strong>in</strong>gimprovement of the competitive position of U.S.manufacturers, especially <strong>in</strong> comparison to Europeanand Japanese counterparts. Beyond the strengthen<strong>in</strong>gof operat<strong>in</strong>g profitability, the foreseeable outcomeof this grow<strong>in</strong>g competitive edge is that U.S.manufacturers will rega<strong>in</strong> ground <strong>in</strong> global trade,expand<strong>in</strong>g exports and putt<strong>in</strong>g downward pressureon imports. The sector which is first <strong>in</strong> l<strong>in</strong>e to takeadvantage of cheaper energy is chemicals, especiallybasic chemicals and fertilizers, s<strong>in</strong>ce these <strong>in</strong>dustrieswill benefit from both cheaper energy and cheaperfeedstock supplies. This competitive advantage islikely to filter to downstream sectors such as agriculture,coat<strong>in</strong>gs, manufactur<strong>in</strong>g, pa<strong>in</strong>t, and plastics.Consider<strong>in</strong>g the size of the trade and the characteristicsof the sector, the primary metals <strong>in</strong>dustry couldalso be a significant w<strong>in</strong>ner, improv<strong>in</strong>g its competitiveadvantage and ga<strong>in</strong><strong>in</strong>g global market share. Asshown, Table H displays the relevant metrics by sector.In the short/<strong>in</strong>termediate run, these trends mayalso fuel substantial <strong>in</strong>vestments <strong>in</strong> these sectors tokeep pace with probable production <strong>in</strong>creases. Players<strong>in</strong> the chemicals sector have already planned to<strong>in</strong>vest $16 billion <strong>in</strong> the next five years. ©H. Top Sectors Benefitt<strong>in</strong>g from a Decrease <strong>in</strong> Energy PricesManufactur<strong>in</strong>g 3%Part of energy Part <strong>in</strong> U.S. Imports Exportscosts <strong>in</strong> sector manufactur<strong>in</strong>g energy ($Bn) ($Bn)<strong>in</strong>put cost (%) <strong>in</strong>put costs (%) 2011 2011Nonmetallic m<strong>in</strong>eral 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 exclud<strong>in</strong>g pharmaceuticalsSource: Bureau of Economic Analysis – International Trade Adm<strong>in</strong>istration

Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>FED. DE RUSSIE (Russia)ALASKAFocus on… Texas, the power plantAnchorageCANADA1/2TexasThe second largest state economy <strong>in</strong> the U.S.CANADAAugustaSeatleMontpellierMAINEOlympiaVERMONTWASHINGTONConcordNORTH DAKOTAProvidencePortlandHelenaDetroit MASSACHUSETTSSalemBismarck MINNESOTAAlbanyMONTANAWISCONSINOREGONBoiseSOUTH DAKOTAMICHIGANNEW YORKRHODE ISLANDSt. PaulCONNECTICUTMadison Lans<strong>in</strong>gNew YorkSioux FallsPENNSYLVANIAHartfortIDAHOWYOMINGDetroitIOWAHarrisburgChicagoNEW JERSEYCheyenneNEBRASKAILLINOISColumbus Wash<strong>in</strong>gtonCarson CityDes Mo<strong>in</strong>esIndianapolisOHIOWESTPhiladelphiaSalt Lake CitySacramentoL<strong>in</strong>colnSpr<strong>in</strong>gfieldVIRGINIATrentonINDIANASan FranciscoCharlestonTopeka Jefferson CityRichmondVIRGINIANEVADADenverFrankfortUTAHKENTUCKYCALIFORNIACOLORADOKANSASMISSOURIRaleighNashvilleOKLAHOMATENNESSEEARKANSASNORTH CAROLINALos AngelesARIZONALittle RockColumbiaSanta FeOklahoma CityALABAMA AtlantaSOUTH CAROLINAPhoenixNEW MEXICOMISSISSIPPIGEORGIADallas LOUISIANAMontgomeryJacksonTEXASBaton RougeAust<strong>in</strong>FLORIDA Atlantic OceanPacific OceanHoustonTallahasseeMiamiNew OrleansMEXICOTexas is the second largest state economy <strong>in</strong> theU.S. after California, compris<strong>in</strong>g 8.8% of U.S. GDP<strong>in</strong> 2011. The Texas economy has grown faster thanthe rest of the U.S. <strong>in</strong> n<strong>in</strong>e of the past 12 years asshown below <strong>in</strong> 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. <strong>in</strong> job growth asshown below <strong>in</strong> Figure 24. In fact, of all the 2.6 millionjobs created between January 2000 and August 2012,1.8 million, or 70%, were created <strong>in</strong> 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. manufactur<strong>in</strong>g jobs.One outstand<strong>in</strong>g feature of the Texas economy is thehous<strong>in</strong>g market, which was relatively resilient comparedto the entire U.S. From the period just beforethe hous<strong>in</strong>g bubble burst, January 2006 to May 2012,hous<strong>in</strong>g prices <strong>in</strong> Dallas fell only 2.7%, the least of anyof the 20 major cities nationwide measured by theCase-Shiller home price <strong>in</strong>dex. The average hous<strong>in</strong>gloss for the 20 cities nationwide over that time periodwas a remarkable 31%. Median s<strong>in</strong>gle-family homeprices <strong>in</strong> Texas were up 5% <strong>in</strong> August 2012 comparedto the previous year. Sales of exist<strong>in</strong>g s<strong>in</strong>gle-familyhomes over the same time period were up 17%compared to a nationwide average of 10%. Permitswere up 36% versus 24% nationwide. The strength <strong>in</strong>the hous<strong>in</strong>g market will provide a boost to the entirestate economy and a robust environment for manufacturersof build<strong>in</strong>g materials go<strong>in</strong>g forward.• • •23. Real GDP Growth24. Manufactur<strong>in</strong>g 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

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States• • • u Sector opportunitiesManufactur<strong>in</strong>g <strong>in</strong>dustry GDP <strong>in</strong> Texas is $192 billionor 10% of all U.S. manufactur<strong>in</strong>g. The concentrationof <strong>in</strong>dustries with<strong>in</strong> Texas manufactur<strong>in</strong>g is shown <strong>in</strong>Table I below. The first column <strong>in</strong> the table <strong>in</strong>dicatesthat petroleum and coal products comprise 26% ofall manufactur<strong>in</strong>g <strong>in</strong> Texas. Along with chemicalsat 20%, these top two <strong>in</strong>dustries are responsible fornearly half of the manufactur<strong>in</strong>g output of Texas.There are significant contributions from computerand electronic products and mach<strong>in</strong>ery as well. Thesecond column <strong>in</strong>dicates that of all the petroleumand coal product manufactur<strong>in</strong>g <strong>in</strong> the U.S., 26% ofit is performed <strong>in</strong> Texas. Texas also produces 15% ofall U.S. chemical products. Once aga<strong>in</strong>, there are significantcontributions from computer and electronicproducts and mach<strong>in</strong>ery.I. Texas ‘ ID Card% of Texas % of total USmanufactur<strong>in</strong>g <strong>in</strong> TexasManufactur<strong>in</strong>g 100% 10%Petroleum and coal products 26% 26%Chemicals 20% 15%Computers and electronic products 14% 9%Mach<strong>in</strong>ery 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 dom<strong>in</strong>ated by theenergy sector. Texas is the number one producer ofcrude oil, natural gas and total energy <strong>in</strong> 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 ref<strong>in</strong>eries accounted for 27% of all U.S.ref<strong>in</strong><strong>in</strong>g capacity. The ref<strong>in</strong>ery bus<strong>in</strong>ess is likely to seesteady growth go<strong>in</strong>g forward as demand from thechemical <strong>in</strong>dustry will be ramped up by cheap naturalgas. Several of the largest oil companies <strong>in</strong> the worldare headquartered <strong>in</strong> Texas, <strong>in</strong>clud<strong>in</strong>g Exxon-Mobiland ConocoPhillips. It has n<strong>in</strong>e major sea ports forexport<strong>in</strong>g and import<strong>in</strong>g petroleum products. WestTexas Intermediate (WTI) rema<strong>in</strong>s the benchmarkgrade for crude oil <strong>in</strong> 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 comb<strong>in</strong>ed withlimited pipel<strong>in</strong>e capacity to transport to ref<strong>in</strong>eries hascontributed to the excess. While Texas is the numberone producer of crude oil <strong>in</strong> the U.S., output has fallento less than one third of its peak <strong>in</strong> 1972.Although there is no doubt that crude productionwill rema<strong>in</strong> a robust <strong>in</strong>dustry 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 <strong>in</strong> frack<strong>in</strong>g and horizontal drill<strong>in</strong>g.Much of the natural gas production goes directly toelectricity production, which will likely be a growth<strong>in</strong>dustry for the foreseeable future. Texas is the numberone producer and consumer of electricity <strong>in</strong> 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 <strong>in</strong> the long run.Texas also leads the country <strong>in</strong> coal consumption withthe majority of its supplies com<strong>in</strong>g from Wyom<strong>in</strong>g.Coal m<strong>in</strong><strong>in</strong>g and consumption is likely to be a weaker<strong>in</strong>dustry <strong>in</strong> the long run because of its emissions andbecause of competition from cheap natural gas. Onebright spot <strong>in</strong> the coal <strong>in</strong>dustry is <strong>in</strong>creas<strong>in</strong>g demandfrom Ch<strong>in</strong>a, which is the world’s largest consumerand importer of coal.26Despite be<strong>in</strong>g an economy heavily dependent onfossil fuels, Texas is also the nationwide leader <strong>in</strong>w<strong>in</strong>d power. There are over 2,000 turb<strong>in</strong>es <strong>in</strong> westTexas alone, and the largest w<strong>in</strong>d energy facility <strong>in</strong> the

Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>world is located <strong>in</strong> central Texas. While crude oil productionand ref<strong>in</strong><strong>in</strong>g are likely to be <strong>in</strong> high demandgo<strong>in</strong>g forward, it would appear that true growthopportunities <strong>in</strong> Texas energy lie more <strong>in</strong> natural gasand renewables.u ChemicalsAs <strong>in</strong> the petroleum <strong>in</strong>dustry, Texas is the leader <strong>in</strong>U.S. chemical production with over 200 chemicalplants. The <strong>in</strong>dustry 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 ref<strong>in</strong><strong>in</strong>g capacity are the ma<strong>in</strong> contributorsto the strong presence of the chemical <strong>in</strong>dustry<strong>in</strong> Texas. But unlike crude oil production and ref<strong>in</strong><strong>in</strong>g,the chemicals <strong>in</strong>dustry is set for strong growth, dueto the emergence of very cheap natural gas. Naturalgas is used as a “feedstock” or basic raw material <strong>in</strong>the production of many chemicals, so its precipitousfall <strong>in</strong> price is also lower<strong>in</strong>g prices for many goodsdownstream. There are thousands of productswhich use chemicals extensively for their manufactur<strong>in</strong>g:apparel, auto parts, clothes, fertilizer, packag<strong>in</strong>g,pa<strong>in</strong>ts, pharmaceuticals, rubber, and all theplastic products which make up so many everydayitems such as appliances, furniture, and the seem<strong>in</strong>glyendless array of consumer electronics such aspersonal computers, tablets, smartphones, TVs andmany others.• The Texas Emerg<strong>in</strong>g Technology Fund is designedto attract R&D to the state; and• The Texas Enterprise Fund also provides f<strong>in</strong>anc<strong>in</strong>gto worthy projects. Recently the Fund providedapproximately $1million each to chemical manufacturersDow Chemical and Kuraray America tohelp f<strong>in</strong>ance their expansions.As far as exports are concerned, like <strong>in</strong> so many othermeasures, Texas is number one <strong>in</strong> the nation, export<strong>in</strong>g$250 billion <strong>in</strong> 2011 with a 17% share of all U.S.exports. Exports grew <strong>in</strong> 2011 over 2010 at a blister<strong>in</strong>g21% rate. Over 20% of Texas exports were ref<strong>in</strong>edpetroleum products, followed by coal, chemicals,computer and electronic products, non-electricalmach<strong>in</strong>ery, and transportation equipment. The topexport markets were Mexico with a 35% share, followedby Canada at 8%, and Ch<strong>in</strong>a 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 <strong>in</strong> Mexicoand re-exported to the U.S. ©The drop <strong>in</strong> natural gas prices along with lower unitlabor costs now make the U.S. one of the cheapestchemical producers <strong>in</strong> the world. Accord<strong>in</strong>g 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 once<strong>in</strong>-a-centurychange <strong>in</strong> 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 expand<strong>in</strong>g<strong>in</strong> Texas, and expectations are that these projects willentail $15 billion <strong>in</strong> <strong>in</strong>vestments, and create as manyas 20,000 new jobs. Clearly the chemicals <strong>in</strong>dustry <strong>in</strong>Texas is poised for strong growth.u Public <strong>in</strong>centives and export routes arecontribut<strong>in</strong>g to this favorable outlook <strong>in</strong> TexasTexas offers a number of government <strong>in</strong>centives topromote growth:• Economic Development Corporations helpf<strong>in</strong>ance both new and exist<strong>in</strong>g bus<strong>in</strong>esses;• Value Limitation tax credits are available forjob-creat<strong>in</strong>g construction projects;27

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United StatesReason #3The commitmentto a conducive bus<strong>in</strong>ess climateAs we have seen from the response to the f<strong>in</strong>ancialcrisis, policy responses <strong>in</strong>clud<strong>in</strong>g the stimuluspackage, have been a decisive factor <strong>in</strong> shap<strong>in</strong>gthe U.S. recovery. Go<strong>in</strong>g forward, the questionis how can the policy environment help susta<strong>in</strong>the positive first signs of a re<strong>in</strong>dustrialization ofthe U.S.? What hampers the realization of its fullpotential? Is corporate cash hoard<strong>in</strong>g a reality?How did the private sector organize to cope withnew challenges and an uncerta<strong>in</strong> economicenvironment? Confidence and forward visibility arekey as uncerta<strong>in</strong>ties, and still cloud the decisionmak<strong>in</strong>gof 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.ItalyGermanyJapanKoreaSpa<strong>in</strong>AustraliaCh<strong>in</strong>a2%0% 5% 10% 15% 20%Source: Organisation for Economic Co-operation and Development28

Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>Objective: InnovationResearch and Development (R&D)is critical to competitiveness and<strong>in</strong>novation, and the U.S. needs to boostefforts <strong>in</strong> this sector. For example, theU.S. is beg<strong>in</strong>n<strong>in</strong>g to fall beh<strong>in</strong>d its globalcompetitors <strong>in</strong> 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 result<strong>in</strong>g growth <strong>in</strong> the number of patentsgranted are obvious. Figure 25 demonstrates thatfrom 1995 to 2012, nations that had a higher averageannualized growth rate <strong>in</strong> the number of patentsgranted tended to also have a higher growth rate ofGDP. Clearly the growth rate of patent issuance <strong>in</strong> theU.S. at under 5% is <strong>in</strong>sufficient to contribute to robustGDP growth. By contrast, Ch<strong>in</strong>a’s R&D programs aregrow<strong>in</strong>g the number of patents issued there by aremarkable 22%, result<strong>in</strong>g <strong>in</strong> an equally remarkableGDP growth of 10% annually. U.S. <strong>in</strong>dustry needs totake this competitive threat seriously if it expects tocont<strong>in</strong>ue on the path of re<strong>in</strong>dustrialization.u The threat appears <strong>in</strong> other measures of <strong>in</strong>novationas well, such as the absolute number of patentsgranted <strong>in</strong> each country. Note <strong>in</strong> Figure 26 below thatthe U.S. and Japan lead this measure with about thesame number of patents granted <strong>in</strong> 2010. But moreimportantly, the chart clearly shows the rise of Ch<strong>in</strong>a’sR&D programs and to a lesser extent those ofSouth Korea. These countries are rapidly clos<strong>in</strong>g thegap with the U.S. and erod<strong>in</strong>g its competitive advantage.Even after patent applications are made, the U.S.stumbles. Figure 27 shows the <strong>in</strong>crease or decreases<strong>in</strong>ce 1993 <strong>in</strong> 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 <strong>in</strong> the U.S. <strong>in</strong> 2009 as it did <strong>in</strong> 1993.By comparison, the approval time <strong>in</strong> South Korea hasfallen 40%, and <strong>in</strong> Japan 20%. U.S. manufactur<strong>in</strong>gand the economy <strong>in</strong> general would be well served byimprovements <strong>in</strong> the process of approv<strong>in</strong>g patents.u The composition of the <strong>in</strong>crease <strong>in</strong> patents showsthreats and opportunities as well. Table J shows thepercentage contribution of each <strong>in</strong>dustry to thegrowth <strong>in</strong> patents between 1995 and 2008. Thefirst columns show the contribution to total patentsgranted worldwide, and as might be expected, sevenof the top 10 <strong>in</strong>dustries are related to electronics,with computers and electrical mach<strong>in</strong>ery tak<strong>in</strong>g thetop spots. The rema<strong>in</strong><strong>in</strong>g columns show the <strong>in</strong>dustrybreakout by country. The U.S. contribution by <strong>in</strong>dustryis the most highly concentrated with a full 19% <strong>in</strong>computers. Computer technology is also <strong>in</strong> the topthree <strong>in</strong> Japan and South Korea, represent<strong>in</strong>g significantcompetition from those countries. The positiveview here is that the U.S. has focused on the highestgrowth <strong>in</strong>dustry s<strong>in</strong>ce 1995, and its lead may make itwell-suited for further competitive ga<strong>in</strong>s.• • •26. Patents Granted27. Change <strong>in</strong> TimeRequired for Patent Approval25000020000015000010000050000080828486889092949698000204060810U.S.JapanKoreaEuropeCh<strong>in</strong>aSource: World Intellectual Property Organization (WIPO)Source: World Intellectual Property Organization (WIPO):29

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States• • •u However, the concentration <strong>in</strong> one <strong>in</strong>dustry israther risky to U.S. manufactur<strong>in</strong>g as a whole. An offsetto that risk is that the second largest U.S. concentrationis <strong>in</strong> medical technology; none of the othermajor economies have that <strong>in</strong> their top three, represent<strong>in</strong>ga competitive U.S. advantage <strong>in</strong> this <strong>in</strong>dustry.Similarly, the third largest U.S. <strong>in</strong>dustry concentration– pharmaceuticals - appears <strong>in</strong> only one other country’slist: Ch<strong>in</strong>a. Other countries show concentrationrisk. Over 40% of Japan’s <strong>in</strong>crease <strong>in</strong> new patents isrelated to computers or electronics. This situation isespecially dangerous given that Japan’s once dom<strong>in</strong>antelectronics manufacturers are now struggl<strong>in</strong>gto survive <strong>in</strong> the global marketplace. South Korea isless concentrated with only about 16% <strong>in</strong> high technology.Ch<strong>in</strong>a however is the most diverse, suggest<strong>in</strong>gthat the Ch<strong>in</strong>ese leadership is foster<strong>in</strong>g developmentacross many <strong>in</strong>dustries as the country seeks tosupport its rapid growth rate.than half of Ch<strong>in</strong>a’s. Clearly the U.S. needs to <strong>in</strong>creaseits dedication and fund<strong>in</strong>g to R&D to compete <strong>in</strong> thefuture global economy. The last column <strong>in</strong> the tableshows how effective a country’s R&D program is bycompar<strong>in</strong>g how many patent applications are maderelative to the amount of R&D spend<strong>in</strong>g. Once aga<strong>in</strong>,South Korea, Japan, and Ch<strong>in</strong>a far outpaced the U.S.<strong>in</strong> 2010.u F<strong>in</strong>ally, 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 spend<strong>in</strong>g as a percentage of GDP exceedsthe average for the OECD countries, it still lags beh<strong>in</strong>dJapan, Korea, and Switzerland. ©uAnother measure of a country’s <strong>in</strong>novation comparesthe number of patent applications to its GDP,as shown below <strong>in</strong> Table K <strong>in</strong> 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 <strong>in</strong> Volume of Fil<strong>in</strong>gs Between 1995 and 2008TotalComputer technology 10.5Electrical mach<strong>in</strong>ery, 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 mach<strong>in</strong>ery, energy 15.9Semiconductors 14.8Computer technology 11.6Ch<strong>in</strong>aDigital communication 7.5Electrical mach<strong>in</strong>ery, energy 6.9Pharmaceuticals 6.5Korea6420Japan<strong>USA</strong>ustraliaCanadaFranceKoreaUKOECDGermanyRussianSwitzerlandSpa<strong>in</strong>ItalyCh<strong>in</strong>aMexicoSource: Organisation for Economic Co-operation and DevelopmentSemiconductors 8.9Computer technology 7.5Electrical mach<strong>in</strong>ery, energy 7.3GermanyTransport 12.7Semiconductors 9.0Electrical mach<strong>in</strong>ery, energy 8.5Note: Total refers to the world total. The IPCtechnologyconcordance table (availableat: www.wipo.<strong>in</strong>t/ipstats/en) was used toconvert IPC symbols <strong>in</strong>to correspond<strong>in</strong>g fieldsof technology. Data <strong>in</strong>clude both first andsubsequent fil<strong>in</strong>gs.K. 2010 Measures of InnovationApplicationApplication toBus<strong>in</strong>ess sectorCountry to GDP ratio R&D ratioKorea 99.8 4.1Japan 73.7 3.0Ch<strong>in</strong>a 32.2 2.8US 18.4 0.8Germany 17.2 0.9Source: World Intellectual Property Organization(WIPO)

Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>Cash hoard <strong>in</strong>st<strong>in</strong>ct: debunk<strong>in</strong>g the mythClearly the U.S. is fall<strong>in</strong>g beh<strong>in</strong>d <strong>in</strong>critical R&D programs. So how will theU.S. <strong>in</strong>crease its <strong>in</strong>vestment <strong>in</strong> R&Dspend<strong>in</strong>g? What policies can the federalgovernment undertake to encouragethis effort? An exam<strong>in</strong>ation of currentbus<strong>in</strong>ess practices reveals somepossibilities.u U.S. manufacturers have grown their profits rapidlyover the past decade, largely due to <strong>in</strong>creasedproductivity. Yet over the same period, manufacturershave <strong>in</strong>creased <strong>in</strong>vestment much more slowly,and employment has actually fallen <strong>in</strong> the sector.Clearly, U.S. manufacturers need to resume a fasterpace of <strong>in</strong>vestment to become more competitive <strong>in</strong>the global marketplace. Profits need to be re-distributedto promote <strong>in</strong>vestment.Figure 29 below shows the growth <strong>in</strong> corporateand non-corporate bus<strong>in</strong>ess profits as a percentageof total assets. The ris<strong>in</strong>g profits are clearly evidenthere also, but this chart breaks the profits down <strong>in</strong>todividends 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 whichrema<strong>in</strong> 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-corporatebus<strong>in</strong>esses. As shown by the blue l<strong>in</strong>e, contrary topopular belief, corporations are not hoard<strong>in</strong>g 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 <strong>in</strong>crease net worth. These efforts have occurred <strong>in</strong>two dist<strong>in</strong>ct periods. After the tech bubble burst andequity values plummeted, bus<strong>in</strong>esses began rebuild<strong>in</strong>gnet worth and par<strong>in</strong>g down liabilities. Then thef<strong>in</strong>ancial crisis started to emerge <strong>in</strong> 2007, drasticallymark<strong>in</strong>g down the value of f<strong>in</strong>ancial assets, lower<strong>in</strong>gnet worth and <strong>in</strong>creas<strong>in</strong>g liabilities. After 2009, bus<strong>in</strong>essesonce aga<strong>in</strong> undertook the task of restor<strong>in</strong>gfiscal prudence to their balance sheets, reduc<strong>in</strong>g liabilities,and rebuild<strong>in</strong>g net worth. The f<strong>in</strong>ancial crisisand the great recession pushed bus<strong>in</strong>esses <strong>in</strong>to the“risk aversion” mode to rebuild their balance sheetsand make <strong>in</strong>vestment a secondary priority.u The good news is that although this risk aversionstrategy is still <strong>in</strong> place, it has been eas<strong>in</strong>g. Bankshave started to make commercial and <strong>in</strong>dustrialloans aga<strong>in</strong>. Consumer confidence is on the rise. Thehous<strong>in</strong>g market may have bottomed, and employmenthas firmed <strong>in</strong> recent months, although it is wellbelow the rate of job creation needed to bolster theanemic recovery. Expectations are that all of thesetrends will cont<strong>in</strong>ue and that bus<strong>in</strong>esses will start to<strong>in</strong>crease their risk appetite such that profits will beused less to bolster the balance sheet and more to<strong>in</strong>crease <strong>in</strong>vestment. • • •29. Distribution of Profits as a % of Assets30. Net Worth, Liabilities, and Liquid Assets as a % of Total Assets6%profits6%try<strong>in</strong>g to buildnet worth....f<strong>in</strong>ancial crisis drovenet worth down...try<strong>in</strong>g to buildnet worth aga<strong>in</strong>...net worth5%5%Liabilities4%undistributed profits4%liabilities try<strong>in</strong>gto de-lever ...f<strong>in</strong>ancial crisis droveasset values down...try<strong>in</strong>g tode-lever aga<strong>in</strong>...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

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States• • •But the federal government could do more to stimulate<strong>in</strong>creased R&D spend<strong>in</strong>g. First, the corporate taxcode should be reformed. At the moment, U.S. corporationsare hold<strong>in</strong>g large amounts of accumulatedearn<strong>in</strong>gs overseas which would be taxed if they wererepatriated. This tax structure obviously impedes theflow of capital back <strong>in</strong>to domestic operations, constra<strong>in</strong><strong>in</strong>g<strong>in</strong>vestment. If that money could be repatriateduntaxed, there would most likely be a flood ofnew capital com<strong>in</strong>g <strong>in</strong> to stimulate <strong>in</strong>vestment andcreate the new jobs which the U.S. desperately needs.The government could also spur <strong>in</strong>vestment by creat<strong>in</strong>ga less uncerta<strong>in</strong> bus<strong>in</strong>ess environment. Specifically,Congress should resolve the fiscal situationas quickly as possible. The details of the resolutionare less important than actually do<strong>in</strong>g it. Cont<strong>in</strong>ueddeadlock <strong>in</strong> Congress, or some sort of temporary fixwill only extend the uncerta<strong>in</strong>ty, imped<strong>in</strong>g <strong>in</strong>vestmentand job growth.Surpris<strong>in</strong>gly though, the U.S. does have one advantage<strong>in</strong> 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,dur<strong>in</strong>g the meltdown of the hous<strong>in</strong>g market, thef<strong>in</strong>ancial crisis, and the result<strong>in</strong>g recession, the Presidency,the Congress, and the Federal Reserve all tookextraord<strong>in</strong>ary measures to mitigate the damage.But <strong>in</strong> Europe, there has been little real progress <strong>in</strong>creat<strong>in</strong>g a coherent plan to deal with the sovereigndebt crisis which is approach<strong>in</strong>g its fourth year. Andthe largest E.U. impediment is that there are 17countries, the International Monetary Fund, and theEuropean Central Bank (the troika) all <strong>in</strong>volved. Whileovercom<strong>in</strong>g deadlock <strong>in</strong> Wash<strong>in</strong>gton may be very difficult,it is not nearly as challeng<strong>in</strong>g as try<strong>in</strong>g to mounta s<strong>in</strong>gular effort <strong>in</strong> Europe.When Wash<strong>in</strong>gton has acted <strong>in</strong> concert, there werepositive results. For example, the American Recoveryand Re<strong>in</strong>vestment Act (ARRA) allocated almost $70billion to the construction <strong>in</strong>dustry, which significantlyslowed the rate of job loss. Similar targetedstimulus <strong>in</strong> the manufactur<strong>in</strong>g <strong>in</strong>dustry could helpspur new R&D spend<strong>in</strong>g, more <strong>in</strong>vestment, andmore employment. One logical target would be the<strong>in</strong>dustry with the highest value-added but one whichis exposed to <strong>in</strong>creas<strong>in</strong>g global competitive pressures- the computer and electronic products manufactur<strong>in</strong>g.California is the center of this <strong>in</strong>dustry. ©Focus on… California, the <strong>in</strong>novation<strong>in</strong>cubatorWhile California has suffered significant joblosses <strong>in</strong> manufactur<strong>in</strong>g over the past decade,conditions are ripe for improvement. Californiais by far the largest state <strong>in</strong> terms of nom<strong>in</strong>al GDPat $1.96 trillion <strong>in</strong> 2011, which is 13% of the entireU.S. economy. California alone is the world’s n<strong>in</strong>thlargest economy, and is larger than Russian, India,Canada, Spa<strong>in</strong>, and Australia. As shown <strong>in</strong> Figure31, California’s GDP growth rate has usually outperformedthe U.S. as a whole and was ranked 10thamong all states <strong>in</strong> 2011.u California is also the largest employer <strong>in</strong> 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 <strong>in</strong> job creation. Perhaps more importantly,job growth <strong>in</strong> California is expected to outpace therest of the U.S. over the next two years. Accord<strong>in</strong>gto a University of California at Los Angeles (UCLA)Anderson Bus<strong>in</strong>ess School forecast, jobs <strong>in</strong> Californiaare expected to grow <strong>in</strong> 2013 by 1.9% vs. 1.5% for allof the U.S., and <strong>in</strong> 2014 the numbers are 2.5% vs. 1.6%respectively. In addition, while the unemploymentrate is among the highest <strong>in</strong> the nation, it appearsthat it may be due to an <strong>in</strong>creas<strong>in</strong>g labor force, suggest<strong>in</strong>gthat relatively fewer workers are becom<strong>in</strong>gdiscouraged and leav<strong>in</strong>g 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 <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>CANADACaliforniaCANADAAugustaThe largest state economy <strong>in</strong> the U.S.SeatleMontpellierMAINEOlympiaVERMONTWASHINGTONConcordNORTH DAKOTAProvidencePortlandHelenaDetroit MASSACHUSETTSSalemBismarck MINNESOTAAlbanyMONTANAWISCONSINOREGONBoiseSOUTH DAKOTAMICHIGANNEW YORKRHODE ISLANDSt. PaulCONNECTICUTMadison Lans<strong>in</strong>gNew YorkSioux FallsPENNSYLVANIAHartfortIDAHOWYOMINGDetroitIOWAHarrisburgChicagoNEW JERSEYCheyenneNEBRASKAILLINOISColumbus Wash<strong>in</strong>gtonCarson CityDes Mo<strong>in</strong>esIndianapolisOHIOWESTPhiladelphiaSalt Lake CitySacramentoL<strong>in</strong>colnSpr<strong>in</strong>gfieldVIRGINIATrentonINDIANACharlestonSan FranciscoTopeka Jefferson CityRichmondVIRGINIANEVADADenverFrankfortUTAHKENTUCKYCOLORADOKANSASCALIFORNIAMISSOURIRaleighNashvilleOKLAHOMATENNESSEEARKANSASNORTH CAROLINALos AngelesARIZONALittle RockColumbiaSanta FeOklahoma CityALABAMA AtlantaSOUTH CAROLINAPhoenixNEW MEXICOMISSISSIPPIGEORGIADallas LOUISIANAMontgomeryJacksonTEXASBaton RougePacific OceanMEXICOAust<strong>in</strong>HoustonNew OrleansTallahasseeFLORIDAMiamiAtlantic OceanGDP for the manufactur<strong>in</strong>g <strong>in</strong>dustry <strong>in</strong> California is$230 billion or 12% of all U.S. manufactur<strong>in</strong>g. Theconcentration of <strong>in</strong>dustries with<strong>in</strong> California manufactur<strong>in</strong>gis shown <strong>in</strong> Table L. The first column <strong>in</strong>dicatesthat computer and electronic products comprise31% of all the manufactur<strong>in</strong>g <strong>in</strong> California, by farthe largest s<strong>in</strong>gle <strong>in</strong>dustry. Along with petroleum andcoal product manufactur<strong>in</strong>g, these top two <strong>in</strong>dustriesare responsible for nearly half of the manufactur<strong>in</strong>goutput of California. There are significant contributionsfrom food, beverage and tobacco, and chemicalsas well.The second column <strong>in</strong>dicates that of all the computerand electronic products manufactured <strong>in</strong> the U.S.,25% is made <strong>in</strong> California. California also produces21% of all the U.S. petroleum and coal products. Andonce aga<strong>in</strong> there are significant contributions fromfood, beverage and tobacco, and chemicals as well.u Computer and Electronic ProductsManufactur<strong>in</strong>gThe computer <strong>in</strong>dustry is clearly the sh<strong>in</strong><strong>in</strong>g star <strong>in</strong>California manufactur<strong>in</strong>g. The <strong>in</strong>dustry is heavily concentrated<strong>in</strong> the Silicon Valley region surround<strong>in</strong>g SanFrancisco. Corporations such as Apple, Cisco, Facebook,Google, Intel, and others have added tens ofthousands of jobs and created billions <strong>in</strong> wealth overthe past decade. The development of the <strong>in</strong>dustry issometh<strong>in</strong>g of a random historical accident, largelyemerg<strong>in</strong>g from <strong>in</strong>novations at Stanford University.As the <strong>in</strong>dustry blossomed <strong>in</strong> the 1980s, a secondary<strong>in</strong>dustry of venture capital formed <strong>in</strong> the region,help<strong>in</strong>g to fuel growth. California’s share of total venturecapital fund<strong>in</strong>g <strong>in</strong> the U.S. is approximately 50%,the majority of which has gone <strong>in</strong>to hi-tech <strong>in</strong>dustries.Part of the remarkable growth surround<strong>in</strong>g the<strong>in</strong>dustry is due to the multiplier effect where one newjob creates other related jobs, as <strong>in</strong> venture capital.The Milken Institute estimates that <strong>in</strong> the computermanufactur<strong>in</strong>g <strong>in</strong>dustry one new job may create asmany as 16 others.L. California’s ID Card% of California % of total USmanufactur<strong>in</strong>g <strong>in</strong> CaliforniaManufactur<strong>in</strong>g 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%Mach<strong>in</strong>ery 4% 7%Other transportation equipment 5% 12%Plastics and rubber products 2% 7%Source: Bureau of Economic AnalysisThese fast-grow<strong>in</strong>g bus<strong>in</strong>esses do require a highlyeducated and highly paid workforce. The San FranciscoBay area has the highest percentage of collegegraduates <strong>in</strong> the U.S. workforce; 44% vs. 28% nationwide.This is a hallmark of <strong>in</strong>dustries where the U.S.does not have to compete on labor costs; rather theycompete on high quality, high value-added production.Ma<strong>in</strong>ta<strong>in</strong><strong>in</strong>g competitive advantage <strong>in</strong> this <strong>in</strong>dustryis critical, and the federal government should help<strong>in</strong> this effort. Educational standards <strong>in</strong> science, math,and eng<strong>in</strong>eer<strong>in</strong>g must be raised. Legal immigrationmust be promoted to keep talented workers on these• • •33

<strong>Euler</strong> <strong>Hermes</strong>Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States• • • shores after college graduation, <strong>in</strong>stead of send<strong>in</strong>gthem away to compete aga<strong>in</strong>st the U.S. Taxes onrepatriated capital should be removed.The overwhelm<strong>in</strong>g success this <strong>in</strong>dustry enjoys is dueto <strong>in</strong>satiable global demand for its products such aspersonal computers, smart phones, and tablets.Competition and cont<strong>in</strong>uous <strong>in</strong>novation have createddemand for products unimag<strong>in</strong>ed just a fewyears ago. Yet this same competition cont<strong>in</strong>uouslydrives prices down due to <strong>in</strong>creased productivity,automation, off-shor<strong>in</strong>g, and cont<strong>in</strong>uous improvement<strong>in</strong> semiconductor design. The <strong>in</strong>dustry is furthercharacterized by a convergence of features onnew products, such as cameras, web browsers andemail on phones. Research and Design (R&D) spend<strong>in</strong>gis critical <strong>in</strong> this <strong>in</strong>dustry.Globally the consumer electronics <strong>in</strong>dustry grewsomewhat more slowly <strong>in</strong> 2012 than previously anticipated,around 2.5%. The <strong>in</strong>dustry probably exceeded$1 trillion <strong>in</strong> added value <strong>in</strong> 2012. Much of the growthis due to emerg<strong>in</strong>g markets which are not yet fullypenetrated. In the U.S. <strong>in</strong> 2013 however, consumerelectronics revenues are expected to grow 4.5% andexceed $215 billion, accord<strong>in</strong>g 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 hightech<strong>in</strong>dustrial production (computers and electronicproducts) to grow by 5.7% <strong>in</strong> 2013 <strong>in</strong> the U.S. Highergrowth <strong>in</strong> production vs. revenues is to be expected<strong>in</strong> this <strong>in</strong>dustry with ever-fall<strong>in</strong>g prices.u PetroleumCalifornia has large crude oil reserves and is the thirdlargest producer of crude <strong>in</strong> the nation. Much of thedemand for this crude comes from with<strong>in</strong> the stateitself and this demand is not expected to drop off <strong>in</strong>the foreseeable future. Of all the states, California hasby far the most vehicles. There are 20 million cars <strong>in</strong>California, 15% of the nation’s total of 135 million. Thenext closest state, Texas, has a little more than halfthat many. Includ<strong>in</strong>g trucks, buses and commercialvehicles, there are a total of 33 million vehicles <strong>in</strong> California,or 14% of the nation’s total. The vast majorityof these vehicles run on gasol<strong>in</strong>e, followed by dieselfuel, and natural gas. Forty percent of all energy consumed<strong>in</strong> California is for transportation.California has always been at the vanguard of environmentalprotection and as such it has uniquerequirements for the gasol<strong>in</strong>e that can be used there.As a result, California ref<strong>in</strong>eries are ranked third <strong>in</strong>capacity nationwide and are basically the only oneswhich produce these blends. The ref<strong>in</strong>eries run atalmost 100% capacity to meet demand. Furthermore,California ref<strong>in</strong>eries have no competition from outsideof the state and are not expected to soon. Thesepresent very good conditions for bus<strong>in</strong>ess go<strong>in</strong>g forward– unquenchable demand and no competitors.California is also the 12th largest producer of naturalgas and, aga<strong>in</strong>, demand is built-<strong>in</strong> with<strong>in</strong> 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 runn<strong>in</strong>g vehicleson this fuel will become more apparent. Municipalbusses, commercial trucks, and other vehicles arealready mak<strong>in</strong>g the switch. Build<strong>in</strong>g the <strong>in</strong>frastructureto support the grow<strong>in</strong>g use of natural gas is likelyto be a significant <strong>in</strong>dustry go<strong>in</strong>g forward as there arevery few fill<strong>in</strong>g stations available.Despite its somewhat spotty record, renewableenergy is mak<strong>in</strong>g strong <strong>in</strong>roads <strong>in</strong> California andwill certa<strong>in</strong>ly be a growth <strong>in</strong>dustry go<strong>in</strong>g forward. For<strong>in</strong>stance, California ranks first <strong>in</strong> electricity productionfrom renewables such as biomass and geothermalenergy. Given the state’s propensity to take thelead on improv<strong>in</strong>g energy efficiency, California willlikely be the premier market for the developmentof renewable energy. For example California haspassed a global warm<strong>in</strong>g bill which, accord<strong>in</strong>g to thestate, “establishes a first-<strong>in</strong>-the-world comprehensiveprogram to achieve cost-effective reductions <strong>in</strong>greenhouse gases through energy conservation andrenewable energy production, effectively mak<strong>in</strong>gCalifornia a hotbed of renewable energy and energy34

Economic Outlook n° 1187 | Special Report | The <strong>Re<strong>in</strong>dustrialization</strong> of the United States<strong>Euler</strong> <strong>Hermes</strong>efficiency <strong>in</strong>novations.” The state has also establishedthe California “million solar roofs <strong>in</strong>itiative” aim<strong>in</strong>g tocreate one million solar roofs <strong>in</strong> California by 2018.u Other <strong>in</strong>centivesCalifornia is try<strong>in</strong>g to lure manufactur<strong>in</strong>g jobs back tothe states with many different programs. One sucheffort is the “Innovation Hub,” which accord<strong>in</strong>g tothe state government “seeks to improve the state'snational and global competitiveness by stimulat<strong>in</strong>gpartnerships, economic development and job creationaround specific research clusters throughout thestate. Innovation Hubs target young, <strong>in</strong>novative companiesthat have been <strong>in</strong> bus<strong>in</strong>ess for less than eightyears <strong>in</strong> a technology cluster…” Other efforts <strong>in</strong>cludeIndustrial Development Bonds and Small Bus<strong>in</strong>essLoan Guarantees.u ExportsTo support exports, the state has twelve cargo airportsand eleven cargo seaports <strong>in</strong>clud<strong>in</strong>g the two largest <strong>in</strong>the nation, the ports of Los Angeles and Long Beach. Thestate’s 17 Foreign Trade Zones (FTZ) are <strong>in</strong>tended to promoteexports by delay<strong>in</strong>g, or even forego<strong>in</strong>g export orimport taxes and duties. The computer and electronicsmanufactur<strong>in</strong>g <strong>in</strong>dustry is of course well represented <strong>in</strong>exports, compris<strong>in</strong>g 29% of the state’s total. California’s topexport markets <strong>in</strong>clude the stable Canadian economy andthe more rapidly grow<strong>in</strong>g economies of Mexico, Ch<strong>in</strong>a andSouth Korea. ©The state government is currently provid<strong>in</strong>g a menuof tax <strong>in</strong>centives to lure manufactur<strong>in</strong>g to Californiaas well. These <strong>in</strong>clude a Research and DevelopmentTax Credit, a Film and TV Production Tax Credit, aWork Opportunity Tax Credit, a Net Operat<strong>in</strong>g LossCarryover provision and f<strong>in</strong>ally, <strong>in</strong> an attempt to furtherpromote “green energy”, the state is offer<strong>in</strong>gSales & Use Tax Exemptions for Clean Tech Manufactur<strong>in</strong>g.35

Economic Outlookseries…N° 1173 u Global Sectors ReviewGlobal economic recovery cont<strong>in</strong>ues, but new threats are aris<strong>in</strong>g.N° 1174 u Bus<strong>in</strong>ess <strong>in</strong>solvency <strong>in</strong> France (only available <strong>in</strong> French)The decl<strong>in</strong>e <strong>in</strong><strong>in</strong>solvencies rema<strong>in</strong>s modest overall and stillvery uneven, with a high number of cases.The French economic environment - the slowdown cont<strong>in</strong>ues.N° 1175 u Global Macroeconomic PerspectivesThe slowdown is confirmed, the weaknesses rema<strong>in</strong>, 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 ReviewLook<strong>in</strong>g for growth where it can be found.N° 1180 u Bus<strong>in</strong>ess <strong>in</strong>solvency <strong>in</strong> France (only available <strong>in</strong> French)The overall decrease <strong>in</strong> French <strong>in</strong>solvencies hides several weaknesses.N° 1181 u Macroeconomic, Risk and Insolvency OutlookA fog cannot be dispelled by a fan.N° 1182 u Special DossierPayment periods <strong>in</strong> 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 aga<strong>in</strong>.N° 1187 u Special ReportThe <strong>Re<strong>in</strong>dustrialization</strong> of the United StatesTo come:N° 1188 u Special ReportTransport: a two-speed world<strong>Euler</strong> <strong>Hermes</strong> North America Insurance Company800 Red Brook Blvd, Ow<strong>in</strong>gs Mills, MD 211171-877-883-3224 | www.eulerhermes.us36This document reflects the op<strong>in</strong>ion of the Economic Research Department of <strong>Euler</strong> <strong>Hermes</strong>.The <strong>in</strong>formation, analyses and forecasts conta<strong>in</strong>ed here<strong>in</strong> are based on the Department's current hypothesesand viewpo<strong>in</strong>ts and are of a prospective nature. In this regard, the Economic Research Department of <strong>Euler</strong><strong>Hermes</strong> has no responsibility for the consequences hereof and no liability. Moreover, these analyses are subjectto modification at any time.

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