US manufacturing: Why 2020 was the bottom of a long decline

The U.S. manufacturing industry has experienced a lifetime of trauma over the past two decades—but we believe 2020 marks the bottom of that long and high-profile decline.

This past year has been particularly traumatic, as the pandemic brought with it the largest cut in industrial earnings on record in the second quarter, driven by the global shutdown that started in January in China and still exists in some form in many countries today.

However, as we look out to 2021 and beyond, there is more reason for hope in manufacturing than at any time since the 1990s. Three major themes are beginning to gain traction that will not only carry manufacturing out of the current doldrums but to new prosperity: a quick recovery from the recession; localization of supply chains, or onshoring; and technological advancements that level the playing field between the U.S. and countries with lower labor costs.

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A painful past

To back up a bit, U.S. manufacturing lost its mojo some time ago. Lack of sustained investment, noncompetitive labor rates and degrading infrastructure opened the door for low-cost countries, notably China, to take the lead as manufacturers shifted production overseas. The end result was an industrial sector that leaked jobs, fell behind in technology and lost investor support. In 2000, U.S. industrial companies were 15% of the S&P 500 index by market capitalization. That number has fallen to less than 9%, with the massive U.S. aerospace industry leading a two-point drop in the past year alone.

So, why do we believe things are about to turn around?

For one thing, the industry is poised to emerge from the Covid-19 recession much more quickly and robustly than it usually does from downturns. That’s because the market for certain goods has stayed strong during the pandemic—which has allowed manufacturers, on average, to remain far more stable than in past recessions. And the sharp hit to earnings experienced from March to July is quickly reversing.

Yes, manufacturers who sell into “ground zero” markets—aerospace and airlines, restaurants, hotels, office buildings, and oil and gas—have been particularly hard hit. But consumer-goods suppliers, like those who sell paper products, personal protective equipment and cleaning supplies, saw huge gains after the initial hit from the pandemic and can’t run their factories hard enough to keep up with demand.

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Hardware stores and HVAC suppliers are also experiencing tremendous growth; Americans have taken the savings from not traveling or eating out as frequently and spent heavily on their homes. Oil prices indicate a global economy in despair, but lumber prices indicate an economy in a boom.

There is no precedent to this that we can find. We’ve never had a recession so bifurcated.

Of course, there is still risk, as the pandemic is far from over. But the data we see today are overwhelmingly supportive of an industrial economy on the mend, with sectors that weren’t strong up until now beginning to recover. Consumables such as industrial tapes and connectors made by companies like 3M and DuPont have bounced back the fastest. Larger purchases, like automobiles, are perking up, as well.

Longer-cycle markets that require big project investment—like new buildings and oil-and-gas drilling—likely won’t recover until after the pandemic subsides. But those markets always trail a recovery by one to two years.

With low interest rates and rising order books, we should start to see manufacturers playing offense again, such as boosting investments in both factories and new products.

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On Main Street

This brings us to the themes of localization of supply chains and the role of technology in the future of manufacturing.

Pre-pandemic, there was already a rising concern around supply-chain risks. Companies that a decade ago felt comfortable as suppliers consolidated and centralized—often solely in China—began to lose faith in globalization and made plans to onshore.

Rising tensions in the South China Sea and heightened technology-theft concerns played a role in this changing mood, as did the Trump administration’s broad use of tariffs and verbal warnings. Executives also began to see that shipping intermediary products halfway around the world and often back again was wasteful and no longer productive.

These concerns were elevated to near panic as supply chains shut down in the early days of Covid. High-profile shortages, such as the lack of PPE for hospitals, may have served as a broader wake-up call for the supply-chain issues that had been creeping up over time. Critical components became hard to find, rare-earth metals seemed to disappear, pharmaceutical supplies tightened.

It’s not just concerns about supplies that will drive onshoring. The math that drove companies overseas in the first place has also changed.

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The cost advantage of low-cost countries is not nearly as great as it once was. Labor inflation in China has been steadily high, particularly as the country transitions from a pure low-cost exporter to a consumer society where workers demand more.

In the U.S., we’ve had the opposite, with north of a decade of labor deflation in the manufacturing world that, while unfortunate, was necessary to improve competitiveness. To make labor costs in the U.S. competitive, you need to be able to produce the same quantity of product with about half of the employees that would be needed in a similar factory in China.

This was not possible five years ago but is today. Automation and other technologies play a big role here, and advancements are accelerating.

With progress in data analytics, the low cost of cloud computing and artificial intelligence, the factory is evolving into a new age. Companies that have already made these investments report all kinds of secondary benefits, including higher safety levels, higher employee morale, lower turnover among staff, higher quality control, faster new-product cycles and lower environmental impacts. The payback is not just financial, as brands are enhanced by quality and corporate culture is enhanced by safety, better job satisfaction and stability.

Software changed the world the consumer lives in; now it’s changing the world that manufacturers live in. And while there are few silver linings in a pandemic, the rate of positive change for American manufacturers has been accelerated for the better. The outlook hasn’t been this encouraging for a very long time.

Key Manufacturing Dates in 2020

• Jan. 3: The U.S. factory sector contracted in December for a fifth consecutive month, the Institute for Supply Management says, heading into 2020 on a weak footing amid trade tensions.

• May 1: U.S. manufacturing contracted in April at the sharpest rate since the last recession, the ISM says. Manufacturing jobs fell by more than 1.3 million, or 10%, to 11.5 million in April, the Labor Department will report.

• Aug. 14: U.S. industrial production increased in July for the third month in a row, the Federal Reserve reports.

• Nov. 17: U.S. industrial production rose 1.1% in October, the Fed says, but is 5.6% below where it was in February. Manufacturing employment rose for the sixth month in a row but is off 4.9% from February, Labor Department figures show.

Mr. Davis is chairman and chief executive officer of Melius Research and co-author of “Lessons from the Titans.”