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The Microeconomics of


Some American companies are bringing back their manufacturing operations to the United States in
a practice called reshoring. This movement towards domestic manufacturing is in response to
increased costs overseas and the benefits of producing goods close to home.

Tim Laux
ECO 101-06
Prof. David Epstein
1 April 2014

Over the last forty years or so, the United States has underwent significant changes in the
goods and services that it produces. Up until 1979, the United States manufacturing sector
experienced constant job growth, with the exception of the Great Depression in the 1930s.
However, since the 1980s, domestic manufacturing has been on a steady decline. (Brauer) Since that
time, many American companies have moved their production operations overseas, engaging in a
process known as offshoring. The reasons for this change are varied, but in general globalization of
the world economy made moving jobs overseas more profitable. While it looked as if this trend
would continue indefinitely, in recent years, some American manufacturers have brought their
production back to the United States. This movement back to a companys homeland is called
reshoring. There are many forces pushing American manufacturers to move their production
operations back to the States.
Annually, the United States and China trade an enormous amount of goods. In 2011,
Chinese exports totaled $399 billion, while American exports totaled $104 billion. (United States
Trade Representative ). This means that the United States trade deficit with China was $295 billion
in 2011, a testament to Chinas sheer industrial strength and the draw it has to global manufacturing
companies. Though there many other countries the United States trades with, China is the chief and
perhaps most extreme example, so this discussion will use US-China trade relations to help illustrate
an idea. First, it is pertinent to understand why China produces so much, and why many American
manufacturers moved their domestic operations abroad. China has the comparative advantage in
making goods that use unskilled or low-skilled labor. Many manufacturers of high volume goods,
such as clothing, toys and consumer electronics have taken advantage of inexpensive and abundant
unskilled labor to increase their profit margins. By utilizing cheap labor, companies reduce their
explicit costs, subsequently reducing their total cost of production. While variable costs such as
shipping the product overseas are usually increased, the reduction of other costs such as wages and
taxes outweigh these increases. (Maynard)
The United States has the comparative advantage in producing goods that require skilled-
labor. The HeckscherOhlin theorem suggests that a capital-abundant country, such as the United
States, will export capital-intensive goods, which are typically produced by high capital investment
businesses. These markets have high barriers to entry, and the goods produced are typically
expensive and/or technologically advanced. Examples include the aerospace, automotive,
pharmaceutical, and semiconductor industries. While these businesses are highly profitable, they
cannot match the volume of low-cost imports from China, causing a massive China-US trade deficit.
However, while it seemed that these industry trends would continue ad infinitum, some
American manufacturers which went overseas have begun moving production back to the States. In
general, these decisions are not gestures of national pride, but rather decisions made at the margin to
improve business performance. Though cost alone is not always the single factor that sways a
companys decisions, it does have significant influence. In the last couple of years, internal changes
in China have caused an increase in the cost of manufacturing there. This increase can largely be
attributed to changing regulations on industry, and increases in the labor costs, land prices, and the
value of the yuan. (The Economist)
One of the most pressing issues China faces is industrial pollution, and its lack of regulation
and enforcement on the issue. While environmental regulations do exist, they are largely unenforced
across the entire country. For example, many coal fired power plants have scrubbers installed, but
few actually use them because it would drive costs up by around ten percent. (Reklev) While many
producers do pay a Pigovian tax on pollution, reported emissions figures are many times falsified.
However, with Chinas new wave of environmental policy, many manufactures and energy
producers are being forced to clean up their acts. The new policy sets up a market in air pollution
permits, setting a cap on total pollution, forcing some businesses to invest in cleaner and more
expensive technologies. Increased energy costs in combination with tighter regulations on industrial
waste disposal and manufacturing processes are contributing to higher costs of production.
Also, due to growing demand for prime metropolitan real estate, especially in cities on
Chinas southern seaboard, rent prices are on the rise in these areas. Businesses are in competition
with developers who have large plans for urban residential development. This causes a rightward
shift in the demand curve for land, and when people begin moving into these residences, the supply
curve for land will shift leftwards. There are short and long term increases in the price of land.
Finally, the cost of labor in the past few years has surged between 10 and 30% (The
Economist), adding significantly to production costs, and thus reducing profitability of offshored
businesses. The inflation of the value of the yuan has partially been responsible for increased labor
costs, though inflation has also pushed up costs on other fronts. In years past, workers from rural
communities flocked to the cities in search of work. Now, employers are having a harder time
drawing workers to their factories, pushing them to increase wages as an incentive. Workers all
across Asia are pushing for better working conditions and wages to support a better lifestyle. Finally,
Chinas one child policy, introduced in 1979 has significantly decreased the available workforce.
Older workers are retiring but there are not enough young workers to fill open positions, causing a
leftwards shift in the labor supply curve, and thus increasing wages.
Labor cost increases are also pushing Chinese manufacturers to move to more advanced
manufacturing processes instead of relying heavily on human labor. In fact, Chinese manufacturing
has already started to resemble American manufacturing in some ways, moving away from low-cost
unskilled labor to higher productivity, advanced manufacturing. Some operations requiring unskilled
labor have packed up and moved to less developed nations, but these countries do not have the
supporting infrastructure of China, so some explicit and implicit costs are acquired there. As the
American and Chinese manufacturing landscapes become more similar, there may be little or no
advantage in keeping production overseas.
The physical distance separating a Chinese factory from an American design office can cause
a slew of related complications. For one, it is tough to control quality of the goods produced. Also,
time to market is longer when designers and producers have to communicate over a long distance
and through a language barrier. When research and development facilities are located in close
proximity to factories, products can be conceived, developed, produced, and improved at a faster
rate, allowing companies to react more quickly to consumer demands. Also, sending a design over to
a foreign manufacturer for manufacturing puts the confidentiality of the design at risk. Theft of
intellectual property is a major problem when manufacturing is offshored. (Moser) Finally, shipping
costs are significantly reduced when products are produced domestically.
American companies in a variety of industries have already begun reshoring and many others
are considering it. China is losing its comparative advantage in producing low cost goods, and thus
the draw to American companies is no longer as powerful. A company requiring unskilled labor will
likely remain offshored but will move to lower cost countries, until those countries go through their
own changes and are no longer profitable. However, manufacturing of goods that require some
amount of skilled labor may largely return back to the States due to the narrowing gap of production
costs between China and the United States. Reshoring gives a company greater control over what is
produces and can significantly increase profitability, making it an intelligent and fruitful decision.

Works Cited

Brauer, David. "What Accounts for the Decline in Manufacturing ." ECONOMIC AND BUDGET
Johnston, Louis D. MinnPost. 22 2 2012. 3 2014. <
Mankiw, N. Gregory. Principles of Microeconomics. 7
edition. Stamford, CT: Cenage Learning, 2014.
Maynard, Micheline. Forbes. 24 1 2012. 2014.
Moser, Harry. Reshoring Initiative. 2014. 2014. <>.
Reklev, Stian. Enforcement seen key to success of China's new environmental markets. 27 March 2014. 2014.
The Economist. The End of Cheap China. 10 March 2012. 2014.
United States Trade Representative . The People's Republic of China. 2012. 3 2014.
Zhan, Simon. China's Rising Costs. 1 July 2012. 2014. <