Made in America, again? Rethinking US manufacturing resilience

0:02Rebecca J. Anderson: If the signal is clear that the United States needs to make something, it will figure out how to make something really fast, really well, because of innovation. And so the underlying part that I have folks say is not that we can't do it or why aren't we doing it and why haven't we already done it. Is the signal clear enough? Is it critical?

0:28Shubham Singhal: That's Shubham Singhal. He's a McKinsey Senior Partner and Chair of the McKinsey Global Institute. You know, geopolitics directly affect the state of manufacturing in the U.S., whether that's because of trade wars or physical conflicts or cyber intrusions. Shubham joins me and Rebecca J. Anderson, who's a Senior Fellow at McKinsey Global Institute, to discuss the actions that leaders can take to lessen their exposure and, hopefully, ramp up their manufacturing and innovation activities. This is the McKinsey Podcast, where we help you make sense out of the world's toughest business challenges. I'm Roberta Fasaro, your host for today.

1:16Shubham Singhal: Rebecca Shubham, thanks so much for joining the podcast today. Thanks for having us.

1:21Rebecca J. Anderson: Thank you for having us.

1:22Shubham Singhal: We're here today to talk about the McKinsey Global Institute's recent report on ramping up manufacturing in America. Why is this such an important question, particularly right now? We fundamentally see two major trends underway in the global economy. One is this idea of growing geopolitical fragmentation. So that's putting a spotlight on things like trade dependencies, supply chain resiliency, and so on. So it's really bringing into the fold the idea of building up capacity, especially in critical industries. And then the other important dimension is the rise of AI and other critical technologies.

2:07Shubham Singhal: And I think there's been a recognition over the last couple decades, as the U.S. has lost a bit of its manufacturing prowess in the global economy, that there's a lot of really important innovation that takes place at the production level. And so by not having a lot of that manufacturing domestically, we're actually missing out on a large part of innovation that takes place. I wanted to focus on one of the key data points from the report, which shows that the U.S. imports about$3 trillion in manufactured goods each year. I'm curious to understand more about the impact of all this importation that's happening in our country.

2:49Shubham Singhal: So of the$3 trillion worth of manufactured goods imports to the U.S. each year, nearly a third of those are in electronics products. So when we think about just the sheer volume of what constitutes the majority of U.S. manufactured goods imports, that's predominantly electronics. And what's interesting about electronics in particular is that a lot of electronics are also considered critical to national security. They're often from a concentrated set of countries. For example, semiconductors. The vast majority of the imported semiconductors into the United States are really from Taiwan and South Korea.

3:30Shubham Singhal: And electronics are often from a geopolitically distant trading partner, as we say. And just to define that geopolitical distance metric, this is something that we at the McKinsey Global Institute have developed that basically looks at UN voting records and essentially assigns each country a score based off of how it's aligned geopolitically. And so the U.S. is kind of at one end of that spectrum, China, Russia at the other end of the spectrum, and then every country kind of in between in that spectrum. So fundamentally, I think electronics is probably the biggest part of the story here. But of course, other things like pharmaceutical products, certain chemicals, rare earth magnets, also a really important part of the story.

4:16Shubham Singhal: The report also says that about 25 percent of the imports are potential, and I'm putting this in quotes, Achilles heels. Shabam, can you talk to us a little bit about what makes a product an Achilles heel?

4:28Rebecca J. Anderson: There's three things that we looked at. One is how critical is the product or category. Second is if you look in terms of the supply sources, does it come from just one country, for example, then that kind of makes a big difference on what the risk to that might be. And then the third one is, does the supply source rest in a geopolitically distant country? In MGI, we define that as whether the two countries' foreign policy objectives align or not. And so when we look at those three and we then categorize all of the different product categories, that's what then leads us to understanding. And if any two of those three factors are present, we think of that as an Achilles heel within that.

5:20Rebecca J. Anderson: It is important to note that if you look at all three of those, that's only 5 % of the total imports. And so that is sort of the part that we say is most important to address from a resilience, from a national security standpoint.

5:37Shubham Singhal: The United States is still a major manufacturing power, but it does produce far less than China at this point. Where does the U.S. still have strength and where has it become more vulnerable?

5:49Rebecca J. Anderson: If you were to think about it, we make planes in this country, we make motor vehicles, or at least the supply chains run within North America when we make them, but we do produce a lot of it here. Trucks. So that whole arena of transportation, there's a fairly significant set of production that happens, which is good news, right? Because it is quite advanced type of production and manufacturing. The second one is, as much of the electronics is a problem for us, there are arenas where we still produce a fair amount. Not whole assembled products. Assembly isn't the biggest thing that we do, but some of the advanced elements that kind of go into it.

6:30Shubham Singhal: And just to maybe just chime in, indeed, it's important to emphasize that while the U.S. has lost a large share of the global manufacturing output, the U.S. is still the second largest manufacturer in the world. It's also the second largest exporter in the world today. So by no means is this that the U.S. has lost its entire manufacturing sector or anything along those lines. Really, the story of the last several decades has been one of a movement up the value chain largely. In other words, movement toward more higher value, more design, more IP oriented types of products, more along the lines of the advanced manufacturing, as opposed to the very labor intensive manufacturing like textiles, let's say.

7:18Shubham Singhal: And what's also quite interesting is looking back over the last several years, computer and electronic products are actually the fastest growing category in terms of output in the United States. So the Federal Reserve has an industrial production index that basically tracks the scale or the volume of production across manufacturing industries. And it's almost 40 % up over the last decade, specifically in computer and electronic products. In the report, you introduce the concept of the ramp-up factor, right, that manufacturers and others can use to measure what it would take to meet domestic demand.

7:58Shubham Singhal: What does that metric help reveal or how can manufacturers use it? So what we did with the ramp up factor is we looked at a granular industry level across 300 or so industries in the United States manufacturing specific subsectors. And we calculated what's the extent of domestic productive capacity that currently exists in the United States. And then how does that compare with the amount of imports that we in recent years have imported? So how much would domestic productive capacity have to scale up to fully meet domestic demand? And what we saw was that across all products, that ramp up factor is about 1.3.

8:46Shubham Singhal: So in other words, domestic productive capacity would have to grow by about 30 % to fully meet domestic demand. However, for those Achilles heel goods, that 25 % of total imports that have these multiple overlapping trade dependencies, those would actually have to double on average in terms of domestic productive capacity. And over half of them would have a ramp up factor greater than five. So domestic productive capacity would need to quintuple. And our ambition or aspiration in developing this metric was really to provide dimension and context around the current discussion underway around reindustrialization.

9:31Shubham Singhal: Because, of course, this is such a big topic of discussion right now, but we found that there wasn't as great of a sense of the order of magnitude that we're really talking about here if we're trying to really become independent or at least boost our resiliency in certain critical goods. Rebecca, looking at the highest ramp-up factor, which products or sectors would be hardest to ramp up? In particular, I would say there's the textiles sector and then the electronic sectors. And they kind of have different order of magnitude in terms of their criticality. So things like textiles are not quite so critical to national security.

10:13Shubham Singhal: They're not necessarily from a concentrated set of countries. So that's not really where we put our focus in the report. But then things like laptops, things like server equipment for data centers, let's say, things like rare earth magnets, we have quite a low amount of domestic productive capacity in any of these really critical items. Shubham, one question about this notion of capacity. The report suggests that running today's existing capacity, running today's factories at peak could generate about$660 billion in additional output, but it really wouldn't make a difference in these areas of largest exposure.

10:56Shubham Singhal: Why isn't the existing capacity enough?

10:59Rebecca J. Anderson: It's a good question, Roberto. I think there's a couple of things that we need to think about. One is, if we were to ramp these up to peak capacity, first of all, you'd get another$660 billion of additional output. Now, there are reasons why we may not have enough orders to fill in that space, for example, because there may be cost differentials that play out. It also, unfortunately ends up that this$660 billion of ramp-up doesn't actually solve the Achilles heel, the 25 % we spoke about earlier, because it is a mismatch between where that Achilles heel sits and where this extra capacity is available.

11:40Rebecca J. Anderson: So if it's not enough to be able to meet the Achilles heal, then we have to think about how do we solve for that differently from just running existing factories at full capacity. That will take real investment to build out as we look ahead.

12:00Shubham Singhal: According to the report, building that capacity could cost up to$2 trillion, right? Rebecca, what are the biggest obstacles to generating that investment beyond capital? Things like specialized skills, having the talent pipeline of people immediately available with the right training in place to actually take the positions as these industries ramp up, that is a significant challenge. Things like having the energy and infrastructure in place, those are also really significant challenges that will have to be grappled with in conjunction with any large-scale reindustrialization effort. And what's important to note is that$2 trillion number, it includes the upstream manufacturing supply chains for all of these Achilles heel products, but it does not include the energy, the infrastructure build-out that would have to be associated with it.

12:58Shubham Singhal: So realistically, that$2 trillion number is probably going to be a bit higher. And then, of course, the other element of it is there needs to be shovel-ready projects. So permitting processes, for example, can take a long time. And sometimes there's a big gap in between the intention or desire to do this project versus when it's actually ready to go and machines can start running and people can start working.

13:24Rebecca J. Anderson: So we've talked to a series of investors. They would look at this and ask the following question, which is, what is my return on invested capital here versus the many other arenas in which I can invest? And we in MGI have published on the next arenas of competition where value creation is happening. And there is significant investment like AI and related infrastructure, for example, information and communication technologies. And so the question with some of this just becomes, why do you believe if you as a private sector are going to make$2 trillion of investment while it's feasible and possible, what would be the reason to do so relative to other things where a significant investment is being made?

14:13Rebecca J. Anderson: And that's also a practical reality that has to be thought through as we seek to make these choices and incentivize the growth of production capacity in the United States.

14:25Shubham Singhal: No, it makes perfect sense. I feel like this might be a good place to insert the AI angle. Could AI help make reshoring economically more viable in ways that weren't possible even 10 years ago?

14:39Rebecca J. Anderson: How much can we move in the case of manufacturing with AI and robotics, move the productivity on a fully loaded basis to make the humans that work there far more productive would be a question. Can we get production to be optimized far better in the plants and the networks with using the latest sets of technologies and work that? It's not a silver bullet. It's a series of applications across the various areas that where we in the U.S. have a higher cost structure or factors that lower our return, and you would have to, in each one of them, say, how would we deploy AI to advance them?

15:23Shubham Singhal: I think fundamentally, any manufacturing of the future is going to have to look quite different, especially in a place like the United States, where there are higher labor costs. So effectively, greater AI adoption, greater usage of robotics, and so on is going to realistically have to be part of the equation for a business case. So there are certain products or certain inputs that are essential for downstream industries, but that may be subject to economic choke points. I know Shubham were working on an article focusing on sort of those pinched areas where you have to make considerations about your supply chain.

16:04Shubham Singhal: How should manufacturers think about that kind of risk going forward?

16:08Rebecca J. Anderson: That's a very good question. And we are seeing that in our work on global trade flows. The geopolitical distance of trade traveled, first of all, is falling. The geopolitical distance of foreign direct investment is falling even faster, which is a leading indicator. So first of all, what it means is you, at a minimum, are going to have to use a term colloquially, French or a whole series of parts of the supply chain that are needed for these critical industries. Now, in addition to that, because there are additional choke points that do emerge where even flow between allies may get blocked, you are going to have to think about ways in which investments can happen onshore or at least very close to.

17:00Rebecca J. Anderson: And that's where I find an interesting playbook from the COVID era. Vaccines got developed very, very quickly. The government showed up very early as a guaranteed buyer if you came up with a successful vaccine. That creates a significant incentive for companies to deploy capital, deploy it at speed. And so pharma companies, for example, didn't just wait to develop to then set up manufacturing. They were doing those in parallel. So apply it now to things like rare arts. Guarantees on pricing floors that are being given to companies takes away uncertainty and increases their willingness to kind of lean in and grow their capacity quite significantly.

17:43Rebecca J. Anderson: So I think there will be those arenas that have to get competed, both with a how do you reduce the geopolitical distance over which those goods travel and in some instances also how do you actually bring them onshore and what kind of incentives would you need to place for them.

18:03Shubham Singhal: So if you were advising a CEO or manufacturing CEO on supply chain resilience what are some of the very first things they can start doing to begin to build that resilience? I would say one general idea that we introduce in this recent ramping up manufacturing piece, but also in some other recent McKinsey Global Institute work we've done, is this idea that for when it comes to things like trade dependencies, we really need an all of the above approach. And fundamentally, that could mean ramping up domestic capacity. It could mean things like rearranging trade, so trying to source from different countries or a wider set of countries.

18:51Shubham Singhal: In other words, maybe building in more resilience and redundancy, even if it's not necessarily the most efficient thing to do from a just sheer bottom line perspective. Then there's other ideas like reducing imports or replacing certain imports, which fundamentally is about innovating processes, innovating the way that things are made. And, you know, there's some work being done out there on can we actually innovate our way around a rare earth's dependency? Like, are there other types of materials that we can use instead? And of course, it's highly uncertain and you can't put any types of expectations or timelines on these types of things.

19:33Shubham Singhal: But historically, that's actually been where the U.S. economy has really shined the most. If we look at just the expanse of the last 250 years of U.S. history, U.S. has been extremely innovative, extremely entrepreneurial. In some separate work we had done, about 100 of the top 100 inventions by our accounting over the last 250 years, about three quarters of them had some extent of U.S. involvement. So this is an important point that I don't think we should forget, that just because things are made a certain way today doesn't necessarily mean they'll always be made that way or that even we'll be using the same products in a rapidly advancing technological climate.

20:18Shubham Singhal: So there's really this all of the above type of approach that needs to also be considered. What is a question or a series of questions that you feel like are going unnoticed among the broader business population about manufacturing?

20:32Rebecca J. Anderson: The first part of it is optimism that the U.S. has not lost its manufacturing. Rebecca mentioned earlier that we are the second largest manufacturer, second largest exporter, some pretty critical industries. Second thing that gets lost is there's a focus on$1.2 trillion of trade deficit. The real thing we would posit is the$750 billion that is the Achilles heel that needs to be resolved is the important issue to focus on, not the 1.2 of a gross deficit at the end of the day. And then I think the third is we've discussed a lot of the details as to how and where and whether the$2 trillion can be deployed.

21:15Rebecca J. Anderson: The simple thing that cuts through it to the 250 years point that Rebecca made is, if the signal is clear that the United States needs to make something, it will figure out how to make something really fast, really well, because of innovation. And so the underlying part that I have folks say is, not that we can't do it, or why aren't we doing it, and why haven't we already done it, is the signal clear enough? Is it critical? And is the business case really there? And have we spent the time to make sure that it is? And if it is, we will. I mean, just look at the rate at which we are building out the equivalent of roads, dams, and bridges for an intelligence economy with AI and the growth in the investment that is happening.

22:12Rebecca J. Anderson: It is a question, therefore, Or is it critical enough? And is the signal clear enough that American ingenuity should go to work on it to solve the problem?

22:22Shubham Singhal: I think those were all really great points. I think the other thing to keep in mind specifically about the American economy in this context, this intersection of this next era of manufacturing, but also taking place in the United States, is that the U.S. economy has shown remarkable resilience over time and also great capacity for reinvention time and again. And the economy that we are emerging from in this fluctuation point, so to speak, is really coming out of a past era of about the last 35 to 50 years or so where we've transitioned from a very manufacturing-based economy to a more services-based economy.

23:11Shubham Singhal: And that was a pretty dramatic transition. And I think there's some things that have come out of that that we're grappling with quite a bit as an economy today. But that whole transition arose from a different moment of disruption. And in many cases, you could say that this was the reinvention that needed to happen at that point in time. But then if you look at the last 100 years preceding that, the U.S. economy reinvented it multiple times over. It reinvented during the Great Depression, during World War II, reinvented coming out of the Civil War. And there's this great depth of entrepreneurship and this depth of capital markets and of willing and able to fund so much of this entrepreneurship as well that I think is very special about the U.S.

23:59Shubham Singhal: economy. And so if things are a national priority, if there's intention behind it, if there's momentum behind that and opportunity, I think the U.S. economy is some really, really great wellsprings of innovation to pull from to make this happen. You're both painting such a wonderful picture of American ingenuity and innovation, which I think people need to hear. Rebecca Shubham, thank you for being with us today. Appreciate it. Thank you so much.

24:27Rebecca J. Anderson: Thank you so much. Enjoyed it very much.

24:30Shubham Singhal: Thanks so much for listening to the McKinsey Podcast. I'm Lucia Raheli. And I'm Roberta Fasaro. Find us on McKinsey.com. We'll have a transcript of this episode up shortly. And if you have any questions based on this episode, please email them to us at themckinseypodcast at mckensey.com. If you enjoyed the show, we'd love for you to leave a rating and a review. We'll see you next time. Thank you.