>> In 2020, the Stanley Black & Decker Corporation opened a massive new manufacturing plant near Fort Worth, Texas. The $90 million facility operated some of the most advanced manufacturing technologies available, aiming to improve efficiency while bringing production of the iconic Craftsman line of tools back to the US. The move became symbolic of a broader effort to reshore American manufacturing. Cutting-edge automation was the key to bringing production costs down to overseas levels. It looked like a textbook success story for this globally respected brand, offering a blueprint for the future of American factories. But after three years of struggling to resolve issues with specialized equipment, production was halted, and the property was listed for sale. Manufacturing firms around the world are grappling with similar decisions of how to leverage technology and where to locate production facilities. It's complicated and goes well beyond estimating direct costs and the potential impact of tariffs. Technology is difficult to integrate, and it's easy to underestimate the impact on staff turnover and the firm's institutional knowledge. Highly specialized skillsets don't always transfer easily between countries. Regulatory environments are usually different, and political and cultural differences can block even the most sensible strategy. How are manufacturers navigating the high degree of uncertainty and shifting their geographic footprint? Can technology help to secure or establish a competitive advantage? And where might investors look for attractive opportunities?

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To understand today's investment landscape, it's important to know how we got here. This is The Outthinking Investor, a podcast from PGIM that examines the past, the present-day opportunities, and the future possibilities across global capital markets. Three experts will discuss the future of manufacturing. Josh Shipley is Executive Managing Director and Head of Europe, overseeing PGIM's global corporate finance offices in the region. Robert Lawrence is the Albert L. Williams Professor of International Trade and Investment at Harvard Kennedy School and was a member of the Council of Economic Advisors during the Clinton administration. Julius Krein is editor of the policy journal American Affairs and the Director of Policy at the New American Industrial Alliance. Most economists agree that a stable manufacturing industry is essential for a healthy economy, even if they disagree on why that's the case or how to achieve it. Josh Shipley considers the current challenges that manufacturers face and how that compares with past macroeconomic shocks like the global financial crisis or the GFC.

>> The response for companies, frankly, has largely been to hold tight, given all the uncertainty and how much that's lingering. Over the last couple of years, we really saw a period of subdued economic outlook. And manufacturers were faced with inflation pressures, still high interest rates off all-time lows, macro uncertainty, mis-curbed investment, whether that was for CapEx for companies or whether that was M&A. For every CEO and CFO we talk to, the addition of global trade tension has magnified this and makes it more difficult to run operations and to finance a business, and make strategic decisions. Becomes almost impossible to forecast for those companies, particularly with a global supply chain. And so, we're just seeing more cautious investment behavior with our manufacturers. We're seeing investment where it is happening on a bit more of a local-for-local basis, but it's not really building out capacity or making big decisions. It's making small changes, typically in the same markets where products are sold while they wait to see how some of this plays out. There are some industries where there's tailwinds, and we're seeing investment there. Think industries tied to renewables, broader infrastructure, defense spending, select business services, consumer staples. But we've also seen other manufacturers struggle. Whether we're talking to companies in Europe or companies in the US or Latin America or Australia, we are seeing that same sense of uncertainty and what do we do next. I think if anything, what we've seen in the past six months since the liberation date at the beginning of April is US companies are some of the ones that feel most paralyzed, and US projects are some of the projects we've seen that have been the most slow because, by nature, if they're part of a global supply chain and they're importing or exporting outside of the US borders, there's just huge uncertainty. For companies specifically operating only in Europe, if anything, they see this as a time to invest within kind of the borders within their markets. They see maybe supply chain opportunities. But I think the uncertainty discussed is really across the board, regardless of where your company's headquartered.

>> The current environment is challenging, but manufacturing was already under pressure from overseas competition and COVID era supply chain issues. Robert Lawrence sees a consistent pattern in the evolution of manufacturing across countries. As economies evolve, the share of manufacturing follows an inverted U shape, rising rapidly, remaining elevated for some time, and then declining rapidly.

>> That is true of the United States, which has had a declining share of manufacturing employment since the 1950s, and it's true of every industrial economy, as well as many emerging economies. And remarkably, it doesn't really matter whether or not countries have a trade surplus in manufacturing or a deficit. They all experience this decline. And today, the United States' share of manufacturing employment is roughly 8% of the labor force. This means that the manufacturing sector is contributing a declining share of output. And, indeed, manufacturing firms are a declining share of value in the overall financial market because only about 10% of total output of the United States is coming from manufacturing. In the aggregate, manufacturing is far less important as a driver of our economy than it used to be.

>> In a society obsessed with growth and technology, it's no surprise this has led to misconceptions about the industry, some of which have undermined it in a meaningful way, particularly in the US. Julius Krein explains.

>> I think the biggest misunderstanding that occurred from what's called the '80s or '90s to very recently is the fact that manufacturing is a capital-intensive industry, often a relatively labor-intensive industry, often an industry subject to a lot of environmental regulations and other things, obviously one that has real marginal costs of production unlike software. So basically, a lot of these manufacturing industries, they traded very low financial valuations. They were not particularly attractive sectors. As a result of that, a lot of people thought that the fact that financial markets tend not to value them very highly, they must not be very important, they must not be very high-tech, and so on. So we lost a lot of strategic manufacturing capability and other strategic supply chain capability. Rare earth minerals mining is not a financially attractive sector in general, and yet if you don't have those supply chains, it causes a lot of problems, including on very high-value sectors. So I think that was the biggest misunderstanding and is the reason for a lot of why many of these strategic sectors were really allowed to wither, if not completely disappear, in the United States. And we've now found in retrospect that not only do these things have very high national security implications, but they're also quite central to the seemingly innovative or so-called innovative high-tech sectors, which are really more intellectual property sectors, whether that's in semiconductors or drones or whatever. And often, if you lose manufacturing, you can lose a lot of that innovation capability. Batteries, drones would be one example, shipbuilding, where not only have we lost the so-called commodity manufacturing, but you've lost a lot of the technological know-how, the capacity to innovate, skilled workforce, and so on. And the other part of this, I think, that has not been fully appreciated is that the connection between high-profit industries and opportunities for internal reinvestment has very broad macroeconomic and even sociopolitical implications.

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So maybe the easiest way to look at it is in the 1950s and '60s, for example, the most profitable companies in the United States were also the largest capital spenders and the largest employers. These were big vertically integrated manufacturers like GM and Ford and GE in the old days, Boeing, and so on. Whereas in the last 20, 30 years, the most profitable companies, namely the big tech companies, are intellectual property companies, and they either outsource and offshore their manufacturing like Apple, or they don't really have any manufacturing you'd speak of. And as a result, the most profitable companies do not really have much internal need for capital reinvestment. They don't have big direct labor footprints. And so, you have large segments of society, large segments of employees are actually cut off from the sources of profits in the economy, which manifests in everything from higher inequality to lower growth overall, lower productivity gains. The joke of, you know, the computer revolution shows up everywhere except in the productivity statistics. I think a lot of that has to do with this and so on. And while it's still unclear how current trade tensions will impact specific segments or regions, or even individual companies, some areas will suffer, and factories will be left to idle. Is it realistic to try to repurpose some of these facilities as demand shifts?

>> The average age of US industrial facilities is something like 55 years old, and that's an average. So for certain sectors, like say shipbuilding, it's even older than that. Something that old, I think, you know, it's often a huge challenge to sort of revitalize that, repurpose that. On the plus side, not having stranded legacy assets that you have to worry about and maybe starting fresh while more expensive perhaps, at some level, it can allow for leapfrogging technologies or just purpose-building facilities for a new technology, rather than trying to maintain an older asset. On the other hand, the Chinese have shown a remarkable flexibility and versatility in being able to convert different manufacturing facilities to produce different products or to upskill them or to integrate them into a different supply chain, and so on. So I suspect it'll be a mixed bag across different countries, different sectors, different asset classes, but there's certainly a lot of US facilities that are just aged out, and new facilities will need to be built.

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>> Today, we also have the hurdle and uncertainty that goes with tariffs and global trade tensions. We haven't seen any major shifts in strategy yet because companies are still trying to figure out how to navigate the added costs, what they can pass through to the consumer, or even what the tariff rates will ultimately be. Some companies believe they can ride out the current trade storm, maybe because of their geographic footprint or their ability to pivot and innovate. Others think the trend will continue and that deglobalization is here to stay.

>> In recent conversations I was having with one of our manufacturers with a global footprint, but headquartered in Italy, they have production plants and facilities in Europe, the US, Mexico. They've moved into Southeast Asia. And the CEO noted he can't measure the impact of the tariffs because even if there's not a direct tariff, it might impact the supply chain going from one country to the next, and he moves product across different facilities. He doesn't know the tariff impact and how it might be negotiated. When you think of semi-finished products, will semi-finished products be impacted by tariffs? And so, from his perspective, it's created just a bit of chaos. Because he doesn't know the outcome, he doesn't know how to react, and he doesn't know how to change his particular manufacturing landscape in terms of should he be operating in the same or different jurisdictions. I think local-for-local onshoring has been discussed for years, but that's absolutely been elevated because of the tariff discussions. I read an article the other day that said 70 to 75% of manufacturers today consider localization increasingly important, if not necessary, to align production, as there is this potential for some deglobalization and, frankly, geopolitical risks. Talking to our borrowers, particularly in Europe, although they would echo that theme, being more local is more relevant than ever. They would also note that it's just easier said than done. It is very difficult, and we're consistently told by our borrowers that moving production to the US or moving production to Western Europe is really difficult and, in some cases, not feasible when you think of the cost to build out production facilities, the higher input costs, the cost of labor. But really, what I keep being told is the lack of skilled labor. But we have seen them take some initiative and some action as it relates to ordering or production speed and pace while this unfolds. We saw some of our manufacturers halt production and halt projects to see how this plays out. You saw others pick up production before the anticipation of the tariff announcement in April. There's just a lot of chaos. There's a lot of uncertainty. And if anything, we feel like, from a European company perspective, they've had a hard time figuring out how they can make this fit in the US. And I've even had some of our companies tell us that it's still going to be cheaper and, frankly, easier, even with supply chain challenges and even with tariff-related costs, to produce in low-cost countries, in Southeast Asia or in Latin America, versus trying to find that skilled labor and the ability to produce in the US.

>> Adding manufacturing jobs is one of the reasons the Trump administration has cited for tariffs, along with shifting the balance of trade and paying down the federal debt. The potential for significant job creation is up for debate.

>> The tariffs are being presented as a way to turn the United States into a manufacturing superpower. But, in fact, in the aggregate, the total number of jobs, if the administration's tariff policies were to totally succeed and eliminate the $1.2 trillion of deficit, my estimate is that the share of manufacturing employment would go from 8% to 9.6% of the American labor force. So the answer is, that's success. Now, will it be that successful? Probably not because, firstly, when we impose tariffs, many of the tariffs are on inputs that other firms have to use. And what that means is that those firms are going to have trouble increasing their sales, their products are going to become more expensive. And so, it's estimated, for instance, that for every steel job that is going to be saved by the tariffs, there are probably 60 or 70 jobs that could be adversely affected by the fact that the products those workers are producing require steel. Products in Canada and Mexico can still benefit from the free trade agreement that we have with those countries. And so, those countries don't have to pay high tariffs. So I would say Mexican products and Mexican companies that can use the duty-free access that they're provided through the USMCA are really going to benefit as a result of these policies because they're going to be able to displace a lot of their competitors who are going to be shackled with higher tariffs.

>> No matter how global trade shakes out over the next several years, there will be some mismatch between jobs and skills. That exists in every economy, but it does seem to be shifting. Just five years ago, it was broadly accepted that the technology boom would soak up job losses in manufacturing, and that the answer was to teach more people to code. Now, however, more and more coding is being done by artificial intelligence. So how should job training resources be applied?

>> What you do need is a sort of new generation of manufacturing workers. It's not exactly the kind of 1950s idealized, nostalgic portrait, but a different kind of skill set of technician able to manage automated manufacturing, robotics, et cetera. And there's a lot of discussion around integrating AI, you know, AI co-pilots and things like that to take someone who's relatively semi-skilled and have them operate at a much higher level. I think the only different wrinkle here, other than the general fact that you always need to train more employees for the growth sector, is manufacturing seems to have a much different educational profile than a lot of these intellectual property jobs. I think if you see these manufacturing fields expanding, and the submarine industrial base alone estimates that they'll need something like 100,000 workers, you could see a shift away from that for your university and postgraduate emphasis and a greater emphasis on apprenticeships, other skills training programs, maybe some more technical education, or specialized scientific technical training, that kind of thing. But it's still very early days, and I think that's an area where policymakers have really struggled to find the right model. And I think there probably isn't a one-size-fits-all model. It's going to be a lot more regional and collaborative.

>> The balance of trade explanation for tariffs is a different story. That's a key focus of tariff negotiations and has become quite politicized. It's important to keep in mind what the balance of trade actually indicates.

>> What a balance of trade tells you is that a country as a whole, let's say it has a deficit, is spending more than it's earning. And therefore, it's a country that's borrowing. Now, what does it tell you about a country's prospects if it's borrowing? Sometimes it depends what it's doing with the money. Sometimes it's quite good to be borrowing if you're using the money to invest, to build capital, equipment, and other ways you'll have to repay the money, and some countries have deficits that they can't sustain because they're borrowing to finance consumption. The total trade balance is an indication of your spending patterns. And there are many reasons where countries trade fairly where the United States has a big deficit. If a foreign country has diamonds and we don't, and we want to buy diamonds, well, we'll have a deficit with that country. And that's a very good thing. It allows us to buy the diamonds we need. And so, using the measure of the bilateral deficits, the deficits we have with individual countries, is a flawed way of telling whether or not they're fair or unfair.

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>> Politics aside, companies will focus on maximizing shareholder value. One of the ways US manufacturers are looking to improve profitability is by leveraging technology. As it turns out, this may be more of an investment problem than it appears on the surface. And it may be more related to a firm's internal rate of return, known as its IRR.

>> US factories, for example, relative to US wage levels, are much less automated than one would expect them to be. And the US actually is a middling player in manufacturing automation. Korea is the most automated, and the US ranks very much in the middle of the pack. In contrast, China, relative to its wage levels, is sort of over-automated, much more automated than one would expect. And so, a lot of this has to do with the fact that US business owners, US investors want very, very high returns on investments in technology, whereas in China and Asia, you know, you can point to cultural reasons, but, certainly, government subsidies, government policies, also mean that their hurdle rates, the IRRs that they want to see on these investments, are just much, much lower. So when it comes to integrating new manufacturing technology, that's really, in many cases, a sort of investment problem in the US and a capital problem. And if you want to see more of that, the government probably is going to have to do something to bridge the gap, to reduce the hurdle rates and expected returns required to get the private sector to invest in this new technology. The other issue you see a lot is, you could call it a sort of agent problem, which is every technology salesman wants to sell his technology product. You can buy the new robot or whatever, but if you don't have the right sensors, the right supporting technologies, then introducing one new piece of technology may not help you. It may actually hurt you. And the US manufacturing sector is a pretty distributed industry. There's a lot of small businesses, a lot of family-owned businesses. They don't necessarily have the right expertise to be able to navigate this thicket of technology vendors selling all this stuff and making sure they have the right ecosystem to support whatever these new technologies are.

>> Government support for manufacturing that would bridge the investment gap could be a game changer in modernizing US manufacturing, and especially for family-operated businesses. On the agent problem, partnerships and industry associations can help, but it takes a significant commitment of resources to make a difference. Europe has some hurdles here in terms of the regulatory environment and cultural expectations. From a lender's perspective, Josh Shipley is especially excited about the opportunities among Europe manufacturers.

>> We've seen strong relative economic performance recently, particularly in Southern Europe, countries like Spain and Italy relative to the rest of Europe, and we have a strong presence there. There are hundreds of strong middle market, family-run companies that are poised for growth and would benefit by having strong institutional partners to complement their core bank lenders. Part of why I'm most intrigued by and most excited about the growth in Europe is, fundamentally, the European market still lags the US market when it relates to private credit. Companies remain primarily bank-financed. And over time, this will have to change, first due to regulation on banks, but also due to increasing capital needs that will be driven by investment spend. Europe has also done a great job of standardizing and improving creditor rights, making lending easier. De-globalization in Europe will have to drive investment within its borders to increase autonomy. I think there'll be significant opportunities from an industry perspective in Europe or, frankly, in all of the jurisdictions where we invest in infrastructure, particularly related to the energy transition. I think other industries that are interesting are defense and aerospace-related businesses, where there's inherent and untapped and unmet growth. You know, on the flip side, I think there'll be sectors where we'll remain cautious. We are always cautious about cyclicals, particularly those tied to construction or directly to the consumer. I think sectors like automotive, retail, and chemicals are particularly vulnerable to tariff uncertainty. It's causing investment delays and increasing refinancing risk for those companies. Overall, I would say from a geographic perspective, I'm most excited about Europe and European infrastructure. And I think there's a lot of opportunities for us to grow there.

>> Despite the challenges, firms that embrace innovation, streamline operations, and adapt to shifting market demands are more likely to succeed. Focusing on resilience and long-term growth strategies could help the manufacturing sector navigate these uncertain times. Thanks to Josh Shipley, Robert Lawrence, and Julius Krein for their insights on the manufacturing industry and its role in the broad economy. The Outthinking Investor is a podcast from PGIM. Follow, subscribe, and if you like what you hear, go ahead and give us a review. If you enjoyed this episode and want to hear more from PGIM, tune into our Speaking of Alternatives podcast. See the link in the show notes for more information.

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