By Rody Camacho, Director, Global Trade Consulting
In a recent Gartner survey of supply professionals, 30% of respondents acknowledged they are taking steps to shift to a regionally based supply chain. While in reality a retrenchment of international sourcing isn’t likely to occur in the near term, the desire to de-risk from global supply chain disruption isn’t terribly surprising.
2020 was a banner year for supply chain disruption, which is saying a lot given the degree of disruption that’s taken place in the past four years. Between March 2020 and March 2021, the world witnessed the shutdown of production in China (the world’s factory), an inability to get goods exported from China once production resumed due to a massive backlog at China’s ports and, more recently, a global shortage of shipping containers and massive congestion at the ports of Los Angeles and Long Beach – America’s gateways for Chinese imports. Add to that the recent blockage of the Suez Canal and soaring freight rates and there’s a strong case for regionalizing production.
Assessing the Cost of Reshoring Production
What’s often missing in the equation is the cost of reshoring or nearshoring production. It is estimated that a wholesale shift away from overseas production would result in a collective expense of about $1 trillion. Moreover, a recent U.S Chamber of Commerce study suggested a 50% reduction of investment in China would eliminate $500 billion in U.S. GDP.
The cost is particularly onerous for mid-sized firms that have been using sub-contractors in China to compete effectively with larger firms in the U.S. that leverage economies of scale to be more price competitive. For those firms, the cost of re-establishing production processes and associated intellectual property and sourcing labor with the necessary skills will be particularly costly.
But production cost is only one part of the equation. The most prominent catalyst to bringing production back to North America is averting risk and reducing trade-related costs. A recent survey by DHL Resilience360 (now Everstream) showed the most common reason (31%) for shifting sourcing was diversifying manufacturing to reduce risk, followed by reducing reliance on China for essential materials (17.9%) and then tariffs and other trade war-relate disruptions (15.9%).
The Nearshoring Alternative
Despite the cost, numerous firms are moving at least parts of their production process away from China, but not necessarily to the United States. While China’s neighbors in Southeast Asia have captured the lion’s share of production that’s left China, Canada and Mexico – both neighbors and free trade partners – have been playing increasingly critical roles in regionalizing supply chains.
A report released by A.T. Kearney in 2020 shows manufactured imports from Mexico into the U.S. rose from $278 billion in 2017 to $320 billion in 2019, an increase of 15% in just two years. In a separate study conducted by Foley and Ladner LLP in December 2019, 67% of the 160 U.S.-based executives surveyed said they have moved, plan to move or have considered moving some operations to Mexico as a result of global trade tensions (67%).
Mexico represents a strategic production opportunity for firms looking to bring supply chains closer to home. The country boasts free trade agreements with more than 40 countries, making it a strategic “plus one” in existing global supply chains. Moreover, the longstanding IMMEX program offered by Mexico’s government allows firms to import raw material, intermediate or unfinished goods into Mexico provided they are later exported out of Mexico for additional production or sale within a set period, with special trade and duty benefits.
Labor costs in Mexico are about 20% lower, saving manufacturers significant costs. Wages are significantly lower Mexico today than they were a decade ago, while wages in China have soared. Sub-contracting options in Mexico are limited compared with China, so manufacturing firms will have to invest in their own production IP and labor force. However, the current administration is investing heavily in youth training programs to increase the level of skills across the workforce. In the interim, nearshoring may not be an option for certain sectors, such hi tech, where the skill level cannot be matched by that of China.
The recent implementation of the USMCA ushered in a new era of cross-border trade harmonization, both in terms of regulatory policy and customs processes. This allows firms to avoid duties and ensure fewer instances of non-compliance for regulated goods. Last but not least, a yet to be approved acquisition of Kansas City Southern by Canadian Pacific Rail has the potential to create a cross-continental railway network under one rail company. If approved, the rail network would significantly increase the speed of north-south rail delivery in North America, allowing firms with integrated supply chains to function more seamlessly.
No Overnight Change
To be sure, nearshoring and reshoring will not be as viable an option for firms producing regulated goods, such as chemicals and pharmaceuticals as regulations in China are far less onerous than they are anywhere in North America.
Beyond that, however, the business case for shifting production from China to North America is become far stronger with each passing year and U.S. firms will be looking south of the border to take advantage of labor-cost efficiencies, special tax programs, geographic proximity and increasingly skilled labor to set up production.
Where nearshoring was once an abstract, hypothetical theory, it has now become an active trend. The only remaining question is the manner in which firms will execute nearshoring plans and over what timeframe.
Rody Camacho holds extensive expertise in trade compliance, as well as import and export operations management and regulations in Mexico. He specializes in risk assessment and process improvements. In addition to Mexico, Rody has worked with clients in South America (Brazil and Argentina) on international transactions within their jurisdictional regulations.