Background
The 1990s was a pivotal decade for global trade. Fueled by the introduction of institutions such as the EU and WTO, along with the implementation of wide-ranging free trade agreements such as NAFTA, the global economy saw unprecedented growth as economies became more integrated.
As globalization catalyzed the formation of a complex network of global supply chains, a rise in international competition drove radical improvements in production efficiency, with businesses quick to take advantage of the natural resource and labor advantages being offered by developing countries. The result was a sharp increase in production capacity, creating lower costs and greater manufacturing output for much of the developed world.
The Rise of China
No country benefited more from this period of mass offshoring than China. Its meteoric rise into a behemoth of global manufacturing became the success story of globalization. Triggered by a set of economic reforms introduced in the 1970s, China gradually began to open up its borders to foreign markets. However, it wasn’t until China’s accession to the WTO in 2001 that its growth began to accelerate rapidly. In 2004, China was responsible for 8.6% of the global manufacturing output, soaring to 28.7% by 2019. The evolution of China into a manufacturing powerhouse positioned China as the largest export destination for 33 countriesand the largest source of imports for 65.
The Nearshoring Equation
Conventional attitudes to offshoring were tested by the pandemic. Widespread disruption across the global supply chain, coupled with exorbitant shipping costs and rampant inventory issues, forced a collective rethink of the importance of resilience in supply chains. However, offsetting the inherent cost advantages of offshoring will require the acceleration and convergence of three macro trends: renewed respect for resilience, the rising priority of ESG initiatives, and a rebalancing of economic incentives.
Supply Chain Resilience
The pervasive inventory issues that were endemic for much of the past two years caused many businesses to reflect on the resilience of their supply chain. The prevalence of the just-in-time inventory management methodology that proliferated over the previous decades resulted in aggressive prioritization of profits at the expense of robust inventory levels.
As the effects of the pandemic began to ripple through supply chains, systemic low inventory levels led to global shortages of products, with the JIT management model landing in the crosshairs of many supply chain executives looking for ways to make their supply chains more resilient. As such, attitudes towards “just-in-time” are shifting towards more “just-in-case” practices, with companies focused on ensuring the resilience of their supply chain through the adoption of new technologies and greater supplier diversification, among other strategies.
ESG Prioritization
In addition to changes to the incumbent inventory management framework, a rise in environmental, social, and governance (ESG) initiatives has put pressure on corporations to adapt their business practices to become more socially conscious and sustainable.
As businesses came under pressure from the pandemic, it was widely expected that “nice to have” initiatives such as sustainability would take a back seat while companies focused on tackling more immediate threats. However, a survey by Barchi Gillai, associate director of the Value Chain Innovation Initiative at Stanford Graduate School of Business, found that 63% of respondents rated sustainability as one of their main priorities for their procurement programs, nearly a three-fold increase from prior to the pandemic. This commitment to sustainability was further supported by an MIT survey published in their State of the Supply Chain Report, where they reported that 82% of respondents maintained their commitment to sustainability initiatives for their businesses.
Nearshoring typically involves moving production from low-income to middle-income countries. Middle-income countries regularly score better than low income countries across a range of ESG metrics. As public sentiment continues to place greater importance on ESG practices, there will be new economic incentives for businesses to shift their production to more socially responsible middle-income solutions.
Economic Rebalancing
Nearshoring requires the evaluation of multiple contributing and interconnected factors to determine whether it makes sense for a company. Nearshoring initiatives often break down due to irreconcilable costs associated with the relocation of production and long-term operational premiums linked with nearshore manufacturing.
Accordingly to Bank of America Global Research, it would cost $1 trillion to relocate manufacturing out of China, highlighting the discouraging amount of capital required to relocate production. On top of this, moving production from low to middle-income countries, as is typical during nearshoring, traditionally results in higher labor costs. Companies can either absorb the additional costs, reducing profitability, or pass on the costs to their customers, potentially impacting sales, competition and threatening overall market positioning.
Despite these obstacles, new tariffs, trade agreements incentives, sourcing Sino-American sentiment, and rising wage growth in Chinaare causing business leaders to start to question the status quo and consider nearshoring more seriously.
Conclusion
Shifting trends are starting to change the calculation for nearshoring. Renewed prioritization of supply chain resilience, coupled with the rising importance of ESG initiatives and an evolving economic landscape, are starting to overcome offshoring inertia. However, high relocation and ongoing operational premiums often make nearshoring expensive for companies to implement and even more expensive to maintain. However, as these trends continue to mold our societies and the cost disadvantages are increasingly offset, expect to see more business start to reconsider nearshoring more seriously as an opportunity for their business.
Edward Routh
Founder of Relloe