14.05.2020 | Post-Covid supply chains – reshoring vs resilience

Bringing Far East production closer to home may not be the most cost-effective or practical solution.

Click here to read an abridged version of the Alaco article in the FT's fDi Intelligence.

Calls for the reshoring of manufacturing have grown louder amid the huge trade disruption caused by coronavirus, yet the costs and logistical challenges may be prohibitive for many firms, with some experts arguing that building greater supply chain resilience should be at the top of corporate agendas.

Lockdown-related supply chain breakdowns, particularly the acute shortages of China-sourced medical equipment, have led to politicians in the West, protectionists and free-traders, advocating greater localisation of production as a hedge against future logistical crises.

President Trump has been at the forefront of the reshoring debate, but European Union leaders too have proposed the building of domestic capacity in crucial sectors including pharmaceuticals, and Japan has set aside over $2 billion to help its companies repatriate manufacturing plants or expand output into Southeast Asia.

For some time, multinational firms have been moving part of their production capacity from China to Southeast Asia and other locations in large part because of rising Chinese labour costs and, more recently, in order to limit exposure to tariffs linked to the US-China trade war.

The pandemic seems set not only to expedite the trend but also to prompt many corporates into undertaking reviews of their supply chain vulnerabilities, likely giving some consideration to reshoring or nearshoring, the movement of a company’s offshore production to a proximal country, such as Mexico for the US and eastern European countries for the EU.

In America, reshoring has been on the rise because of the increasing costs of locating output in China and greater US competitiveness due to corporate tax and regulatory cuts, according to the American trade publication Industry Week. In 2018, it said, the number of reshoring job announcements reached 145,000, the second-highest annual rate since the publication started tracking the trend in 2007. However, serious challenges, both financial and practical, militate against localisation.

Another US business title, Supply Chain Drive, reports that companies that have reshored to the US are typically smaller producers targeting niche markets, while bigger firms have often struggled to recruit the skilled labour they require, with some having to invest in automation. Relatedly, several central and eastern European nearshoring locations have invested significantly in robot technology to make themselves attractive to multinationals.

But while automation is clearly an option for companies wishing to relocate from China, it requires significant upfront expenditure as part of a transition that will throw up a number of other substantial costs and complications.

In the Global Supply Chain Law Blog, Rosemary Coates, the executive director of the Reshoring Institute, an organisation that helps corporates move supply chains back to the US, says those wanting to exit China face paying off local employment contracts, commonly 1-2 years in length; the Chinese government may not allow their equipment to be relocated; and local partners might continue to produce their product after they have left.

While the FT reports that US policymakers have discussed government-backed loans specifically for companies to move production back home, along with tax breaks as a reward for doing so, such provisions overlook the difficulties firms face in unravelling their supply chains. According to the newspaper, PhRMA, the trade body representing US drug manufacturers, says altering just one element of a supply chain could take “years” and incur “significant costs”.

There is a view that western political leaders may have been too quick to offer reshoring solutions to the problems their domestic manufacturers have faced. Writing in Yale Global Online, Stephen Roach of Yale University, a former Chairman of Morgan Stanley Asia, argues that in “their rush to embrace nationalistic, anti-China clamouring for supply-chain liberation, politicians are all but ignoring the complexity of these networks and the considerable amount of time and effort required to construct them”.

While at least some reshoring is probable due to the pandemic, a broader geographic shift in production seems likely to be limited by the associated costs and logistical issues. Some experts suggest that it makes sense for companies planning for disruptive events to build greater resilience into their supply chains.

Roach points out that “under the guise of efficiency, managers may have taken too much slack, or redundancy, out of the system – leaving them vulnerable to bottlenecks”.

In an Op Ed for the FT, chief economist at the European Bank for Reconstruction and Development, Beata Javorcik, said in future firms will give more thought to diversifying their supplier base “to hedge against disruptions to a particular producer, geographic region or changes in trade policy.

“This means building in redundancy and perhaps even moving away from the practice of holding near-zero inventories. Costs will certainly rise, but, in the post-Covid world, concerns about supply chain fragility will come right after those over cost.”

Caroline Freund, global director of trade, investment, and competitiveness at the World Bank, said in a commentary in Barron’s that in the face of a deadly pandemic, nationalist policies may appear rational, but they are not built on economic fundamentals.

“It’s far more effective to leverage global supply chains to ramp up production quickly and efficiently,” she said.  “It’s much smarter to increase international cooperation to stockpile essential goods and build resilience to future shocks – especially in developing countries.”

As lockdowns ease, supply chains will likely begin returning to some degree of normality. At the same time, corporates will no doubt review their configuration and resilience to guard against future disruption.  While assessing the costs and benefits of logistical change will be challenging, the current state of play seems unsustainable.