The North American Decade—Industrial Policy-Rebuilding Assembly, Manufacturing and Distribution in North America
This Commentary, along with a future one, outlines our forecast for a North American decade. The Biden Administration’s Industrial Policy coupled with building resilient regional supply chains could potentially steer our economy towards bringing back assembly, manufacturing, and distribution to North America. However, the Administration’s Industrial Policy will spark many questions about its ultimate impact.
Fractured World-Global Trade Vulnerabilities—Result Enhanced Supply Chain Resilience
The pandemic, conflicts in Ukraine and the Middle East and global political and economic divisions highlights growing vulnerabilities in global trade. These forces will necessitate enhanced supply chain resilience and transparency at the expense of efficiency, possibly moving away from traditional globalization. Instead, the concept of “re-globalization” calls for resilient regional supply chains capability of withstanding reoccurring “once in a century shocks.”
Building Resilient, less China Centered Supply Chains—Emerging Markets Benefit
Free world leaders expected China’s 2001 entry into the World Trade Organization (WTO) would liberalize that nation and foster a more peaceful world. “There was a lot of desperation to believe that” according to a former CIA East Asia analyst quoted in The Wall Street Journal. Instead, the reality of those hopes fell short due to the Pandemic and rapidly rising geopolitical tensions. These factors spotlighted vulnerability to supply chains centered in China, particularly for the United States.
The solution involves building more resilient, less China-dependent supply chains, a complex process likely taking 3-5 years. Some global supply chains already began relocating to politically friendly countries. The result benefitted emerging market economies like India, Mexico, and those in Southeast Asia (see Figure 1.)
Global Trade Patterns Take a Geopolitical Turn
(Average Change in bilateral trade with each group since Q1 2022)
Source: UNCTAD calculations based on national statistics
Resilient Regional Supply Chains Next Step—Benefits North America
The pace and scale of major supply chain relocations hinges on future corporate investment plans for facilities and logistics systems. A McKinsey Global Institute 2022 survey reported that 44 percent of supply chain managers plan to regionalize their supply chain networks up from 25 percent a year earlier (see Figure 2.) Early signs of an investment shift can be seen in the decline in foreign direct investments to China over the last eighteen months (see Figure 3.)
Over time, the economic power of the United States will favor shifting resilient regional supply chains to North America. This shift will enable USMCA trade agreement signatories ( US, Mexico, and Canada) to strategically position their facilities and logistics systems for optimal economic gain.
Mentions of Re-Shoring Over Past Year
(Companies mentions of re-/near-/on-shoring 100=max)
Source: AlphaSense, BoA GLOBAL RESEARCH
Foreign Direct Investments-China-Quarterly
Sources: State Administration of Foreign Exchange, Reuters, Noah Opinion
U.S. Less Dependent on Intermediate Parts from China—Reshoring less Disruptive
Initial supply chain modifications may relocate assembly plants to lower-cost Southeast Asian countries near China. During this transition, China will continue to supply key intermediate assembly parts. According to a Brookings Papers on Economic Activity, China produces approximately 40 percent of intermediate components used globally (see Figure 4.) Yet, the U.S. imports only five percent or less of its assembly parts. Therefore, reshoring and nearshoring can enhance American supply chain resilience without significant disruption.
World Production of Intermediate and final Manufactured Goods-(1995-2018)
Source: Brookings Papers on Economic Activity, Hidden exposure Measuring U.S. Supply Chain Reliance---Baldwin, Freeman, Theodorakopoulos
North American Regionalization—Factories in Mexico—Increases One Day Delivery Capability—Reduces Working Capital Costs for Inventories
Initially, regionalization through Southeast Asian countries may first lengthen supply chains, increasing friction and costs. However, locating new regional assembly operations near key consumer markets can offset these challenges. Among the regions outside of Asia, North America, housing the largest consumer market, stands to gain the most. Shortening supply lines can facilitate one-day deliveries, not possible from Asia, cut inventories, and lower associated working capital costs. Major U.S. retailers will source more from Mexico to leverage these advantages to enhance delivery speeds and reduce inventory costs. Recognizing the long-term threat of supply chain regionalization, China increased direct investment in Mexican production and distribution facilities (see Figure 5.)
China Direct Investment in Mexico (annually)
Sources: CEIC, The Wall Street Journal
Repatriating Businesses—Face High Labor Costs—Automate/ Produce in Mexico
U.S. firms repatriating manufacturing, assembly, and distribution must tackle slow U.S. work force growth and high labor costs. Solutions may include automation to replace manual labor and AI to boost efficiency. However, if labor intensive processes resist automation, utilizing Mexico’s lower-cost labor will provide an attractive alternative (see Figure 6.) However, current policies of Mexican President Lopez -Obrador’s put a cloud over foreign direct investments. The publication Latin American Advisor pointed out that a stronger rule of law along with further policy changes could boost foreign direct investments. The June 2nd presidential elections will bring one of the two female candidates to office, potentially favoring investment-friendly policies once his term ends.
Mexican Wages Compared to Other Countries
Source: Organization for Economic Cooperation, Federal Reserve Bank of Dallas
U.S.--Mexico Border Production—North/South Logistics Systems/Direct Carriers Substantial Growth
U.S. owned maquiladoras along the U.S.-Mexico border offer cost effective assembly alternatives to China. Employing lower cost labor, these plants assemble intermediate and final goods for export to both the U.S. and globally. Tense U.S./Sino relations enabled Mexico to surpass China as the U.S.’s top trading partner in 2022 (see Figure 7.) Bloomberg Business Week reports Mexico’s imports of intermediate assembly parts from China outpaced its exports to the U.S. since 2017 (see Figure 8.) Over time, Mexico will likely follow China’s strategy and produce intermediate assembly parts locally. With the push for nearshoring production and distribution in Mexico, north-south logistic management systems plus the direct carriers should experience substantial growth over the next decade.
Share of Total U.S. Manufacturing Trade-China-Mexico-Canada—2002-4/2023 (%)
Source: Organization for Economic Cooperation, Federal Reserve Bank of Dallas
Mexico—Export to U.S.---Imports from China—2017-2022 (% Change)
Sources: IMF, UNCTAD, Bloomberg Business Week
Equity-Automation-Logistics: This Commentary leads to potential investments in factory automation as well as generative AI. As supply chains evolve, logistics managers and direct carriers handling north-south North American traffic will also gain advantages. A future Commentary will explore additional investments that will profit from the Administration’s emphasis on domestic industrial production.
Equity-Emerging Markets: Shifts in supply chains from China will spur growth and investment opportunities in specific emerging markets. Historically, investments in these markets focused on China, its companies, or used China-led emerging market ETF’s. However, given both its size as the second largest economy in the world and, yet its status as an emerging economy, China should uniquely stand on its own. Given the inherent volatility in emerging markets, we advise investors to use actively managed emerging market funds guided by seasoned managers to participate in these markets. Their experience will enable them to selectively capitalize on the changes outlined in this Commentary.
Fixed Income-Fed Policy Shift-Increase Duration: In its December meeting, the Fed focused back to its dual mandates of inflation and employment. With that change, the Fed then increased its expected rate cuts in 2024 from two to three. If inflation continues to trend lower, multiple cuts in 2024 seem more likely. If this scenario unfolds, short-term fixed income investments will face increasing reinvestment risk. To offset this risk, current Treasury note and bond rates offer attractive real rates of return for the first time since the Great Financial Crisis. Therefore, we continue to view extending fixed income duration an attractive option for investors.
Alternatives: Amidst changes in the financial industry and markets, alternatives can prove attractive by providing the diversification benefits of lower correlations with stocks and bonds. In this uncertain investment environment, alternative investments can both help manage risk and potentially enhance returns.
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