Reshoring for Resilience: Building Strength, Stability, and Prosperity in a Multipolar World

Overview

• Trends in globalization and lean manufacturing have made global supply chains more efficient, but also more vulnerable.
• Deteriorating geopolitical relationships have left the United States dependent on unfriendly nations for some of our most critical goods and manufacturing inputs.
• That vulnerability played a major role in the Covid supply chain disruptions, which were then compounded by the Russian invasion of Ukraine.
• The supply side shocks brought about by Covid and the Russia/Ukraine war likely contributed to the sustained inflation we are experiencing today, like the Arab oil embargo of the 1970s.
• Reshoring our manufacturing base can create high-paying employment opportunities which can revitalize our middle class and spur increased economic activity via higher consumption and a reduced trade deficit.
• While reshoring may create structurally higher production costs, it can also reduce the likelihood, length, and severity of supply-side shocks that often serve as inflationary catalysts.
• Reshoring industries like semiconductors can serve profound national security benefits similar to achieving energy independence earlier in the 21st century.
• Reshoring supply chains can allow for more progress and better control of all three aspects of the Environmental, Social, and Governance (“ESG”) movement.
• Although the benefits to the United States may outweigh the costs, the process of reshoring may make the global economy less productive and drive a further breakdown of international relations.
• The main challenges of successful reshoring efforts are labor shortages and lost productivity, both of which can be mitigated by investments in technology.
• The overall trend will create direct and long-lasting demand drivers for many U.S. companies, primarily in the industrial, materials, energy, and technology sectors.

How Did We Get Where We Are Today?

Free Trade and the Rise of China

In 1947, while picking up the pieces from World War II, leaders from across the world seized the opportunity to rewrite the global order, fostering a new era of international cooperation and free trade. The General Agreement on Tariffs and Trade (“GATT”), signed in 1947 by 23 countries, sought to expedite global economic recovery by facilitating global trade. The International Monetary Fund (“IMF”) was created in tandem to reconstruct the global monetary system and facilitate the free flow of capital that would be needed to finance cross-border trade. Over the years, GATT expanded and ultimately laid the groundwork for the creation of the World Trade Organization (“WTO”) in 1995. By the 21^st century, countries, corporations, and investors could allocate capital almost anywhere on the globe. A new system emerged where developed economies could rely on developing economies for cheap labor and a vast supply of raw materials and natural resources.

This trend was supercharged by the admission of China to the WTO in 2001. With the sixth-largest economy and a billion people, China seemed set to continue its transformation from a communist-ruled, agrarian economy to a formidable global trading partner and bastion of capitalism. The country’s large population provided a source for low-cost goods production. Only eight years later in 2009, China surpassed Germany as the world’s largest goods exporter.

World Rank: Goods Exports (Current US$)

The impacts to the Chinese standard of living were profound. In 1990, 67% of the population was living in extreme poverty (defined as living on less than $1.90 per day). By 2015, that number was below 1%¹.  In contrast, such dramatic growth came at the detriment of domestic manufacturing in the United States (and other G7 nations). America’s share of global manufacturing fell from 25% in 1997 to 17% in 2019².

Lean Manufacturing and the Efficiency/Resiliency Trade-Off

Another globalization trend was the proliferation of just-in-time inventory management (“JIT”). Also known today as “lean manufacturing,” JIT was pioneered by Toyota in the 1970s and quickly spread to manufacturers all over the world. The idea was to minimize inventory needed along the value chain. By holding only as much as was needed at any given point of the production cycle, companies could reduce supply chain bottlenecks and working capital requirements, all of which allowed for lower-cost production. Advances in technology and global trade allowed companies to stretch their supply chains across the planet, maximizing efficiency. The tradeoff for such efficiency was resiliency. A leaner supply chain may be less costly, but it also has little room for error. Heading into 2020, the world had built a network of supply chains that were highly efficient, but severely vulnerable to shocks.

To illustrate that vulnerability, McKinsey Global found that companies can expect supply-chain disruptions lasting a month or longer to occur an average of every 3.7 years. The consulting firm also found that large companies should expect a disruption that erases more than 40% of a year’s profits at least once every decade³. Many industries rely on highly concentrated geographies for production or sourcing of critical inputs. Further, the U.S. and other major economies are increasingly finding themselves relying on unfriendly nations for products they can’t live without. The share of global trade conducted with countries that rank in the bottom half of the world for political stability (as defined by the World Bank) rose from 16% in 2000 to 29% in 2018^3.

A Global Pandemic Turns Risk into Reality

The emergence of Covid-19 in 2020 severely disrupted the global manufacturing system built over the previous seven decades. The outbreak brought about factory shutdowns and port closures that cut off the supply of many products taken for granted. Suddenly, our efficient supply chains simply couldn’t get goods to where they needed to be. Intensive Care Units of hospitals were forced to ration masks and gloves.  Cars sat half-finished on assembly lines waiting for semiconductors. Meanwhile, cargo ships sat idled at ports, waiting to be unloaded, yet freight rates were surging.

New York Fed Global Supply Chain Pressure Index

Russia Fuels the Fire by Turning Off the Gas

Russia stressed the system even further when it invaded Ukraine in January 2022, kicking off Europe’s largest major conflict in the last 70 years. Most of the world came to the swift defense of Ukraine, enacting punitive measures meant to cripple Russia economically. Russia hit back by cutting off the supply of oil and natural gas.  Many European countries like Germany were particularly exposed, relying on Russia for 50% of its natural gas needs⁴. With the help of its allies, Germany acted quickly, cutting its share of gas supplied from Russia to a third of its total demand by May, and within a year announced that it no longer relied on Russia for its energy supply⁵.  Germany avoided a worst-case scenario, but not without a little luck (a warm winter), and not before energy inflation reached its highest level in over 40 years. Energy and food inflation brought total inflation rates to levels not seen since just after the fall of the Berlin Wall.

Year-Over-Year Consumer Price Inflation: Germany

Tying in the ESG Debate

The current supply chain system also makes life difficult for U.S. corporations from an ESG (“Environmental, Social, and Governance”) perspective. Intuitively, longer supply chains demand more fossil fuels. But there are also implications for “S” and “G”. As it stands today, developed nations outsource much of their manufacturing to developing countries like China, Vietnam, India, and Indonesia. If companies and regulators are not careful, low-cost employment can quickly become exploitation. Without local laws governing labor conditions, it can be tempting to blur ethical lines for the sake of profitability.

Even without intent, companies can still inadvertently wind up with human rights violations in their complicated networks of manufacturers and suppliers. Practices of foreign companies deep in American supply chains can be opaque, leaving even their corporate partners unaware of the working conditions involved.  Many companies (e.g., Nike, Apple, Nestlé) have been forced to rebuild their reputations after revelations of dependence on child labor or dangerous factories in poor countries with long hours and paltry wages. A welcome byproduct of the reshoring initiative is to end up with supply chains that have not only a lower carbon footprint, but also better visibility into the working conditions involved in the process.

Taking a step back to the “E” in ESG, much of the pollution emitted by developing countries is a byproduct of the production of goods that are ultimately sold back to developed nations like the United States. Although we have made some progress in preserving our environment, the outsourcing trend has enabled us to also “outsource” our pollution, leaving other countries with the direct consequences. When the factories are operating under our laws and located in our neighborhoods, U.S. corporations would at least have stronger incentives to prioritize safety and ecological preservation.

How Can Reshoring Benefit Us

Potentially Higher GDP

One result of globalization has been a consistent widening of the U.S. trade deficit since the 1970s. An increasingly negative trade balance (particularly in goods) has acted as a drain on U.S. GDP for a half-century.

Net Goods Exports as a % of GDP

Recall the formula for GDP:

Reshoring efforts will initially contribute by way of increased business investment (I) as new networks of factories and logistic systems get built out within our borders. As production starts to come online, we may begin to see a reduction in imports (M) and/or increase in exports (X). Together, a smaller trade deficit (X-M) can reduce the drag on GDP we’ve seen for the last five decades. Even when accounting for potential losses in productivity (e.g. relatively higher labor costs), we expect this trend to ultimately be accretive to U.S. GDP over time.

More Jobs + Better Wages = Higher Consumption

The declining manufacturing sector removed the employment engine of a large portion of the American population. In fact, manufacturing is still the main source of employment for roughly 500 counties across the U.S^6. One study even found that one-third of the country’s manufacturing workforce relies on food stamps or other federal assistance programs to make ends meet⁷. Most manufacturing jobs of the future will require a higher level of technical skills and will pay accordingly (many already do). And while increasingly complex, not every job will require advanced degrees. Brookings found that 60% of jobs in semiconductor manufacturing (a highly complex process) do not typically require even a bachelor’s degree. Even those that worked in “Production” averaged about $95,000 in compensation⁸. 

Higher wages for the manufacturing sector can feed through to higher aggregate economic activity via consumption (the “C” in the GDP equation above). The Economic Policy Institute estimates employment multipliers for each sector, accounting for jobs created by the sector’s supply chain as well as indirect employment from spending the sector’s incomes. Durable and nondurable manufacturing boast some of the largest employment multipliers, creating 7.4 and 5.1 indirect jobs for every direct job, respectively. For context, some of the lowest employment multipliers were retail trade (1.2x) and accommodation and food services (1.6x)⁹. Manufacturing is a multifaceted economic process that requires technology, infrastructure, heavy equipment, transportation, production inputs, and many other elements to function. The increasing demand across these broad supporting industries is what drives the indirect job growth. Industries with far lower multipliers, such as retail trade and accommodation/food service run much leaner operations and require far less support from suppliers and associated industries.

Much has been written about the demise of the middle class in America. The decline in manufacturing that went along with it was no coincidence. Back in 1992, presidential candidate Ross Perot coined the phrase “giant sucking sound” to describe the flight of factory jobs across our borders. Thirty years later, the sector is as crippled as ever. These jobs still matter. Setting the sector back on the right course can help revitalize our middle class, which will cause positive reverberations across the entire economy.   

Opportunity for the Industrials, Materials, Energy, and Technology Sectors

Reshoring an industry is a capital- and labor-intensive process that can span decades. Outsized capital expenditures present opportunities for a variety of industries. The buildout of factories and necessary infrastructure present opportunities for the industrials and materials sectors. Reshoring will also likely lead to increased spending on technology as companies seek higher levels of efficiency to make up for increased labor costs.

Though technically transitional, the long lead times for manufacturing projects means the “picks and shovels” effects of the transition will not be short lived. For example, semiconductor fabrication plants (“fabs”) usually take a minimum of five years to build (not to mention the $10 billion price tag). Prolonged investment by American’s largest corporations creates business opportunities along the value chain, particularly for the small and medium businesses that support them.

Higher National Security and Less Reliance on Unfriendly Nations

The actions of Russia in 2022 show the danger in relying on competitor nations for critical domestic inputs. Germany’s reliance on Russian natural gas serves as a warning. Natural gas accounts for about a quarter of Germany’s total energy consumption, mostly for heating and industrial purposes¹⁰. As noted earlier, prior to the invasion, over half of that natural gas came from Russia. When Russia threatened to cut off the supply of gas as retaliation for Germany’s support of Ukraine, the European nation found itself unprepared for the implications of a severe energy crisis that could halt manufacturing activity and/or leave its citizens without heat for the winter.

Our domestic energy independence very much limited Russia’s economic leverage against the U.S. The same cannot be said for our reliance on China. The best example of this is semiconductors. The United States makes up 25% of the world’s semiconductor consumption, followed closely by mainland China at 24¹¹. Our domestic manufacturing capacity has struggled to keep up, falling from 37% in 1990 to 12% by 2020¹². Further, over 90% of leading-edge semiconductor manufacturing is now done outside the United States, mostly in Asia¹³.

Much of China’s ascent in chip production has come from its government’s willingness to subsidize domestic production. Boston Consulting Group estimates that the total cost of ownership for U.S. advanced logic semi fabs is roughly 40% higher than in China. However, over two-thirds of that difference is a direct result of government incentives¹⁴. The semiconductor industry is a far cry from the labor-intensive, low-skilled goods production by which the country made a name for itself. So why is it pouring so much money into building market share?  The importance of chips for the global economy cannot be overstated. Controlling a single point of failure in the supply of them gives a country enormous geopolitical leverage.

Another area of vulnerability is rare earth minerals. These minerals are critical inputs for everything from electric vehicle batteries to F-35 fighter jets and Javelin missiles. Although China has only 1/3 of the word’s estimated rare earth reserves, it mines 60%, and processes 85% of the world’s supply¹⁵. For a real-life example, in September 2022, the Department of Defense was forced to grant Lockheed Martin a waiver from procurement laws after it was discovered that a magnet used in production was made from Chinese cobalt and samarium alloy. Deliveries of the F-35 were suspended for about a month after the discovery¹⁶.

Luckily, the process of securing our rare earth supply chains has already begun. MP Materials recently announced plans to build a factory in Texas where it will process rare earth alloys and magnets sourced from its mine in California. MP’s CEO believes the company will be able to accommodate all of the Department of Defense’s rare earth needs¹⁷. The company also announced a partnership with General Motors, providing the automaker a fully domestic battery supply chain for up to 500,000 electric vehicles per year¹⁸. The Australian company Lynas also received a Pentagon contract to build a heavy rare earth separation plant on the Texas Gulf Coast. When operational in 2025, that plant will be the only one outside of China capable of separating heavy rare earths¹⁹.

Lower Supply Chain Vulnerability = Lower Risk of Supply Side Shocks

It is true that relocating manufacturing away from lowest-cost producers can lead to a structural increase in cost of production. However, another aspect of the tradeoff is that reshoring can reduce the risk, length, and severity of supply-side shocks that often serve as inflationary catalysts. For example, many point to two Arab oil embargoes as major contributors to the sustained bout of inflation in the 1970s. Luckily, advances in drilling techniques and new supply discoveries helped America attain energy independence in the 21^st century. With a “reshored” energy infrastructure in 2022, we found ourselves much less vulnerable to Russia’s potential energy weaponization than other countries.

Similarly, bottlenecks in the semiconductor supply chain likely played a major part in the beginnings of the current inflation cycle. In the early days of the pandemic, logistical failures limited the supply of semiconductors, just as global demand for PCs turned up to accommodate remote work. To make matters worse, in late 2020, the US Department of Commerce imposed severe restrictions on trade with Semiconductor Manufacturing International Corporation (SMIC), China’s largest chip manufacturer. For context, about a quarter of the world’s manufacturing subsectors use semiconductors as a direct input (and those industries account for 39% of total manufacturing output. As a result, prices of anything that needed a semiconductor skyrocketed²⁰.

While achieving energy independence was a big step towards supply-side resiliency, achieving “chip independence” can further strengthen a critical aspect of manufacturing for a multitude of end products.

Shorter and Newer Supply Chains Can Facilitate the Move to a Sustainable Future

All else equal, shorter supply chains consume less energy. In fact, for sectors including telecommunications, automotive, media, personal & household goods, and food & beverage, over 95% of the environmental footprint is driven by the supply chain²¹.

The reshoring trend gives us an opportunity to rebuild supply chains that are not only shorter, but more advanced. With a clean slate, companies can utilize the newest technologies, processes, and energy sources to build factories and infrastructure that are more sustainable. For context, 63% of China’s 2022 electricity production came from coal, compared to 22% in the United States, and 6% in Canada²². China has indeed made promises to move towards carbon neutrality. However, catching up to the rest of the world will be costly and may undermine the competitive advantage it enjoyed over the last few decades.

As discussed earlier, more localized supply chains can give corporations better visibility and control of the social and governance practices of the vendors and suppliers they interact with. An American company can feel relatively more relaxed about “headline risk” surrounding working conditions in a factory in Ohio than one in Vietnam (although Amazon and its controversial warehouses serve as an important counterpoint).  Hiring local and supporting American jobs is also known to be a successful marketing strategy. Rebuilding goodwill within local communities can help create a strong brand, particularly in geographies where manufacturing is some of the only employment available.

What Are the Risks of Reshoring?

Potential for Structurally Higher Inflation

The main benefit of outsourcing is the ability to optimize supply chains and reduce costs by taking advantage of countries with lower wages and input costs. All else equal, moving production away from the lowest-cost geography will raise the final price of goods. In fact, many attribute the benign inflationary environment in the last few decades to globalization itself, which enabled a flood of cheap Chinese goods to keep a lid on global prices.

We believe there are several ways to mitigate this inflationary risk. Before getting into them, we would first argue that the factors which allowed for cheap goods produced by efficient but vulnerable supply chains may not exist to the same degree going forward. For one, China has made commitments to mature its economy beyond one that relies on low-cost labor and dirty energy to produce cheap goods. Chinese leadership is refocusing on gaining competitive edges in more advanced industries. It has also committed to a major overhaul of its manufacturing sector with a goal of achieving carbon neutrality by 2060. Under this framework, Chinese goods won’t be as cheap as they were in the past.

The United States can mitigate the inflationary impacts of reshoring by narrowing its focus to industries and products that are not overly labor intensive. (i.e., semiconductors, chemicals, heavy machinery) At the same time, we can strengthen our supply chains via the related concept of “friendshoring,” or the practice of maintaining international supply chains, but focusing on nations with which we have positive international relations. India comes to mind, with its massive population, abundance of natural resources, and relative cooperation with the rest of the G20.

Further Breakdown of Global Cooperation

It is safe to say that global geopolitical relations have generally deteriorated over the last several years. While we have argued that reshoring is necessary, we also acknowledge the gravity of such a decision. Making a commitment to rebuild and reroute supply chains away from hostile nations is a provocative act. It may also be the final nail in the coffin of an era of global cooperation that has done great things for the world’s population since the fall of the Soviet Union in the 1990s. By making this difficult choice, we are further cementing a new multipolar world order that is at best, more competitive, and at worst, outright dangerous. Much of this is out of the control of any one country, but the decision to drive wedges further between world superpowers should not be taken lightly. Reshoring is a long and expensive process that is impossible to reverse in the short term, and highly difficult in the long term. Taking steps toward supply chain independence closes a door of negotiation that cannot be quickly reopened.

What is Good for the U.S. Economy is Not Always Good for the Global Economy

Economists generally agree that free trade allows for efficient allocation of resources and maximization of global output. Reshoring flies in the face of that concept. While we have laid out arguments for why reshoring can benefit U.S. GDP, the trend may be detrimental to aggregate GDP at a global level.

Breakdowns in global cooperation can lead to redundant supply chains and less productive logistic networks. The geopolitical consequences all but ensure a global economy rife with tariffs, quotas, and other non-economic measures. Any step taken away from free trade should be expected to negatively impact the global equilibrium between supply and demand. Geopolitical tensions have left us with a difficult choice between vulnerability and inefficiency. It must be acknowledged that choosing to focus on our own security may end up as a net negative for the global population from a purely economic standpoint. Even still, we believe that higher national security, protection against supply side inflationary shocks, and a socioeconomically revived middle class are all tangible benefits that can transcend our borders and bolster geopolitical stability for us and our allies.

What are the Challenges to Overcome?

Labor Shortages and Lack of Workforce Pipelines

One lasting impact of the decline in American manufacturing has been damaged enthusiasm for manufacturing as a career. Yesterday’s manufacturing jobs developed a reputation for being low-skilled, low-paying, and in many cases, physically taxing or even dangerous. Today’s manufacturing jobs are more technical, higher-paying, and safer. Even as the “Manufacturing Renaissance” is well under way, employers and trade unions are struggling to recruit new talent.

At the aggregate level, the demographic issues of declining fertility rates, net migration, and labor force participation have reduced the overall prospects for employment in the decade going forward.

For a real-world example, Intel estimates it will need 2,300 technicians when it opens the first of its planned semiconductor plants in Ohio. To help address this need, the company is partnering with Central Ohio Technical College, a nearby community college, to ramp up its technology program. As of now, the program only has about 150 students.²³ As a country, we need to emphasize the importance of careers in trade and manufacturing. Young people need to understand the opportunities for high wages and job security that exist in these lines of work.

Higher Productivity Needed to Mitigate Higher Labor Costs

Investments in technology and education will be required to make up for the increased costs that will come from moving supply chains away from geographies with the lowest labor costs. Advances in automation, robotics, and other efficiency-bolstering technologies can help control unit labor costs.

What Progress Have We Made So Far?

The Biden Administration has made reshoring a focal point, continuing with the “Buy American” campaign that politicians on both sides of aisle have aligned themselves with. The President put these plans in motion with the CHIPS and Science Act (“CHIPS Act”) and the Inflation Reduction Act (“IRA”) in 2022.  The CHIPS Act provides over $50 billion for semiconductor research, development, manufacturing, and workforce development. The IRA will direct nearly $400 billion in federal funding to energy, manufacturing, environmental, transportation, and agricultural initiatives. U.S. companies are responding in force, starting the long process of moving their manufacturing back home.

Kearney surveys found that not only are manufacturing executives already taking steps to reshore or “nearshore” (see graphic below), but they are also being influenced by their peers. The consulting firm separately found that 81% of manufacturing executives might be influenced by seeing other American companies take similar steps.

We are seeing increasing evidence that the reshoring trend is not simply receiving lip service from executives feeling pressure from governments. Companies in a variety of sectors are taking concrete steps to move at least some of their manufacturing operations back home. We expect the trend to continue picking up steam.

Where are the Opportunities for Equity Markets?

Aside from the indirect benefits of more jobs and better wages, the process of reshoring will create structural demand drivers for several sectors in particular:

• Industrials

The buildout of manufacturing facilities and the logistics networks that serve them will provide plenty of work for many of the country’s industrial corporations. The process starts with front-end consulting and engineering, moves to construction, fills the factories with machinery, and relies on air freight, road, and rail networks that will deliver products to trading companies and distributors. Each step of the way will create opportunities for other American companies that support the transition.

• Materials

Reshoring our supply chains will require an extensive uplift from our materials sector. As we discussed before, industries like metals and mining are in the process of reshoring themselves. In addition, the process will require construction materials to help build facilities, chemicals to provide other critical production inputs, and containers and packaging to help move goods along the newly constructed value chain.

• Energy

To state the obvious, each step of the process will require energy. We have an opportunity to take a big leap towards clean energy sources as we rebuild our facilities and infrastructure. Realistically, we will also require fossil fuels while we work towards carbon neutrality. This presents opportunities for energy exploration and production, refining, and distribution companies, many of which fall within our borders.

• Information Technology

We expect companies undergoing the reshoring process to make sizable investments in technology to drive productivity and mitigate the impacts of higher labor costs. Building efficient and productive supply chains will require advanced software and cutting-edge electronic equipment. As we’ve noted, much of this equipment itself requires semiconductors. After everything is built out, we will need help from the IT Services industry to keep it all running smoothly.

• Real Estate

Lastly, all the above will continue to contribute to high demand for industrial real estate, which may provide tailwinds for industrial REITs or other companies involved in the space.

Conclusion

Post-WWII trends in global cooperation allowed developed nations to lean on developing nations to create networks of lean global supply chains that were highly efficient, but vulnerable to shocks. Beginning in 2020, two of those shocks came in the form of a global pandemic and a hot war in Europe featuring one of the world’s top energy exporters. Even further, geopolitical degradation has left the United States dangerously reliant on some of its strongest rivals for a multitude of critical raw materials, components, and end products. These factors all combine to reinforce the need for the reshoring of manufacturing and supply chains for a variety of industries. The risks of doing so include the potential for structurally higher costs of production, loss of global productivity and aggregate economic activity, and cementing further deterioration of global geopolitical relations between the world’s economic superpowers. These risks can be offset by strengthened national security, a revitalized middle class through high-quality employment, reduced likelihood, length, and severity of supply-side inflationary shocks, and “picks and shovel” opportunities for many sectors along the way.

Several trends are converging to create a unique moment in our history – one where reshoring may be both politically palatable and economically sensible.  And while it may run counter to the economic intuition that has permeated American business culture for the past several decades, this is our opportunity to learn from recent history and take measured steps toward building more balanced – and more resilient – supply chains.

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Sources

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