Manufacturing supply chain global outlook
The COVID-19 pandemic sent global supply chains into disarray. Until a couple of years ago, almost all manufacturing industries across the world produced goods through highly decentralized supply chains, primarily governed by costs. The advent of the US-China trade war and the emergence of the COVID-19 pandemic has triggered a paradigm shift in the US, highlighting a greater focus on distributing risks and being adaptable to situations, whilst also competing on costs.
US-China Trade Relationship (Pre-COVID19)
In 2019, imports of goods from China fell to $452B, from $539B in 2018, showing a sizable decrease of 16.2%. This change was a definite result of the ensuing trade war between the two countries, resulting in the periodic escalation of tariffs from both sides and deteriorating trade negotiations on multiple occasions. As a result of this standoff between the two countries, a few US firms restructured their supply chains, creating an observable shift in US imports from China to Vietnam and Mexico. While US imports from Mexico rose by approximately $13B (4% increase), Vietnam garnered an even higher expansion of $17B (36% increase)*.
With the emergence of COVID-19, US firms have started analyzing and contemplating potential shifts in their respective supply chains. However, fundamentally, this next phase of restructuring of supply chains will be dependent upon numerous discrete, independent corporate decisions based on the cash flows of each respective firm. While some companies will strive to do the bare minimum and stick to the status quo, others will look to think ahead and shorten or scatter their current supply chains. This presents a unique opportunity for the federal government to use incentives and progressive policies to bring back manufacturing to the US.
*It is important to note that the shift in imports to Vietnam and Mexico may not show a complete picture of the actual trade proceedings, as US officials and industry analysts have gathered evidence to identify the use of ‘transshipment’ in Vietnam. Through transshipment, producers in China ship goods to Vietnam, where they are minimally processed and re-exported as Vietnamese goods, thereby allowing Chinese producers to dodge tariffs.
To reduce dependency on imports and increase its self-sufficiency, the federal government has already taken action to bring back manufacturing of critical products to the US. Firstly, Phlow, a Virginia-based public benefit drug manufacturing company, has received federal government funding of $354 million (with an additional $458 million appropriated) for the creation of essential generic medicines in the US. This funding is in line with the Trump administration’s aim to boost drug manufacturing in the US and reduce reliance on foreign manufacturing for important medicines and Active Pharmaceutical Ingredients (APIs), 72% of which are produced abroad. Secondly, the federal government is also in talks with Taiwan Semiconductor Manufacturing (TSMC) to spend $12B and build a chip factory in Arizona. Currently, a proposal with bipartisan support is being reviewed that will grant TSMC $22.8B worth of tax breaks and incentives.
TSMC is one of three (the others being Intel and Samsung) pioneering firms in the world that produce chips having transistors 10 nanometers or smaller. Along with TSMC, the federal government is also exploring an increase in local manufacturing presence of Intel and Samsung. The creation of high-speed and efficient chips is central to US national security and remains a high priority for the federal government.
Secretary of State Mike Pompeo recently said the crisis should prompt a reassessment of U.S. reliance on China, not just for pharmaceuticals but rare-earth minerals, nuclear materials and “a host of other things that really are central to American security.” On similar lines, in the past few months, 6 separate bills, with bipartisan support, have been introduced in Congress to curb the US dependence on foreign pharmaceutical goods. Based on the federal government’s recent investments, incentives, and statements, it is clear the US government desires to shift the production of essential pharmaceuticals and high-tech components central to national security back to the US. The application of high-tech components spans across the fields of communication, aerospace, and defense technology. These shifts would largely be built upon the allotment of government incentives such as refundable income tax credits, federal funds/state incentives, and R&D grant funding. However, these significant investments do not serve as a harbinger for the large-scale movement of non-critical manufacturing from low-cost Asian countries to the US.
The state of US manufacturing
In 1970, 25% of the population in the US was involved in the manufacturing industry; today, less than 5% of the working population remain involved. In the past few decades, there has been a massive shift in jobs to the services and technology industry. Since 2012, labor productivity in the manufacturing industry has declined steadily, with the labor productivity index falling to 98.4 in 2020. While the Trump administration remains optimistic about reducing unemployment by bringing back manufacturing jobs to the US, past records suggest that this may either be unfeasible for the manufacturing industries hoping to move out of Asia, or it may not produce the ‘promised’ number of jobs locally.
In 2019, South Korean company LG electronics built a manufacturing plant in Clarkesville, Tennessee. This was largely done in response to the increased tariffs (in 2018) on washing machines originating from South Korea. However, the highly sophisticated 1 million square foot facility was created using high-performance automation and produced only 600 jobs. Another similar example of the Taiwanese company Foxconn, which built a facility in Wisconsin that produced only 178 out of its promised 13,000 jobs so far. This has happened primarily due to Foxconn’s inability to be cost-competitive as compared to their Chinese counterparts, resulting in a change in business plans and causing an indefinite delay in starting production at full capacity. The original deal, which awarded Foxconn $4B in tax incentives is currently being renegotiated by the state of Wisconsin.
In totality, the combination of skilled labor shortages, high degree of technology and automation, and lack of manufacturing productivity suggest that an immediate resurgence of the US non-critical manufacturing remains highly unlikely. The credibility of plans built on promising to bring back jobs rests much lower than the more recent rhetoric of national security.
While moving production to the United States may not be the preferred option for many firms, but some degree of change in the global supply chains is imminent.
Riding on the success of the USMCA (US-Mexico-Canada), Mexico has presented itself to be a lucrative option for firms looking to relocate to a location that is close to the US. In recent years, Mexico has become a top exporter and producer of electrical machinery and vehicles. Already home to American multinational firms such as General Motors, Ford, and General Electric, Mexico portrays a familiar destination in terms of coordination as well as strong bilateral relations. With labor costs lower than that of China, a highly educated workforce (producing ~130,000 engineers every year), and government incentives such as IMMEX, Mexico presents a long-term opportunity for manufacturers to consolidate and capitalize on the policies under the USMCA. However, firms will also have to keep in mind the revised country of origin rules that stipulate at least 75% of manufacturing value-add in Mexico to qualify for zero tariffs (up from 62.5% under NAFTA).
Alternatively, for a firm looking to relocate in Southeast Asia, Vietnam has turned into a go-to manufacturing hub for companies worldwide. Vietnam has been the biggest beneficiary of the ongoing trade war between the US and China. Foreign direct investment in 2019 reached $38.2B (a 7.2% increase from 2018). Vietnam has turned into a manufacturing hub for some of the world’s largest companies such as Google, Foxconn, and Samsung. While most companies have turned to Vietnam to avoid tariffs and leverage the lower labor costs, Vietnam still needs to develop considerable corporate infrastructure to prove itself as a true long-term substitute for China.
Given that COVID-19 has not reached its peak globally and the short-term outlook on manufacturing still looks blurry, it is still too early to estimate the timing and magnitude of the relocation of US firms. However, firms will be well served to exploring restructuring their supply chains to increase their resilience and adaptability in the wake of global disruptions.