In our last post, we discussed the evolution of globally integrated supply chains over the past 20 years, which began with the outsourcing of manufacturing to low-cost jurisdictions, and its impacts, both positive (lower cost goods) and negative (lower growth in developed economies).  This trend began to reverse itself over the past decade and tensions between the developed world and emerging economies like China have accelerated the process. Geopolitical fractures between key trading partners like Russia and Europe, or China and the U.S. have many concerned that globalization, and all its ancillary benefits and costs, may be reversing course.

We would argue against this thesis. If the supply chain disruptions during the COVID lockdowns established one thing (beyond how fragile our health care system is), it is that the global economy remains deeply interconnected. A shock in one part of the world still reverberates across the globe.  A recent report, Global flows: The ties that bind in an interconnected world | McKinsey, by McKinsey attempted to quantify this and concluded that every major region imports more than 25% of at least one important resource that it needs, and often much more, as illustrated in the graphic below:

 

In short, globalization may be entering a phase where the focus shifts from efficiency (low cost, speed) to resiliency (proximity to end markets, diversified operations, security).  This shift will require considerable investment and will undoubtedly create some unintended consequences.  As always, there will be winners and losers.  Here’s how we view this dynamic evolving in the years ahead:

• Reshoring is not the only answer.  Consider semiconductor manufacturing.  The U.S. controls the bulk of the intellectual property, while manufacturing is concentrated in Asia (Taiwan, Korea, China).  While the big players in this space (eg. Taiwan Semi, Micron, Intel) are building plants in the U.S. to diversify their operations, this will take considerable time and money, in addition to navigating a far more complex regulatory environment. In short, resilient supply chains come at a considerable cost.  Rising costs will undoubtedly be passed on to the end-markets, creating further inflationary pressures that we are working so hard right now to stamp out.
• “Friend-shoring” is a potential release valve.  Relatively “young” countries (by age) in friendly jurisdictions with lower regulatory hurdles offer a potential release valve for these building tensions.  Mexico and India stand out, owing to their young populations, lower tax rates and wage structures, and similar export capabilities to current manufacturing giants like China. 

 

And they are not alone.   Many countries in the Emerging Markets will benefit from the shift in supply chains to countries with younger and well-educated populations.

 

(Source: Piper Sandler)

 

• Automation and Robotics another potential beneficiary.  Increased use of automation and machine-driven manufacturing processes offer the potential for further efficiencies and economies of scale. 

 

As with other trends shaping markets in the years’ ahead, we and our trusted partners have identified investments that should benefit from these trends and adapted portfolios accordingly. There will be winners and losers.  We want to do our best to ensure our clients are on the right side of the trade.