Reshoring: The next great global trend

The Perspectives Podcast Reshoring: The Next Great Global Trend

With

Candace Browning Head of BofA Global Research

Chris Hyzy

Chief Investment Officer,

Merrill and Bank of America Private Bank

And Vikram Sahu

Head of Asia Pacific Research, BofA Global Research

 

Candace Browning: For decades, much of the world is becoming increasingly global. Trade between countries was expanding and many U.S. and European companies steadily began moving much of their manufacturing and supply chains overseas, in particular to China. But in recent years, that trend has begun to reverse, something the current global health crisis is actually accelerating.

So why is this new deglobalization trend happening now and what does it mean for the future of economic growth and our everyday lives?

Hello, and welcome to this market edition of the Perspectives podcast. I’m Candace Browning, Head of BofA Global Research. In today’s show, we’re exploring why more and more companies in the U.S. and the around the world are making the move back home, something also known as “reshoring.”

We’ll unpack the forces driving this trend and we’ll look at the implications it could have for our daily lives in terms of job creation, higher wages and new economic opportunities, as well as the potential costs and risks.

Joining me for this conversation are Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank.

Chris Hyzy:                Hello, Candace.

Candace Browning: Vikram Sahu, Head of Asia Pacific Research for BofA Global Research.

Vikram Sahu:            Hi, Candace.

 

Candace Browning: Okay. So Vikram, let’s start with you. You’ve done a great deal of research into this growing shift from globalization to localization. What do you think are some of the key factors driving this shift?

Vikram Sahu:            Thanks, Candace. To address that question, I want to take a step back for a minute just to define what we mean by globalization.

Its genesis can be traced back to the formation of the General Agreement on Trade and Tariffs in 1948. This, as a reminder, was a precursor to the World Trade Organization and its overall purpose was to promote international trade and to reduce tariff and non-tariffs barriers. It was enormously successful. After multi-decade process, we ended up with the world that was described by Tom Friedman in his book, The World is Flat.

Now what globalization assumes amongst many other things is market access irrespective of production location and for companies, the freedom to pursue the maximization of shareholder value. And while this has been a force for good in many, many ways, another outcome has been a 25 percentage point decline in the U.S. and Europe share of manufacturing and also accompanied by China’s rise to become the second largest economy in the world.

Globalization to localization, quite simply, is an ebbing of that wave of globalization. Now, there are many, many reasons for it but the key factor, the key structural factor is an ongoing shift to stakeholder capitalism where corporations are continuing to focus on shareholder interests but they are also focusing on a broader community of consumers, employees and the state.

 

Candace Browning: So this shift has started, Vikram, but why has it been accelerating recently?

Vikram Sahu:            Great question. At the start of the year we conducted a survey of our fundamental equity analysts around the world, and these are people who cover something like 3,300 companies. And at that time we had some  very simple findings. We argued that global supply chains were on the move. We argued that this was the first signs of reversal that we’ve seen  in a multi-decade trend and that while the breadth of the shift was unusual, the depth was very moderate. And most companies at that time seemed to be experimenting with something we called a China-plus-one strategy where they were keeping the existing supply chains largely in place but they were running pilot programs in alternative locations and at the time, we expected the success or failure of these little pilots to determine the velocity of future change.

Only six months later the pandemic has accelerated our calculus and it’s done it because it’s exposed fault lines in global supply chains. We re- surveyed our analysts and we found that companies in over 80% of global sectors experienced severe supply chain disruptions during the pandemic. More importantly, over three-quarters expect greater scrutiny of the existing supply chains and as a consequence and anticipation of that, they are widening scope of their existing reshoring plans.

Candace Browning: Okay. So the pandemic really accelerated this, but can we just take a little step sideways here for a second and actually define what things like global supply chains actually mean?

Vikram Sahu:            Sure. Look, in the past, manufacturing would typically take place in one of two places: either where you had your primary raw materials or close to

 

channels of distribution like rivers or ports, preferably both. Global  supply chains allow your production to be location agnostic.

The best way to try to illustrate what I mean by that is let’s take a humble T-shirt which costs about ten bucks. Its production would take at least two trans-Pacific trips and three additional intra-Asia shipments before it gets manufactured and delivered. That’s the most dramatic example of global supply chains.

And by the way, if you look at the full lifecycle of the product, depending on where the garment is discarded, it could take another trans-Atlantic or trans-Pacific shipment before it sees the end of its life. And one byproduct of that is the fashion industry today has a second highest CO2 footprint of any sector. That’s a primary example of global supply chains.

Candace Browning: Wow. I had no idea that T-shirts were such travelers. You learn something new every day.

Chris, let’s switch to you for a minute. How much are the tensions  between the U.S. and China do you think influencing this trend of deglobalization? I mean national security issues, intellectual property theft, the growing tech war between the U.S. and China are all growing in importance, but can you unpack the role that you think each of those are playing and are there implications for some particular industries, like 5G  or semiconductors or rare earth metals or even pharma?

Chris Hyzy:                Yes, Candace. When you think about the economic crisis and the financial crisis coming in conjunction with the health crisis, you’re now starting to see significant movement towards national security being the number one

 

priority here. So the tensions between U.S. and China influencing these trends are number one.

The tensions are likely to continue to be higher in the years ahead and that’s what the pandemic has taught us as well as Vikram stated, which is this access and the ability and the disruption of what’s most vital to us that we’ve seen through the health crisis, which is access to our own pharmaceuticals, access to biotechnology and the production of what is needed the most during times like this. So this is an area that creates geopolitical tensions.

In a world that has very low growth, the access to the supply chain, the control of the supply chain should help increase job growth, should help in infrastructure redevelopment, should help a whole new renaissance but actually in its essence, it’s about first and foremost right now national security.

Candace Browning: Okay. Well, let’s bring this home a little bit more for what these changes might mean for us as individuals. While there’s certainly costs involved, the longer term benefits here in the U.S. could include job creation in a number of industries, higher wages, increased business investment in research and development, which leads to more innovation.

So Vikram, what are your thoughts on this? Could this actually ultimately lead to a manufacturing revival in the United States?

Vikram Sahu:            Candace, this is going to have profound implications and particularly for places like the U.S. By multiple estimates the U.S. has lost 3.7 million jobs to China between 2001 and 2018. And as Chris said, on the other side of that trade, China’s risen to become the second largest economy in the

 

world and on its current trajectory, it’s likely to become the largest economy in the world sometime between 2025 and 2028. The theme that we’re talking about has the potential to alter that equation.

So let’s unpack it a little bit. We estimate that a $1 trillion capital expenditure cycle spread over a five year period would support the shift of all foreign manufacturing in China that’s not intended for consumption in China. In other words, companies would still be in China for China, but Apple for instance would not be manufacturing in China for the rest of the world.

That $1 trillion capex cycle to support reshoring would be like an adrenaline shot to the heart for the local economies where production is shifting and that’s not because of the absolute amount which is large, but also because of the multiplier effect.

Chris Hyzy:                Yeah and Candace, you also will see corollary job growth created. If you are bringing reshoring back and as Vikram said, $1 trillion may sound like a lot but actually to reshore non-Chinese consumer led businesses back to the United States, it can be done and it can be done relatively quickly and that could lead to job growth in things like warehousing, the production of electrical vehicles in mass scale, defense and aerospace produced jobs because of increased national security.

You could go into increased servicing of the new areas that have been created, the programmers, the engineers, and then on the lower skilled areas of all of this. We have a big way to go here. We’ve lost millions of jobs through the pandemic, much of which those jobs may not go back into the restaurant or some of the other areas that had been most harmed by the pandemic. They may go into construction. But with this movement

 

in the next few years, this single biggest uptake of jobs should be in logistics, transportation, warehousing and factories.

Candace Browning: So on a related note, income inequality and lack of access to opportunities are very real and persistent concerns. Could the potential for job growth and higher wages that we’re talking about reach more historically disadvantaged communities here in the U.S.?

Could that multiplier effect help in creating more widespread job opportunities? Vikram, do you have any thoughts on that?

Vikram Sahu:            Sure. I’ll give it a go and then turn it over to Chris. The short answer is any sustained recovery in capex and manufacturing would have a multiplier effect on the broad economy particularly now when the economy is below full employment.

It could lead to jobs, higher wages and create R&D spend. All of that incremental economic activity leads to more tax revenues and that then generates ability to spend on infrastructure and that creates a virtual circle. A rising tide lifts all ships. Chris?

Chris Hyzy:               Yes, I would agree with Vikram. We all know that housing drives the U.S. economy and the collateral effects of jobs feeding into the housing cycle is significant. We see the same type of effect with reshoring or a manufacturing renaissance and although manufacturing may not get to the heights it was in the past because of our service led economy, the world itself is moving towards a service led type of economic advanced economy.

 

But I would go a step further as you say. Those five or six or seven other jobs are promulgated from a manufacturing renaissance. Think transportation, think that last mile to get that good to your house. Through the pandemic era, I don’t know about anybody else, but there’s at least five or six trucks showing up maybe very other day here delivering something and that outgrowth should continue.

Warehousing, how about all of the real estate of failed retailers that will open up in the years ahead? Who’s going to buy that real estate? It’s the warehousing companies to be able to build out those facilities to provide the jobs, number one. Number two, to provide that scale to get goods to the home.

You think about the biotechnology arena and pharmaceutical arena, the jobs and other areas that are created because of national security interests and stopping those fault lines and disruptions that we all experienced going back to the first quarter of this year.

Candace Browning: Okay. Well, this all sounds very positive, Chris, but are there also risks  that we need to consider?

Chris Hyzy:                Yeah. One risk or two risks that I would point to. First is geopolitical. That’s the obvious one. The harder line actually appears to be increasing each month, each quarter, each year as we go forward particularly with China. The second one is what they call a K recovery that is beginning to be picked up. That K recovery, that letter, is where the advanced skills benefit from a reshoring where the lower skilled areas may not. And  that’s because you need skills in engineering for the most part to be able to service what is likely to occur, which is an outgrowth in technological innovation.

 

Now having said all that, the lower skilled areas can be retrained and that’s something that we should focus on particularly for the disadvantaged communities so we don’t have that K recovery.

Candace Browning: Okay. That makes sense but let’s talk about the policy implications that  we should be considering. Could we see a whole new industrial policy take shape and what might that look like?

So, for example, what I’m thinking about is could we see support for worker retraining or maybe even that large scale infrastructure spending program we’ve been talking about for so many years. Could that actually happen, Vikram?

Vikram Sahu:            All of the above. Let’s talk about policy for a minute. While reshoring supply chains will lead to some cost inflation, we think that policy makers will be working aggressively to explore offsets to those higher costs and those could be involving subsidies, tax breaks, low cost loans.

Many of these are already in action. Examples are in the U.S., Europe, Japan and India. A tangible example would be TSMC, which is one of the largest manufacturers of semiconductors in the world, and its recent decision to locate its 5 nanometer plant in Arizona, as a perfect example, where you had Arizona’s natural comparative advantages combined with a successful policy, which prompted TSMC to locate that manufacturing there.

Turning to infrastructure, the American Society of Civil Engineers has estimated in the past that the U.S. has an unfunded infrastructure gap of more than $2 trillion and the current administration has called on Congress to pass legislation that generates at least $1 trillion in infrastructure

 

investment, so we believe that this is going to happen. And I think the anticipation of tax revenues from higher economic activity will also help fund that. Chris, would you like to add to that?

Chris Hyzy:                Yes. I think you’ve absolutely nailed it, Vikram, in terms of the policy initiative. We’ve all seen that the need for infrastructure has risen in the last few years from really just environmental reasons, climate reasons, etc. But now with a potential reshoring renaissance happening, the roads, the bridges, the toll ways, for sure, the port systems.

Policy that takes shape based upon either a crisis timeframe or something that is in growing need is usually the most effective policy and that’s what we’re likely to see this time around. As you said, subsidies, credits, tax breaks, etc. and it should likely squarely go right to job growth.

So the policy that could take shape is one that if it shows if you’re a company that can show you’re increasing jobs, you’re applying a job growth initiative, you’re more than likely to get that break in that locale to produce that reshoring initiative.

Candace Browning: Okay. So Chris, let’s talk about how these changes could affect how we invest. So for example, how should we think about small-cap versus large- cap companies or U.S. companies versus international companies and what impacts should this have on our thinking about diversification and rebalancing?

Can you just comment on what are some of the key takeaways for investors to consider in all of this?

 

Chris Hyzy:                Absolutely, Candace. This is massive and this is something that’s going to force investors to rethink how they currently allocate. You mentioned small caps versus large, U.S. versus international, and also whether you rebalance more frequently or not, is volatility going to go up?

We think volatility in the minds of investors is more about uncertainty than any one number or any one movement up or down in an index. Uncertainty in the next few years is clearly going to go up, which should lead ultimately to higher volatility overall, but it could also lead to higher growth opportunities in the U.S., which means the U.S., relative to the rest of the world could be in a better position.

Now, we also know that the weaker dollar could help international growth overseas and the weaker dollar is occurring right now because of the significant stimulus and liquidity that the U.S. has put in place because of the pandemic. But that tends to be very tactical.

On a strategic basis, we still believe that the U.S. is so-called in the catbird seat relative to the rest of the world because of its strategic access to natural resources, skilled labor, highly educated workforce and exposure to technology overall.

Now innovation across sectors usually starts with the big companies and many times it can start with the government like we saw with the defense business in NASA many, many years ago. But now what you’re starting  to see with the cloud and the build out of the next version of the cloud is the ability for small companies to become significantly efficient enterprises and that’s what we expect.

 

Small companies have generally been left behind recently relative to the mega companies, but with the reshoring movement and the ability to quickly pivot, a small company has that opportunity. So we think opportunities for small caps relative to large caps in the next five to six years should be on the rise.

And last but not least, in terms of diversification, we think a lot in terms of value and growth, we think a lot in terms of sector allocations. We think a lot of those lines are going to become blurry, particularly value and growth and we would rather investors think more about strategic opportunities that benefit across a wide variety of industry groups that ultimately feed into your exposure to the rising themes that a reshoring, manufacturing renaissance, deglobalization theme can produce. And  that’s what we believe on an active management perspective is the area of greatest opportunity for investors.

Candace Browning: So Vikram and Chris, we’ve covered a lot of ground today on what I think is a very important subject and one that could actually just be in its very beginning stages.

If you could sum up the significance of these changes and what they could mean for our listeners, what would it be? Vikram?

Vikram Sahu:            Candace, we believe emphatically that we’re seeing an ongoing shift to stakeholder capitalism, and this is where corporations are going to have to focus on shareholders’ interests, absolutely, but as well as a broader community of consumers, employees and the state and all of this creates both profound change as well as profound opportunity.

 

Chris Hyzy:                Yeah and Candace, from my perspective, I would like to see this movement as a movement that we call STAR, which is Strategic Technology Automation Reshoring, and that is an opportunity for the United States to be able to apply both the private sectors’ labor force today, the skills today, the engineering capacity, the access to semiconductors  and high-end technology today, the access to natural resources today. Put that all together with the correct public policy around education and retraining and reskilling, as well as infrastructure redevelopment.

Those factors should create a higher growth economy for the U.S. in the out years, which ultimately stops this worry of a K type of recovery into more of a recovery for more versus recovery for the few. And for me, that is the biggest opportunity set that we could see unfolding before our eyes.

Candace Browning: Okay. Well, I think that optimistic note is a great one to end on. Chris and Vikram, thanks again for joining me for this conversation. I know it’s an area we’ll continue to watch very closely in the months and years ahead.

And thank you all for listening to this market edition of the Perspectives podcast.

My co-hosts have been Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank and Vikram Sahu, Head of Asia Pacific Research for BofA Global Research.

I’m Candace Browning, Head of BofA Global Research. Thanks again for listening.

 

This podcast was published on August 27, 2020.

 

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