For the better part of 2020, or what now seems like an eternity, we have been in the midst of an unprecedented economic transformation. Office workers have been sent home, restaurants and retailers that depend on foot traffic have been crippled, and supply chain gaps have been painfully uncovered. Despite this shock, we have also seen incredible resilience from governments, companies and individuals. Echoing the WWII war production efforts, the speed with which manufacturers have responded to healthcare equipment shortages is nothing short of heroic.
After the crisis has passed, the question for everyone will of course be, “what next?” Clearly, the world has changed in the most dramatic fashion. Leaders at every level are now questioning a generation's worth of conventional wisdom. Rapid responses to gaps in our healthcare systems and supply chains will eventually give way to careful reflection focused on the inherent fragility of these systems, with a eye towards strengthening their ability to withstand even bigger shocks. Mindless pursuit of the cheapest option at the expense of systemic health will be much less palatable. Looking more carefully at their communities, people will start to ask whether they need to further than just paying a little extra to support local producers.
In this environment, the question of security will naturally lead to the question of whether we will see a repatriation of manufacturing capability. At 3AG we firmly believe not only that overseas manufacturing capability will return to North America, but that this reshoring will occur faster and more extensively than anyone expects. Not only will we see companies move overseas production capacity back to Canada and the United States, but we will see already-established local manufacturers dramatically retooling and scaling production across the continent.
But why should this be the case? After all, this crisis may be foreshadowing complete economic disaster. Companies will double-down on cost saving initiatives as consumer demand collapses, right?
Even in a world of significant economic pullback (which for the record we don’t subscribe to) there are many compelling reasons to bet on a coming local manufacturing renaissance. Maybe it’s because we’re all suckers for the underdog. Everyone loves a good comeback. Or maybe it’s something more – an untapped, primal urge to fight back when the odds are against us.
Let’s be real, this is not Hollywood and there is nothing to guarantee a storybook ending. But there are many factors that we believe will provide a powerful incentive for companies to increase local manufacturing capacity.
Let’s look at each of these factors in depth.
Without a doubt, medical supply scarcity has served as a wakeup call for healthcare planners around the world. Much has been said about shortfalls related to PPE, as well as machines like ventilators specifically required to deal with respiratory issues. But trade deficits exist with other products, particularly pharmaceuticals from both a raw component and finished product perspective. In the United States the net deficit for these products in 2019 was over $88 billion, meaning that America imported 45% more pharmaceutical products than it produced.
Examining aggregate numbers doesn’t tell a complete story, but a trade deficit implies that for every product exclusively exported, there will likely be another that is exclusively imported. On paper, the cost rationale behind importation of cheap, disposable equipment is makes sense. But in aggregate, a relentless pursuit of the lowest cost provider leads to an endgame where small set of suppliers control the market. And when those suppliers experience an unexpected shutdown it becomes a mad scramble to fill the gap.
While medical equipment is currently top of mind, deficits exist in a wide range of other products. In fact, the gap is approximately $700 billion for the top 20 imports/exports (excluding re-imports), with the top three American exports producing only a $50 billion surplus of petroleum products, fuel oil and plastic materials. The deficit side of the ledger covers a wide range of products including: passenger cars, vehicle accessories, pharmaceutical preparations, cell phones, virtually all electronics, telco equipment, industrial machines, apparel and textiles, medicinal equipment, furniture, industrial supplies and toys.
While end-products tend to be headline grabbers (we can all visualize a finished good), it’s worth noting that for each end-product there is a large number of intermediate manufacturers who in turn supply multiple manufacturers. Rarely do companies go completely vertical, from plantation to end-product, the same way that Henry Ford did a century ago. Instead, they depend on other manufacturers to provide them with components and semi-processed materials for their production. Traditionally, these “manufacturers to the manufacturers” clustered locally for obvious reasons – proximity to customers and suppliers, availability of skilled workers, and even efforts to copy the success of local peers.
What this means for governments still reeling from the current crisis is that the way a product is produced might matter as much as the product itself. Simply assembling is not enough. At a national or regional level, inability to access component inputs can be nearly as crippling as lack of access to the final product. In other words, efforts to secure local production require to efforts to secure local, if not national production of the inputs as well.
Corporations have also scrambled to deal with supply-chain shock, although not in the same way as governments. Starting in February, the majority of Chinese factories and their employees were in full lockdown. For North American planners, this meant living through the excruciating experience of watching a slow-moving disaster in real-time, knowing that trans-pacific container traffic would take 2-4 weeks to arrive empty.
Companies depending on overseas imports face a double whammy. First is the immediate impact of losing supply. But the second is a lack of agility due to transportation lags. Scrambling to find a replacement supplier that at best can get product to your country in four weeks means that you’ve already explicitly or implicitly made a decision to significantly sacrifice flexibility in your process.
Thus, many North American companies have dealt with not only one, but two crises in the early part of 2020: first a lockdown in China, followed by a lockdown in their own country.
One consequence of witnessing local businesses struggle with reduced hours, social distancing and collapsing demand is that individuals have witnessed the economic impact of this crisis firsthand. Not surprisingly, there is a strong push for individuals to support local business and “buy local.” While this movement is currently focused on local retailers, it is not outside the realm of possibility that it will eventually move beyond retail, particularly when the definition of local is expanded beyond municipalities to encompass regions, states and provinces, and countries.
In 2019, The Netflix documentary American Factory introduced the world to an unexpected reversal –Chinese manufacturers building capacity in the United States. While other examples of companies setting up shop in the US, including Tianyuan Garments and Sun Paper Industry certainly don’t indicate a wholesale shift, they do provide evidence that North American manufacturing must be close to offshore in terms of affordability.
There is evidence to back this assertion. Looking at the BCG Global Manufacturing Cost Competitive Index we can see that the total cost of production in America is only slightly higher than that of China. Decades of wage increases abroad, improved local productivity, and aggressive efforts to attract factory jobs have closed the gap on what was once a slam-dunk low-cost decision. For half a decade this has been the case, with organizations citing only a 5% price gap since 2015.
Since these numbers are in aggregate, it’s worth noting that some products will be significantly cheaper and others significantly more expensive to manufacture abroad. The point is that price alone is not an overwhelmingly powerful argument for offshoring. Rather, it begins to look more like a rounding error, particularly in a time of such dramatic economic change.
Today the rationale for manufacturing abroad may have more to do with overseas manufacturing clusters actually capable of producing the product, as opposed to price alone. But we expect this will change over time as well.
One would be hard-pressed to find a governor or premier with a “jobs plan” that doesn’t include some form of manufacturing. What is interesting is in seeing how far these regional leaders will go to attract factories.
Although not exactly manufacturing, the recent “14-month Bachelor-like competition” for Amazon’s HQ2 showed exactly how far regional governments were willing to go in order to win high profile companies. Today it’s not uncommon to see regional governments provide tax holidays for both companies and workers, retraining programs, and other creative approaches.
But beyond randomly hunting for any job that comes along, many regional governments are looking to build out broader manufacturing hubs. Examples abound, from NGen, an advanced manufacturing network headquartered in Ontario, to the local plan to turn Catawba County in North Carolina to a high-tech manufacturing hub.
Industrial hubs benefit directly from the network effect; that is, the total power of a local industrial hub is greater than the sum of its parts, due to the fact that collaborations between different but like-minded organizations result in rampant innovation and scale for those involved. Regional governments will do everything in their power to support these types of initiatives, if they aren’t already.
The trend for the past two decades has been one of accommodation to an ever-lengthening supply chain. Managers in mid-western American towns now need to pay careful attention to Pacific weather patterns, international trade actions, port authorities and many other factors happening thousands of miles away. As noted by McKinsey, not only is supply-base transparency hard to achieve when looking at hundreds or thousands of suppliers for a single product, but the scope and scale of risks can be downright intimidating when factoring in proprietary data systems.
None of this complexity happened overnight, and solutions to address new issues from a lengthening supply chain accumulated in a patchwork fashion. Evidence of this is apparent from a burgeoning Third-Party Logistics (3PL) industry supported by rapid growth in supply chain management software. According to HBR, 44 million people work in the “supply chain economy.” While much of this growth can be attributed to advances in IT and management science, one does wonder whether a good percentage of this industry exists to for the sole purpose of supporting overly complex supply chains that could easily be collapsed into something more local and manageable.
North America is rich in geographic diversity and resources. A quick look at the CIA Factbook indicates that Canada and the United States are both rich in a wide range of resources, including: coal, copper, lead, molybdenum, phosphates, rare earth elements, uranium, bauxite, gold, iron, mercury, nickel, potash, silver, tungsten, zinc, petroleum, natural gas, timber, arable land, potash, diamonds, silver, fish, wildlife, petroleum, natural gas and hydropower. Even rare-earth elements critical for advanced technologies like cell phones and electric batteries are abundant; the challenge has been one of developing existing resources as opposed to having them in the first place (see the Canada–U.S. Joint Action Plan on Critical Minerals Collaboration).
If it can be built, it can be built from scratch in North America.
The Tax Cuts and Jobs Act (TCJA) passed in 2017 included provisions to encourage American corporations to repatriate approximately $1 trillion in cash held abroad. Previously, these companies were only liable for American taxes on these accumulated profits when repatriating the cash, hence the growing hoard of funds. By imposing a one-time tax on all offshore holdings, the incentive to maintain these funds abroad disappeared, and over $777 billion came back to America in 2018.
The point here is not to debate the nuances of international finance, but to highlight that massive repatriation initiatives have occurred in the not-so-distant past. Combined with the recent passing of the $2.2 trillion CARES Act, significant precedent already exists for other massive, coordinated efforts with wide-ranging economic impact.
Governments are reacting fast to a rapidly changing environment. Health Canada has revamped guidelines to provide expedited access and authorization of new medical devices and treatments. Companies are seeing evidence of this fast-track approval. For example, a dog-bed manufacturer in in BC was able to switch to production of N95 respirator masks and secure contracts with provincial health service authorities and the RCMP within weeks. Similar stories are popping up across North America, including emergency approval of test kits from companies like Luminex in Austin.
While it remains to be seen whether governments will apply lessons learned during this crisis, an optimistic viewpoint is that the attitude of “we can’t do that” will be replaced with one that counters “well, we just did.”
Given that North American economies have just undergone massive shocks while simultaneously experiencing unprecedented government intervention, one might ask what to expect next? Will North America crumble away, only to be a historic footnote? Or will leaders use this crisis to drive systemic change, reawakening a slumbering powerhouse?
While specific details will most certainly require fine-tuning, we expect to see several things happen:
Again, we will briefly examine each prediction in detail.
The gates have been opened. In Canada, a C$107 billion support package met approval in March, while the aforementioned CARES Act will provide $2.2 trillion to support American governments, businesses and citizens. But these programs were designed to dull the economic shock wrought by the pandemic and maintain liquidity in the system, not to rebuild the economy.
We anticipate that the rebuilding phase will incorporate something similar to the Tax Cuts and Jobs Act (TCJA), both in terms of goals (repatriation of assets) and scale ($1 trillion or more). A program that encourages North American businesses with factories abroad to shift production back home will make sense not only from a political perspective, but from one of national security, especially with memories of the recent pandemic freshly burned into the collective psyche. Similarly, support for existing local manufacturers to increase production, either through aggressive tax credits or outright grants will likely be implemented.
While particular emphasis will be placed on production of critical healthcare products, in short order we expect to see these programs applied across all forms of production.
With a national stimulus program as a backdrop, regional and local governments will look to make their mark. Playing to their existing strengths, we expect to see fledgling and well-established hubs double-down on their efforts to establish local excellence (for example, a focus on automotive supply chains in Ontario and Michigan).
At the same time, regions looking to make a move will push hard to attract talent & factories. Expect to see more focus on “advanced” and “high-tech” manufacturing in areas with advanced education institutions and existing tech centers. Areas like the Toronto-Waterloo Region Corridor (16 universities), Silicon Valley (5 universities) and the Raleigh-Durham Research Triangle (3 universities) will benefit from a renewed focus on tech and associated local manufacturing prowess.
There is a good chance that the buy-local movement will expand beyond just local restaurants to include local product design and manufacturing. The “Made in USA” and “Made in Canada” labels, and even regional labels like “Made in NY” will come to represent more than just local jobs. They will represent regional and national security through a promise of self-sufficiency.
As a side note, we expect technologies like blockchain to finally reach mainstream as companies deploy it to proudly publish locality credentials.
A renewed focus on local production will come at a cost, and likely this will be financial. Local manufacturing simply won’t have the same global scale seen by some overseas producers. That said, end-consumers have already been moving towards a focus on quality over price, and this trend will likely continue.
In order for manufacturers to gain social license to setup shop in someone’s backyard, they will need to prove their environmental credentials. Desire to see proof of environmental stewardship will come not only from the communities where these manufacturers produce, but also from end-consumers. Again, expect to see a real demand for technologies like blockchain that can help validate green credentials.
Aside from the obvious need to be prepared for social distancing associated with potential future outbreaks, manufacturers will place particular emphasis on configurations that allow for maximum flexibility, both in terms of production volumes and actual retooling capability for specific products. The future is uncertain, and measurements of production resiliency will become as valuable as production numbers in determining whether a company can survive the next market downturn.
With a much more noble purpose, governments will look to local manufacturing partners not simply as a source of jobs, but as a source of regional and national security. Just as the Great Recession of 2007-2008 led to a focus on food security through an explosion of urban gardening, the Great Pandemic of 2020 will drive a relentless focus on self-sufficiency. Local jobs at local plants will become synonymous with regional security and proof of a larger social contract.
Broadly speaking, the next 6-24 months will be a period of dramatic change, paralleled perhaps only by the previous hollowing-out of America, the only difference being the speed with which the former will take place. Local and regional manufacturers will be asked to step up and provide far more than just finished products.
Even with support from all levels of government, companies will still be subject to economic pressures, and will need to double-down on simultaneously improving both efficiency and flexibility.
The result however, will be a dramatic improvement in economic resilience and self-sufficiency that will help us all to get through whatever crisis we face in the future.
Broadly speaking, the next 6-24 months will be a period of dramatic change, paralleled perhaps only by the previous hollowing-out of America, the only difference being the speed with which the former will take place. Local and regional manufacturers will be asked to step up and provide far more than just finished products.
Even with support from all levels of government, companies will still be subject to economic pressures, and will need to double-down on simultaneously improving both efficiency and flexibility.
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