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Tectonic Shifts in Global Supply Chains

What a move toward deglobalization could mean for investors and companies

Tectonic Shifts in Global Supply Chains image

BEFORE THE WORLD HAD EVEN HEARD of the coronavirus, the intricate transnational trade networks that feed the modern factory already appeared vulnerable. A wide range of forces are responsible: From trade disputes to national security concerns to climate change and the rise of automation and robots. “It’s not just one factor but many,” says Candace Browning, head of BofA Global Research. “And what’s remarkable is that they’re all happening at the same time.” The result? A fundamental—and accelerating—shift toward deglobalization, as more and more companies are bringing supply chains, manufacturing and jobs closer to home, according to a report from BofA Global Research, titled Tectonic Shifts in Global Supply Chains. 

What does this mean for the U.S. and global economies?  How might companies best adapt to the changing environment, and could this present new opportunities for investors?  Co-authors Browning and Ethan Harris, head of Global Economics for BofA Global Research, share their thoughts on this evolving trend and the seismic changes it represents.

What ignited your sense of urgency around the changes that may be underway in the global economy?

Candace Browning: We’re always looking beyond daily events at bigger economic trends affecting the United States and the world. We’d heard that companies were thinking more locally but wanted to gauge whether it was myth or reality. So, we surveyed our international team of equity analysts—who together cover some 3,000 global companies—and were struck by what we found. Across 12 industries ranging from semiconductors to capital goods, companies in more than 80% of those industries are rethinking, or plan to rethink, at least some of their supply chains. We weren’t surprised that companies are shifting from China towards lower labor costs in Southeast Asia and India. What really did surprise us was the number of companies, particularly in North America and Asia, that intend to “reshore” supply chains to their own country or region.  Firms in almost all industries plan to make the transition work using robots and automation. Our forecast that industrial robots will double to 5 million units by 2025 may be conservative—and the cost of automation and robots keeps going down.

“Reshoring” refers to bringing a business operation that was moved overseas back to the country or region in which it was originally located. It’s the inverse of “off-shoring.”

After decades of globalization, some manufacturing appears poised to move back to its country or region of origin. But today’s high-tech factories require highly skilled workers familiar with robots and automation, and as newly opened factories compete for those skilled workers, retraining might be required to increase the pool of eligible workers.

Source: BofA Global Research, Tectonic Shifts in Global Supply Chains, Feb. 2020.

Reshoring of jobs—especially those requiring higher skill levels—could also drive higher wages, especially since manufacturing jobs, on average, command higher wages and total compensation than comparable non-manufacturing jobs. In the U.S., for example, total compensation is on average 15% more for manufacturing jobs – and 19% more for those with a college degree.

Source: Economic Policy Institute (Adapted from Langdon and Lehrman, 2012).

Note: Data is for workers aged 25 and older

Increases in domestic manufacturing can also promote a ripple effect on the wider economy. Every $1 in final sales of manufactured products supports $1.33 in output from other economic sectors.

Source: Bureau of Economic Analysis.

Manufacturing also tends to increase employment in other sectors. For every 1 new job in manufacturing, 6 new jobs are indirectly created in other businesses.

Source: Economic Policy Institute, 2019.

An increase in manufacturing could also spur innovation through investment in research and development. Manufacturing industries spend, on average, 5.5% of domestic net sales on R&D, while non-manufacturing industries spend only 3.6%.

Source: National Science Foundation, National Center for Science and Engineering Statistics, 2016.

All this change could also lead to new opportunities for investors, in areas like automation, industrial companies and financial services firms.

"What really did surprise us was the number of companies, particularly in North America and Asia, that intend to ‘reshore’ supply chains to their own country or region."

—Candace Browning,
head of BofA Global Research

What exactly are supply chains, and why is this shift so significant?

Ethan Harris: For 60 years after World War II we witnessed a steady rise in international trade and revolutionary changes in how products are made and sold.  Today, through complex networks of suppliers, a single smart phone or appliance contains parts sourced from many countries. In the last decade, though, international trade has leveled off, and our new findings suggest that what had seemed a relentless march toward globalization may now be reversing. Of course, that doesn’t mean that international trade will end. But when you consider that the companies in the 12 global industries we cover represent $22 trillion in combined market value, even incremental shifts toward “deglobalization” could have major implications for economies, jobs and consumers.

Why now? What’s driving this trend?

Browning: Higher wages in the developing world and advances in automation are reducing some of the cost benefits that have long made overseas suppliers so attractive. Another factor is ongoing trade tensions, even taking into account the new Phase-1 trade deal between the United States and China. National security is a growing concern as countries seek to protect their technologies. From an environmental, social and governance perspective, sourcing parts locally may leave a smaller carbon footprint and help companies ensure that suppliers treat employees well. It’s too early to know which of these forces will play the most important roles in deglobalization, but we’ll be watching developments closely.

Who might the beneficiaries be, and where are the challenges?

Harris: U.S. companies seem most ready to embrace automation and its cost savings. Technology companies and their suppliers could benefit as demand for robots rises. Generally, larger companies tend to have multiple suppliers and their scale may give them greater flexibility to adjust supply chains. China faces perhaps the greatest challenges. The underlying story is positive, with a rising middle class earning more money. But that means China needs to speed up its effort to depend less on exports and more on domestic consumers and services. The coronavirus, which has forced a number of Chinese factories to slow down or stop production altogether, contributes to these pressures.

“We’re calling this a ‘tectonic’ shift because we expect things to move slowly but persistently over the next five or 10 years. It won’t happen overnight, but some of the forces seem unstoppable.”

—Ethan Harris,
head of Global Economics, BofA Global Research

Browning: Small U.S. businesses may also benefit as part of industrial “clusters” that develop when large manufacturers move into an area. Manufacturers spend 5.5% of domestic net sales on research and development, compared with 3.6% for non-manufacturers, so that, too, creates opportunities for companies that support them.1 In some cases, reshoring will mean moving supply chains to nearby developing countries. So Mexico is likely to benefit from reshoring of U.S. companies, for example.

What does all this mean for workers and consumers now?

Browning: Some 400,000 U.S. factory jobs are currently unfilled, and companies are going out of their way to lure job seekers with higher wages, signing bonuses and other benefits. Moving supply chains closer to home will increase the demand for skilled workers such as welders, engineers and machine programmers—and manufacturing jobs already pay 15% more in total compensation than nonmanufacturing jobs.2 So, wages are likely to grow. But jobs, too. Ten years ago, conventional wisdom held that workers were all going to be replaced by robots. Yet while automated factories do require fewer employees, every new manufacturing job generates an estimated six additional jobs indirectly.

On the left, header text reads: Manufacturing has a multiplier effect. Text continues: The add-on effects when manufacturing returns home can support additional economic development in many areas. On the right is a graphic, a circle surrounded by five other circles connected by a dotted line, that depicts the text. In the middle is a large circle with the words reshoring/relocation in the center. The five outer circles each have different words in the center, which include: skilled jobs, higher wages, improved tax base, industrial clusters, driver of R&D. Source: BofA Global Research.

The benefits may be less pronounced among service companies, and unskilled workers will face steeper challenges. So, companies and policymakers alike will have to emphasize retraining and other programs to help give workers the skills they need for the new manufacturing landscape.

Harris: For consumers, a lot depends on what the major forces behind deglobalization turn out to be. If it’s mostly about trade barriers, consumers will pay higher prices, which is obviously not good for them. But if it’s because companies find greater efficiency through automation and lower shipping costs, that’s good news for everyone. That story is still unfolding.

What risks does deglobalization present?

Harris: Protectionism or national security could prompt government anti-trade policies that make this process happen much too quickly. In the technology sector, for example, different countries have developed very different capabilities. Forcing everyone to suddenly shift to local supply chains would be incredibly expensive and quite disruptive. One of the toughest challenges for governments will be finding ways to address national security concerns while minimizing those disruptions.

How quickly do you expect these changes to take place—and what should investors watch for?

Harris: We’re calling this a “tectonic” shift because we expect things to move slowly but persistently over the next five or 10 years. It won’t happen overnight, but some of the forces seem unstoppable. National security and protectionist concerns aren't going away. Automation’s not going away. Labor costs in China aren’t going to suddenly drop.

Browning: While deglobalization is likely to play out over a number of years, a look at market values and fund investments tells us that investors may not be fully prepared for a sustained recovery in manufacturing that could begin by mid-2020. We see opportunities ahead for industries ranging from automation to industrials to the banks that will help finance changes in supply chains. For these reasons, we believe investors should start thinking now about the implications for their portfolios, and how they can prepare for the global shift.

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