Stephen Meurice: There’s three words that are guaranteed to make any customer’s blood boil lately: supply chain issues. It conjures visions of empty shelves, delays, high prices. And it’s not just an inconvenience for customers, it’s costing companies, too.
Rodrigo Echagaray: Companies need to have a reliable supply chain. So nearshoring is really all about that.
SM: That’s our guest today, Rodrigo Echagaray. And that term he used, nearshoring, that's what he's here to talk about today.
RE: I think the easiest way to explain this is [by] just to think about how companies need to be able to source inputs in a safe way to produce and ship the products to the end customer.
SM: Rodrigo is the Global Head of Product Management and Head of Latin America Equity Research for Scotiabank. He’s here to give us a nearshoring 101 lesson. He’ll break down what the term means, what implications it has beyond supply chains, and why it’s the next big thing in global markets.
I’m Stephen Meurice and this is Perspectives.
Rodrigo, welcome to the show.
RE: Thank you, Stephen.
SM: So, in the intro you gave us the rundown of what nearshoring is and we’ll break all that down in detail in a minute, but first I’m curious, is nearshoring the same as friendshoring, which is an expression that I've heard recently. I think our deputy prime minister has used it a couple of times. Are those the same thing?
RE: I would say so. They’re related to the same concept that companies around the world need to be able to source and produce their products in a safe and reliable way. Throughout COVID that was challenging and especially companies located in the Americas are concerned about some of the trade conflicts taking place between the U.S. and China. On top of that, there is conflict in Ukraine. And so people are rethinking their strategies around supply chain. And that means bringing production to places that are more friendly to the investments.
SM: Right.
RE: When companies are thinking about their strategies and where to produce, geopolitics is now an important variable of that equation. And just to give you a bit of context, China’s market share in the U.S. imports used to be 24% at the peak and it’s now at 13%.
SM: So the Americans are importing, already importing, a lot less from China than they were before.
RE: Yes and this has implications beyond supply chains.
SM: So after decades, I guess, of what maybe was called offshoring, where manufacturers and companies producing all kinds of things move their operations offshore, often to distant parts of the world, to parts of Asia, including China, of course. That was what business was doing really for the last several decades. Is that a good way of describing what offshoring was?
RE: That is exactly right.
SM: Okay. And now we've kind of — it looks like we're thinking about going in the opposite direction. So, what you're talking about, when you refer to supply chains and geopolitical troubles in various parts of the world, is bringing that production back closer to where those businesses are based?
RE: Absolutely. I think the U.S. being the biggest market obviously tends to attract a lot of investment decisions from companies because that's where the biggest market is. And so essentially what nearshoring means is that Americas as a whole — and we'll talk a little bit about what that means for Mexico, Canada and the U.S., specifically — but Americas as a whole is likely well-positioned to attract some of these investments coming back from China to the Americas.
SM: Right. So maybe go into a little bit more detail on the specific issues that are driving this. You mentioned China and you mentioned COVID. What problems for supply chains and so on are those issues causing or have they caused?
RE: I would say there's two examples that I can think of. One, if the U.S. government imposes import tariffs to products coming from China, that obviously increases the price of goods being shipped and it decreases the competitiveness of manufacturing in China or Asia. The other example that I would flag is semiconductors. That's an industry that is very important for different reasons, including security. And the U.S. government has been incentivizing investments in the U.S. so that we bring a lot of the production to the Americas and so that the reliance on China is reduced from that perspective.
SM: Right. And over the course of the last few decades, as we said, a lot of manufacturing has moved to the far East, including to China. Why now? Because presumably that happened because it was cheaper to manufacture those things. What's the incentive to move it back now?
RE: I think cheaper for a long time was the main driver. I think safer now is an important part of the equation as well. There wasn't this concern around a trade conflict. And so as boards and companies think about their long term investments, now they have to adjust their equation, where safer and more reliable, therefore, has to be included as part of the analysis. I would also say that there's been a lot of fiscal incentives from the U.S. government mainly, but also from Canada, to bring some of these investments back around clean energy, around semiconductors. And so, these fiscal incentives are also driving some of those decisions by the companies.
SM: And so what do you mean by fiscal incentives? Subsidies to bring that kind of manufacturing back?
RE: Absolutely. Yes.
SM: And why would they be doing that?
RE: I think, again, going back to the ability to safely access and rely on a supply chain that is closer to home, where you don't ultimately depend on a conflict that could arise.
SM: Right. And you mentioned around sustainability and the products associated with that. So, I guess wind turbines, solar panels or such things that I think in the last while have been primarily made in China also. So that's a market that could be opened up here as well.
RE: Yep, I think in the last 12 months since the Inflation Reduction Act was enacted, there has been a lot of investments going into solar, for example, a lot of battery plants or investments around that are also taking place.
SM: Right. I guess supplying batteries to all the electric cars that are going to be built is a big deal now. There are announcements of new plants all the time, it seems like.
RE: Yes, approximately 50 electric vehicle battery plants are slated to open in North America over the next few years. And copper, lithium, these are minerals that are produced in the Americas. So, one of the things that we think is going to happen is, as some of these industries return or receive some of these investments in the Americas, other parts of that same ecosystem will benefit. And so, what we think will happen is we will see first and second derivative investments of some of that unfolding in the coming years.
SM: And you mentioned the Inflation Reduction Act. That's the American government's attempt both to reduce inflation, but it also has a huge climate component to it.
RE: Yeah, for sure. Climate initiatives are an important part of that. And I would say one of the things that we also think about some of these investments return is that we would like to see a bit more of a homogeneous conversation across countries, especially Mexico, U.S. and Canada, around some of the policy making. In other words, it is helpful that the U.S. has those incentives, but it would be even better if all three USMCA partners would have similar incentives to make sure that this is a truly transformational process for the entire North American region. As opposed to just country specific.
SM: Right. And is that sort of coordination taking place or is it likely that I guess you're talking about Mexico and Canada taking similar steps?
RE: I think Canada has taken a lot of very similar steps. I think there is work to be done to make sure that the same policies point in the same direction in terms of rule of law, in terms of climate change. I think there are some opportunities on that.
SM: And if you were to explain to an average person what is the benefit to, say, Canada or North America more broadly, of a policy of nearshoring or friendshoring, what's the upside?
RE: I think that's a good question, because what we're seeing in northern Mexico, specifically in Monterrey, which I would say is probably the epicenter of nearshoring today, is that a lot of multinational companies have announced significant manufacturing investments. Tesla, General Motors, Mattel. And when that happens, you have to go and hire a bunch of engineers. These engineers have to live somewhere. And so that increases manufacturing, increases employment, increases real estate demand, increases cement demand. So, if you can think about that in the context of the entire North American region, I think that's where it could get extremely interesting for the USMCA partners. One industry growing could lead to other industries benefiting from this nearshoring trend.
SM: So ultimately, it just contributes to the growth of the economies of all three countries.
RE: Absolutely.
SM: Okay. So a lot of the manufacturing that was offshored over the course last years, it helped make those things inexpensive for people. Are all of those things likely to also come back, or are we talking really about specific sort of higher end products? And is there ultimately an impact on the consumer? We did the manufacturing there because it was going to be cheaper; if we bring it back. does that mean things get more expensive again?
RE: I think there is an argument for that. I would say there has been a lot of articles flagging that companies that were used to build semiconductors in Taiwan, for example, and that are trying to replicate the same efforts in the U.S., are finding that the construction is significantly more expensive. Access to labour is more challenging and regulations are just simply different. So at the end of the day, the equation is really ultimately about being closer to the end consumer and what that saving on the transportation and logistics and the safer environment, offsetting some of those incremental costs.
SM: Right. So what you're saying is that an item being cheaper isn't all that helpful if you can't get it to your customer in time?
RE: That's right.
SM: So there's upsides and at least potential downsides from a cost perspective. But at the end of the day, the feeling is that there is benefit to moving in that direction?
RE: That's right. I would say the main reason ultimately is that you have to be able to rely on your supply chain. So ultimately, while pricing is definitely important, the cost of producing that is very important. The reliability of that is probably even more important. So as companies undertake multibillion dollar investments that span decades, committing to those investments in Asia today is likely less appealing than it was before.
SM: So, companies need to invest lots of money in order to create the products or new businesses that they want to do. There used to be a cost benefit to doing it in other parts of the world, particularly in Asia. But the risks now associated with it, particularly supply chain risks and deliveries and all of those things, perhaps those costs are beginning to outweigh the benefits.
RE: Yeah, in fact, if we look at nearshoring investments related to industrial real estate in Mexico, a lot of that investment is coming from Chinese companies. We are finding there are industrial parks in northern Mexico that are catering entirely to Chinese companies.
SM: Well, that's interesting. So how much nearshoring is already taking place?
RE: I would say we are probably in the second inning at best. This really just started a couple of years ago, and again COVID probably was one of the catalysts of that. But I would say some of these investments, they've been announced, but there is a ways to go, still. There is a lot that just hasn't materialized. It's just been announcements of companies setting up shop in, you know, northern Mexico or whatnot. But I don't think we've seen the full impact of this.
SM: Right. But in your business, I mean, this is the area that you work in. People are talking about it. This is becoming an important part of what you see going forward.
RE: I think so. The Mexican peso is the best performing currency year to date. The Mexican Stock Exchange is one of the best performing stock exchanges in the world. So definitely people are paying attention and they're seeing that the North America region could become a good place for investments going forward. We are also seeing more M&A (mergers and acquisitions) CP, The Canadian [Pacific] Railroad Company acquired Kansas City Southern, and they recently launched an initiative where you can ship products essentially from Canada all the way to San Luis Potosí in Mexico. We have also seen recent announcements from Air Canada launching new routes to northern Mexico. So, there is definitely glimpses that this is happening.
SM: And there was already a fair amount of economic integration, obviously because of formerly NAFTA and now the USMCA.
RE: Mm hmm.
SM: But you see those economies becoming even more integrated with one another?
RE: That's what we are arguing on a report we recently published. We are arguing that integration is likely to only increase. And I think that will be beneficial, ultimately, to all three countries.
SM: And of course, if you do business in Mexico, so you have some direct knowledge of that and some expertise that you can put out there in the market.
RE: Yeah and we've been pretty active going on the ground, meeting with private companies, meeting with operators of industrial parks and obviously public companies as well. And definitely, we are seeing on the ground that these investments are arriving in that region, and that is having an impact — first and second derivative impacts — in other industries.
SM: And the world is paying attention and global markets, people, are noticing this as the next big thing?
RE: I would say so. I don't know if it's up there with artificial intelligence, but it's definitely one of the themes that is on everyone's strategy book. I think boards, especially for multinational companies, are being forced to, at the very least, rethink about how they're going to source inputs and integrate their supply chains globally.
SM: I think we'll leave it there, Rodrigo. Thank you so much. That was really interesting and appreciate you coming on the show.
RE: Thank you, Stephen.
SM: I've been speaking with Rodrigo Echagaray, Global head of product management and head of Latin America Equity Research for Scotiabank.
