Doubts about China as the ideal place to manufacture cheap consumer goods for the West have been voiced for years. Chinese factory wages, the lowest among Asian economies in the 1990s, increased more than fivefold between 1993 and 2015. Tariffs imposed by the Trump Administration, and continued by President Biden, raised prices on thousands of imported Chinese products and materials. The COVID-19 pandemic temporarily choked off the flow of goods from China’s factories, causing many manufacturers to question the wisdom of single-sourcing from that country. And this year, U.S. imports from Mexico surpassed those from China. It’s a trend that can no longer be ignored, and a recent working paper from Harvard Business School has given it a name: The Great Reallocation.
No single country, let alone the U.S., is the sole beneficiary of the shift. Vietnam, Malaysia and other Southeast Asian countries, as well as India, are among those seeing an uptick in local sourcing of low-cost goods. Mexico, due in large part to its prior status as a manufacturing center for the American automotive and electronics industries, is a big winner in the push for “nearshoring” of production serving U.S. markets. And a certain amount of activity is returning to the U.S., as long as automation can be deployed on the production line to make it economically feasible.
While Mexico is currently grabbing most of the headlines about new and evolving sourcing strategies, the larger story is about “rebalancing flows that are very complex, in ways that a lot of economists don’t have an easy time projecting,” says Misha Govshteyn, chief executive officer of MacroFab, supplier of a digital platform for global electronics manufacturers. But one thing, he says, is crystal clear: “The monolithic idea that China is the world’s factory is becoming more and more of an anachronism.”
The decision on where to site manufacturing is more than a question of chasing after the cheapest labor, Govshteyn says. (When China became more expensive, productivity there actually rose.) And a successful move to Vietnam, where wages are lower, must be accompanied by a significant investment in roads and other infrastructure, as well as worker training.
The number-one reason why manufacturers are diversifying from China is growing geopolitical risk, Govshteyn says. They can’t chance having production disrupted by the capriciousness of government action or a prolonged trade war. And that’s where Mexico, with its relatively stable diplomatic ties to the U.S., as well as proximity to end-markets, enters the picture as an attractive alternative.
Mexico’s status in U.S. eyes is nothing new, Govshteyn points out. “Before China ramped up as the world’s factory, Mexico was very much the best factory partner for the U.S.,” he says. The country had a long-established network of maquiladoras — factories built expressly for cross-border markets and benefiting from, in most cases, duty-free status of their output. The large numbers of Mexican workers who were employed by the electronics industry in the 1990s “got squeezed out [by China] and are coming back.” They’re also available to train younger entrants. As a result, “we’re nowhere near tapping out on Mexican and Central American [labor] capacity.”
Most Mexican manufacturing is concentrated in the northern part of the country, in Monterrey, Guadalajara and Tijuana. That serves to lessen concerns about inadequate transport infrastructure, although substantial development of roads, rails and ports will be required if Mexico is to reach its full potential as a manufacturing powerhouse for the U.S. and other major consumer markets.
Road and rail are, for the moment, adequate to support current levels of activity, Govshteyn says. Even with the exit of some independent freight operators from the market during the pandemic, there’s approximately 18% more truck capacity now than was present when COVID-19 hit. And trains are moving across the border with few delays.
What is of concern, he says, are security crackdowns at the border, resulting in long delays for trucks crossing from Mexico into the U.S. No country, it seems, can escape the fallout from political tensions between trading partners.
The U.S., meanwhile, stands to benefit from some reshoring of production to within its borders. “There’s probably more manufacturing in the U.S. than a lot of people realize,” Govshteyn says. “We’re still one of the top manufacturing countries out there.” Domestic manufacturing accounts for around 10.7% of the nation’s output, employing 8.41% of the total workforce.
It would be a mistake to assume that manufacturers are abandoning China entirely, Govshteyn says. MacroFab’s second-largest customer has so far moved only about 20% of its production capacity to North America, with an eventual target of 50%. Barring another massive geopolitical crisis, such as China blockading or invading Taiwan, the shift will continue to happen gradually.
“Few companies are pulling up stakes entirely,” Govshteyn says. “These things play out over multiple years, but the trendlines are definitely heading in that general direction.”