Ep. 214 - Reshoring Challenges

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You're listening to the economics and country risk podcast from S&P Global Market Intelligence ORG. In each episode, our experts will provide you with the where, how, and when to make decisions that transform your business.

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Companies are finding that supply chain disruption is not receding, and the reliability of inputs such as transportation is not returning to normal. We see a need to invest in resilience projects that cut risk and improve profitability, such as reshoring. Reshoring, of course, has its challenges. To discuss these challenges, we are joined by the following analysts from S&P Global Market Intelligence.Aries Poon, head of Asia Pacific Insights and Analysis, Rafael Amiel PERSON, Director Latin America and Caribbean Economics, and Sam Parkin PERSON, a senior economist with our pricing and purchasing team. We're going to start with a high-level overview, and then we will dive deeper into labor and infrastructure, and then delve into responses to these challenges and what we're watching. Aries, let's start with you. What would you say is the APEC ORG narrative on reshoring?

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So the driver behind reshoring has been evolving. And in terms of today's context, it has been about the competition between U.S. GPE and mainland China GPE, where some of the manufacturing facilities in mainland China, which is owned by Chinese and owned by other multinationals, are being relocated to ASEAN, India, Eastern Europe and Mexico GPE. The main reason is in order to continue access to the U.S. GPE market. But in fact, adding additional facilities outside of China happened for more than 20 years.But back then, it was because of China GPE's rising production costs, and these facilities are looking at where they can have cheaper labors and cheaper raw materials.

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And Aries, what would you say are the main challenges of reshoring to the APAC LOC region?

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Thanks for the follow-up question. In fact, the reason I brought up the brief history of reshoring is because up until the current period of the U.S.-China competition, China Plus One astrology has been there, but it was very slow. It picked up pace in recent years primarily because the businesses have to do so, much less because of commercial consideration, such as cost, because otherwise they would lose access or they would have

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reduced access to the

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U.S. GPE markets. And what that tells us is if we take out geopolitics from the whole reshoring calculus,

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and then we can see that in these APEC, Sokacchana plus one destination, such as ASEAN and India GPE, they actually have some lacking in terms of labor skills, in terms of infrastructure, in terms of a proximity to end market, and because those alone were not sufficient to be attractive for these businesses to relocate it out of mainland China GPE. But I have to say because right now we see the reshoring is focusing on more of the high-tech sector, which makes the labor skills become an even more urgent requirements for that movement. But one more thing about geopolitics is all these China GPE Plus One destinations,they are treading the political landscape very, very carefully in order not to antagonize either U.S. or mainland China GPE. One of the reasons is China GPE remains a top market for these locations and also the top source of FDI. They also can't afford to lose access to the US GPE markets. And also internal politics might play.We all know that this year is a heavy year for elections. And newly elected governments will have to strike a balance between responding to local politics while making sure that they are in a place to maximize trade gains or investment gains from both China GPE and the U.S.

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Let's move on to Latin America for a high-level overview, particularly Mexico GPE. move on to Latin America for a high-level overview, particularly Mexico GPE. Rafael PERSON, what is the reshoring narrative for your region?

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Mostly the reshoring activities are happening in Mexico GPE. Mexico really is a country that geographically is the best choice for the United States GPE in terms of setting up plan or reshoring. The relationship is long, not after the free trade agreement of North America LOC, the initial NAFTA, now the USMCA, the revised free trade agreement, give Mexico GPE a tremendous advantage geographically in terms of how they know each other, how they operate, how the plants operate and ship to the United States GPE, which is mostly ground.So just to give a little bit of context, Mexico GPE reshoring is happening now, especially in those products where the United States GPE is putting higher tariffs because of trade issues. Mexico GPE has taken advantage of that already. But for the first time, since 2002, the U.S. imports from Mexico has been larger than from China GPE. So the picture for Mexico GPE looks good.

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And, Rafael, what would you say are the main challenges to reshoring to Mexico GPE in particular?

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Yeah, in our baseline scenario, we incorporated reshoring activities. And we added increased investment, increased foreign direct investment in the coming years. But we added in a fashion that we call soft reshoring or mild reshoring because there are challenges. One of them is infrastructure. Mexico GPE will need to build roads. Mexico GPE will need to increase the supply of energy, especially electricity. Mexico GPE will need to address the issue of water.So infrastructure is a big issue that can be overcome with the investment, comings with a capital inflows, but they need to have first the political will to do so. So there are issues also from the political stand of Mexico GPE, wanting to be energy sufficient and not to allow the private sector of foreigners to enter freely in the energy market.Another constraint that near-shoring phases in Mexico GPE is labor supply. We assess that the market is a little tight. We assess also that workers may come from Central and South America LOC, skilled workers may come. Mexico GPE needs to prepare and open up to process those visas for those workers that could come. So it's not impossible, but it has to happen yet. And the third constraint for Mexico GPE as an optimal or ideal,reassuring location are the operational and security risks, which are basically red tape caused corruption and the violence that happens in the country.

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And you brought up labor there, which sets us up to bring Sam PERSON into the conversation. Sam PERSON, what is the labor narrative when it comes to reshoring?

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So there are two elements to labor. The first one is labor costs. So recently what we've seen is higher labor costs in the U.S., Mexico GPE, Eastern Europe, Western Europe LOC, and this is because of inflation. So higher inflation has actually flowed into wage growth, and this is propelling wages up. This has been aided somewhat by minimum wage increases.So we've seen that in Eastern Europe, and we've seen that in Mexico GPE. Now, in Asia LOC, it's not as much the case in that it still had inflation, but not as much. And so wages haven't been as high. However, that's not to say that wages aren't growing high in Asia LOC. Generally speaking, there's more investment, there's greater domestic demand, and there's greater labour demands because what companies are doing is tapping into cheap labour and exportingitems and goods outside. The other element is labour market complexities. So what we've seen, generally speaking, is a decline in vacancies and a decline in labor demands. And this has been present globally almost. So it's been present in the US and in Western Europe LOC. And it's been present in Eastern Asia LOC as well.So what we saw was maybe Q1, 2022, we saw very high vacancies as economies recovered from the pandemic. What we've seen that is decline since interest rates have risen and global demand has lowered. And as a result, vacancy rates have lowered. And this is betraying lower labor demand.On the other side, we have labor supply. Again, generally speaking, we've got the U.S. and Western Europe LOC, seeing labor shortages in their respective regions. And in Asia LOC or eastern Asia, I should say, what we're seeing is low unemployment rates. So roughly between 1 and 3%, generally speaking, apart from India GPE, which is seeing a higher unemployment rate.But broadly speaking, these Eastern Asian NORP countries are seeing low unemployment rates. And what this means is that there's a lack of labour availability, really. And this is why we saw really high vacancy rates during 2022, the start of 2022. And that's because we've got high vacancies, high demand for this low cost of labor. And yet we've got this low unemployment rate. So that labor supply isn't there. A final thing to consider really is skill shortages. We've touched upon it slightly.The US and Western Europe LOC seriously see skill shortages. In Eastern Asia LOC, it's a bit different because when you move production there, you kind of know what you're seeking and know what you're desiring in terms of skill level. However, you're still seeing low skills labor markets like India and Vietnam GPE.

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And let's stay with you, Sam, and zoom in on the regions that we're focusing on today. So what would you say the labor picture is like in APAC LOC particularly?

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So it's a mixed picture in APAC LOC, I'd say. However, it has common themes. The common themes are a lack of skilled workers. You've got a low unemployment rate, and you've got a desire for low-cost labour. Malaysia has a high-skilled workforce, but with that comes a higher labour costs within the country. It's similar to China, actually. The unemployment rate is roughly around 3%. So there's a little bit of scope for labour availability here. If we look at, say, India, the unemployment rate is 9%. So it's almost an anomaly. It's much higher than other Eastern Asian NORP countries.However, this is unskilled labour. With India GPE, it's still got strong hiring intentions, and this is plus an upward wage pressure within India GPE. And this is because of strong domestic demand, and there are some, I'm not saying loads, but some infrastructure improvement. Finally, Vietnam GPE has a low cost oflabor. However, it's got a low skill base. It's also got a low unemployment rate. There's a lot of demand in Vietnam GPE, because of the cheap labor, of course, but because of this high investment because of some infrastructure increases as well. So what you'll find is, again, of course, but because there's high investment because of some infrastructure increases as well. So what you'll find is, again, labor demand, as interest rates start to subside and ease and global demand improves, you'll find that there'll be strong competition for this labor in Vietnam GPE, especially considering how reliant Vietnam is on exports. Ariries, thinking about what Sam PERSON just shared with us,

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what would you say are the factors that are influencing labor markets in APAC LOC?

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Sam has made a very good overview of some of the key China Plus One ORG destinations and the labor market situation. I think there are three things that are we looking at here. One is the government's strategy in education. And then the rural workforce and urbanization. And lastly, it's about gender. And I think for education, it takes time. You know, you invest right now, but you might see certain level of skill labors being graduated on Mars maybe in 15 years or 20 years. And in the last wave of reshoring when,you know, factories are moving into Vietnam GPE and other places because of low cost, not because of geopolitics. And back then, we see Malaysia, Vietnam GPE in particular, they are doing very well in terms of positioning the educational system in order to provide high-level skilled labors. In that sense, actually, Malaysia has been doing very well. Another thing is about rural workforce, because I understand in most of the unemployment metrics, it doesn't include rural workforce or doesn't really reflect the population that is in agricultureand farming. That also speaks to another challenge for Asia-Pacific LOC is some of these countries are still predominantly having population working in the rural sectors.

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And so I think the government is also trying to push for urbanization. But again, it's not just any policy that can push for urbanization. Usually people urbanize because they are being lured by the wealth prospects and employment prospects in cities. And that also comes with many other different moving factors, such as FDI, such as, you know, the business environment and tax and all that. Finally, it's gender.I think gender is a very big factor in Asia, Pacific LOC in particular, because many cultures do not encourage mothers to work. So we're essentially eliminating half of the population from eligible workforce. Now, I understand, for example, in Japan GPE, they are already trying to encourage some mothers to work. But it's not that simple because it actually speaks to the entire social welfare system, child care system, even schooling systemin order to create an environment that is actually sustainably possible for women as a category, not individual women, but women as a group to be able to be in the workforce. And also without certain gender, then you might also lose some certain skill sets that might be needed in a digital economy. So I think these three might be some of the key drivers in some of the phenomenon that Sam PERSON had described just now.

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Good points there, Aries PERSON. Sam, coming back to you, what about Latin America, Mexico GPE in particular, what does the labor picture look like there?

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So focusing on Mexico first, what I mentioned earlier is high wages, and this is in response to higher inflation and somewhat stronger investments. This is going to gradually fall to 2016 levels as inflation continues to fall. Raphael PERSON mentioned about lowering employment. What we're seeing there is with this increase investment in moving production, we've seen unemployment gradually fall down towards mid-2% level. The skill level of Mexico is between China and Thailand GPE.So I would say it's a good alternative for China somewhat and Thailand GPE. Moving to kind of the rest of Latin America and South America LOC. Brazil, Colombia and Peru GPE, what we've seen as high wages. Again, this is in response to higher inflation, and this is gradually falling. It's not just going to drop off. It's going to be a gradual fall, especially after industries and sectors are looking to recapture real wage losses that they saw previously.Unemployment rates in these countries are higher, and so this implies that labor availability is greater. However, of course, it's not as close to the US, and Mexico GPE is more desirable because of a higher skill level, for instance.

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Rafael PERSON, what economic factors would you say are influencing labor markets in Latin America, Mexico GPE in particular?

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The labor market is tight because Mexico has been growing a little bit more than an average in the past two years. But I have to add that in terms of the minimum wage policy, the government of Mexico in the past six years have been very aggressive increase in the minimum wage, and this has been pushing up labor costs generally, not just the minimum wage, but in the pyramid of wages, they have gone up. And another factor that constraining the supply of labor is migration. So at all levels, unskilled, unskilled workers migrate. And recently in the past few years, it appears not official numbers yet, but it appears that migration has increased. So this has shortened the supply of labor and increased the wages and salaries in Mexico GPE.

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Let's pivot now to infrastructure. Aries, what infrastructure-related challenges do we see in the APAC LOC region?

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Infrastructure like ports and stable electricity, they are very key to all kinds of manufacturing activities. In fact, and in order to be a prominent China GPE Plus One destination for Southeast Asian and India GPE. These two are becoming more urgent than ever. As I mentioned about the impact of election cycle, making long-term planning less effective in the past, and I think that has been seen in where the infrastructure level is today.For example, in India GPE, it still doesn't have a single deep water port. And in Vietnam GPE, we still saw Brownout, which is electricity supply stoppage, even late last year. And in the northern part, where there were a concentration of technology and semiconductor factories. And just like education, if you didn't take the time 20 years ago, then now you have to play catch up. There is one complexity, though, who is going to fund this infrastructure?Now, for some countries like India GPE, they probably can do it themselves. They have deep pockets, and they have very determined government and policy priorities. So that probably is not a problem. But when we look at other countries, for example, Vietnam, or maybe even some other countries in Latin America LOC, they would likely to turn to some countries that have deep pockets and they have been doing international lending and investments. And another thing is natural disasters. It might not be catastrophic. It might not havelasting implications of supply chain. Still, these are costs that you need to take into account. And for typhoons, they're not only stopping electricity, they could actually create safety, personnel safety, for the people who work in

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those places. Rafael, let's talk about Latin America LOC. You've already touched on this a little bit, but what infrastructure-related challenges do you see there?

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It's usually a challenge, but many times it is also an opportunity, and it depends on the global business cycle or the policy, the political cycle. A country with sound macroeconomic management is always going to attract investment in infrastructure, which is relatively easy. It requires just capital. It doesn't require lots of technology, new technology to be developed. In Latin America LOC, the needs are very wide in terms of roads,ports, even in connectivity, in telecommunications, and also supply of electricity and water. We see that as part of the opportunity and as part of the growth story and the growth picture that we have for many countries in the region, including Mexico itself, as we discussed, Brazil GPE is a very open field to build infrastructure. They are working on this and the abundant natural resources that Brazil has, and Mexico GPE has another country in the region, open the rules for building infrastructure, which is muchin need, I will say, and then productivity growth will follow once the infrastructure is there.

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So now we've touched on labor, we've touched on infrastructure, we've touched on geopolitics, and some of the domestic operational risks. Let's talk about the responses that we're seeing to these challenges. Sam PERSON, let's start with you. Can you tell us about responses to the labor market challenges?

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Yes. So Aries PERSON touched upon it earlier in educational reforms. I think these are very important. So you've got educational reforms occurring in Vietnam GPE. So there's a push to get people in school, achieve their education, get degrees, etc. In India GPE, this is the same. You've got a push for to get people back into school and into schools and finish them, but you've also got a couple of other initiatives. The first one being the formation of ministry and skill development and entrepreneurship, and the second one being the skill India mission. And the second one, it had an ambitioustarget of upskilling 400 million workers. So again, it's about pushing these low-skilled countries and trying to upskill the civilians and people there to attract more manufacturers and to attract more investment. The issue that these countries are facing, and this is global as well, but the issues that these countries are facingis that there's competition for skilled workers. I mentioned earlier that Western Europe LOC had a lack of skilled workers. And what they're actually doing is they're adjusting their immigration policy to try and attract skilled workers from outside the EU ORG. So for instance, Germany GPE has this new opportunity cause. So it's going to be a big challenge for the likes of India and Vietnam GPE to actually retain their workers, their skill workers, so that there's not a brain drain. And we see a brain drain of sorts in Eastern Europe LOC, actually.So what these countries need to do is they need to, of course, upskill their population, but also retain them within their own country.

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What else should we be watching out for on the labor front in the near term?

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I think the immediate worry for me as a labor market analyst is analyzing how monetary easing occurs, how global demand will react. Now, if global demand reacts very quickly to interest rates easing, so optimism improves, general international demand improves, what we'll see is vacancy rate skyrocket. And for these countries, it will create upward wage pressure. And so that's what I'm going to be looking for in the immediate term. Another one is minimum wage increases.And Raphael touched upon it with Mexico GPE. We've had a number over the last few years. I'm going to be looking forward and looking to see and keeping an eye on where we see indications perhaps of another minimum wage increase, although it's quite hard to measure. It's the same in Eastern Europe LOC. So you're seeing it in these places where you expect production to be moved, and it's something to keep an eye on for labor costs for sure.

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Raphael, let's move over to Latin America LOC again. What responses are you seeing from governments there, and in particular, what has Mexico GPE been doing to address reshoring? Well, as part of the free trade agreement,

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the US GPEMCA agreement, Mexico and the US, they hold this high-level economic development dialogues continuously. And the U.S US and Mexico GPE have met several times, and the US GPE has shown interest, and they have agreed on the specific sectors. And then the government of Mexico GPE is working on these areas as to be able to provide and supply the U.S. GPE manufacturers.But yes, this is what is happening. In terms of education, Mexico GPE and the U.S., and especially the north of Mexico has always been looking up into the U.S. GPE and preparing to provide the skills and the labor that the manufacturing oriented to the U.S. GPE requires. So on that, there is nothing new that has happened, but it's there. And Raphael PERSON, what else should we be

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watching out for in the near term? Mexico will have general elections in June. And certainly

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there will be a change in administration. And given the current president's charisma and his level of authority, we assess that this is not going to happen with either candidates. So we see more opportunities. We see a new government that will be a little bit more flexible to talk and allow the private sector to take on larger projects. So that's a plus. But yet, there is uncertainty about the elections in Mexico

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that are coming immediately. And also there will be elections in the U.S. GPE that may change the picture as

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well. Ariz, what about in the APEC ORG region? What are governments doing there to address reshoring challenges?

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So one of the main thing that the biggest countries in ASEANs ORG have been doing is trying

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to be in the economic partnerships with China and US GPE separately. Malaysia, Singapore, Vietnam, Indonesia, Philippines, and Thailand GPE. They are in both the RSEP, which is regional comprehensive economic partnership and the IPEF inter-Pacific economic framework for prosperity. And for Malaysia, Singapore, Vietnam GPE, they were also in the comprehensive and progressive agreement for Trans-Pacific Partnership, which is a framework thatincludes EU ORG. Now, so what we see is these Asian countries, they know well enough that this is an insurance of whatever they might happen between U.S. and meaning of China GPE in the future is if they're in both camps, and that will likely make sure that their market access or, you know, FDI sources and all that would not be severely impacted if the dynamics of the politics between U.S. and Maine and China GPE change for the other direction in the future. So that's one. The other one is I want to talk about migration. Oftentimes we look at whether countries can attract talents into the country or they can train their own talents.But what happens, for example, with the Philippines and India GPE and all that, there were well-trained students, a well-trained population. They actually decided to go elsewhere because of a high wages or because of a different prospects. And that is the brain drain that I'm referring to. And I find the governments in Asia Pacific LOC has been in a tough spot on that, mainly because when you look at, for example, the Philippines GPE economy or even the Pakistan economy, they rely heavily on remittance.And the remittance comes from some of the very smart people who are earning very high salary in developed markets and send the money back home. And that is actually a main part of GDP. So the government has to balance between having this stable and possibly growing source for the economy versus having these people to be physically in the country to offer the value that they don't or they can't have currently, I think it could be an existential challenge for countries where they have a lot

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of population working overseas. And speaking of that, Ares PERSON, what else should we be watching out for in the near term? For example, any elections like Raphael mentioned? I think that's the elephant in the near term. For example, any elections like Rafael PERSON mentioned? I think that's the elephant in the

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room, right? The U.S. GPE presidential election. Reshoring is a very costly exercise, and there is no way to go about it, but you kind of have to do it. And I think what businesses are looking at is we don't need to go full-blown on board right now. We just need to do the bare minimum that we need to in order to maintain access with the US GPE market. But what if the rules or what if the rules of the game change? What if terrorists change? What if the restrictions take on a different format because of a change in administration in the US GPE? And I think all these will be something that we all have towatch very closely over the next six to 12 months or even beyond, actually.

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Thank you. Right. Well, we've given you a lot to think about today and we're committed to continuing the conversation. We're doing deeper dives into our 2024 themes on our weekly economics and country risk podcast. You can find more thematic coverage and connect themes on our weekly economics and country risk podcast. You can find more thematic coverage and connect and on our blog. Thank you to Aries, Raphael, and Sam PERSON. And thanks to you all for engaging with us.Until next time.

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