Those who bemoan the offshoring of manufacturing jobs to foreign countries such as China often ask why we can’t restore those jobs to the U.S. But this question misses the point; the U.S. has historically been a dominant manufacturing center and can undoubtedly become one again. The real questions are “At what cost?” and “Can we afford to do so—or afford not to?” In other words, what are the tradeoffs, and which supply chain segments make the most sense to reshore?
The Benefits of International Trade
International trade has existed for centuries—think the Silk Road—but until the 20th century, trade was small relative to overall economic output because economies were more isolated. The U.S. economy, for example, grew rapidly without Chinese manufacturing and supply chains for more than 200 years, particularly in the decades immediately following World War II. After the war, pent-up domestic demand was high. Elevated savings rates during the war supplied liquidity and capital, returning GIs provided labor, plus factories were no longer needed for war production. The government for the most part stayed out of the way, and this combination of circumstances created a powerful recipe for rapid growth. This precedent would seem to offer proof that we don’t need international trade. We could be the nation-state equivalent of doomsday preppers.
But international trade provides a deeper supply chain bench. Different countries have absolute advantages: You can more easily grow oranges in Brazil and Florida than in Norway. Many countries have attempted to go it alone to some degree, subsidizing industries they deemed important. This policy sometimes yields benefits, but those investments also use resources that may have been better spent elsewhere. North Korea is an extreme example that follows the juche idea, an ideology that promotes self-reliance of the state. In large part, international sanctions forced North Korea to adopt juche, but the country’s leaders took the idea further, even sealing the borders after the onset of the pandemic. This has not worked out well.
Some might argue that North Korea is small, with huge disadvantages like a centrally planned economy, while the U.S. is a large capitalist country with vast natural resources. Surely, with these advantages, the U.S. can be self-sufficient and immunize itself from disruptions to international supply chains.
The history of China’s economic growth, too, has been different from that of the U.S. China did not have strong internal demand and had a centrally planned economy. Only after Deng Xiaoping instituted economic reforms that embraced free markets and capitalism did the Chinese economy begin to grow rapidly. Hundreds of millions of people rose from poverty into the middle class in only a few short decades. This growth exploded after the Clinton administration granted China most favored nation status and after China was admitted to the World Trade Organization in 2001. International capital poured in, and labor migrated from rural China into the cities, feeding an economic boom the same way returning GIs fed the U.S. boom after World War II—but to meet world, not domestic, demand. Till now, China’s economy has been mostly export driven. Some take this to mean that China is more dependent on the U.S., and the rest of the world, than the U.S. is dependent on China, and therefore view it as further evidence that decoupling would be painless for the U.S. But would it?
In actuality, there would be significant costs to decoupling. Just as the division of labor among individuals increases output by allowing each of us to specialize in the products or tasks we do best, the same is true with division of labor among nations, not only due to their absolute advantages, but also because of comparative advantages. Globalization has been a boon to the U.S. economy, even when U.S. workers could have done a job as well as (or better than) foreign workers, by allowing lower-skilled jobs to be done overseas while freeing up U.S. labor to focus on higher-skilled jobs. Workers in China and elsewhere actually support workers in the U.S. The world is much better off when people trade freely between countries. Abandoning this greater productivity would be the economic cost of decoupling—not to mention the political and social costs that would also result.
Offshore Manufacturing Isn’t as Cheap as You Think
Despite the benefits of globalization, however, there are also costs, or tradeoffs. These include not only the obvious economic costs, such as the increased cost of transportation, but also a myriad of costs that are more difficult to see and quantify. There are often-overlooked costs such as duties, pipeline inventory and related holding costs, quality risks and intellectual property risks. To ameliorate these risks, supply chains require greater amounts of “insurance,” which in large part consists of additional inventory that is costly to produce and store.
The longer the supply chain, the greater the risk of disruption due to natural and other disasters. The Russian invasion of Ukraine is one such calamity that has profoundly affected supply chains, particularly in Europe. Not only do distant supply chains require higher inventories as insurance against disruptions, but items also just take longer to get here. That means demand must be predicted further into the future, increasing forecast errors and again requiring ever greater amounts of inventory, “just in case.” Increased inventory costs can eat away at the savings from the lower prices of components sourced overseas.
Another downside of globalization is losing the benefits of just-in-time (JIT) manufacturing. JIT manufacturers require suppliers to be close to minimize disruptions, reducing the need for inventory and reaping the benefits of increased quality and reduced costs and stockouts associated with JIT. Toyota, arguably the “leanest” company in the world, has weathered the shock of government-induced pandemic lockdowns better than its competitors by using JIT, resulting in both low inventory and fewer stockouts. These benefits are lost when trading globalization for JIT.
In addition, offshoring creates possible risks of a reduction in innovation because manufacturing is too far away for management to be able to completely understand what is happening, “since offshoring production of intermediates may also reduce the feedback from production to research efforts.” This same phenomenon is one of many reasons bureaucrats and government central planners do such a poor job of running an economy.
Recognizing these economic risks, certain organizations such as Deere and Company have already moved manufacturing back to the U.S. Foreign corporations are also investing in the U.S., such as Taiwan Semiconductor’s investment in U.S. chip production. The Reshoring Initiative’s “2022 Q3 Data Report” provides a better understanding of this overall reshoring trend.
Political Risks of International Trade
Doing business with allies can be difficult enough, but there are additional risks associated with trading partners with whom the U.S. has a more contentious relationship. Existing tradeoffs for U.S. companies doing business in China include forced technology transfers and government edicts that management grudgingly accepts as a cost of doing business, but now the benefit side of the equation is also being affected. The manufacture of Apple products and other goods has been disrupted due to lockdowns in China, some resulting from violent protests. Even though the national government has now reversed course on “zero-COVID,” infections may worsen disruptions, especially as workers head home for the Lunar New Year. It’s becoming more challenging to do business, and some U.S. companies are already under pressure from clients concerned about disruptions to reduce their exposure to China. A trade war and tariffs have caused supply issues and other problems for companies in both countries. Decoupling by government decree is becoming a real possibility.
These risks cannot be taken lightly, as U.S. companies could suddenly lose customers or suppliers. They must have contingency plans for such possibilities. Some organizations have already reacted by reshoring, while others have near-shored to countries such as Mexico. Others have simply found alternatives such as Vietnam and India, where Apple has moved a portion of its iPhone production.
More concerning for the long term, the Chinese national government is unwinding some of Deng Xiaoping’s reforms. Bureaucrats are being installed on corporate boards, and the government is expanding its habit of picking winners and losers. This leads to inefficient capital allocation, making these companies less competitive and less attractive as partners because of increased costs and decreased efficiencies. U.S firms could be forced to look for alternatives due to poor supplier performance.
The world is a much better place when people can trade easily between countries in free and open markets, but historically this has rarely been the case. Politicians and bureaucrats just can’t help but interfere, no matter where they are from. It is also impossible to become Fortress America and reshore everything. No country has ever been 100% self-sufficient.
The costs of reshoring certain industries would be high, but so could potential benefits. Too often offshoring is done just because it is the path of least resistance. The key is for corporate leaders to recognize when it makes sense to offshore, and from where, and when domestic production would be the better option. They must understand the costs, develop risk management strategies and prepare for disruptions to ensure their organization’s survival by securing alternative suppliers and inputs. In other words, they must understand the tradeoffs.
This article is first in a two-part series on reshoring. Part two will discuss in more depth how reshoring can be accomplished. The views expressed in this series are those of the author, not of Lehigh University.