Andrew Rymer, Senior Strategist, and David Rees, Senior Emerging Markets Economist, at Schroders look at which economies and stock markets stand to benefit from the re-orientation of global manufacturing away from China.
With the end of this global economic cycle, and regime shift, there is a theme which has increasingly captured the attention of markets and investors. “Nearshoring”, “reshoring”, “onshoring”, “supply-chain diversification”, “friendshoring”, “slowbalisation”, “de-globalisation”, even “re-globalisation” have been terms used to frame this theme.
Whichever the term, these all encompass some form of potential disruption to the era of globalisation that began in earnest in the early 1990s. Breaking down different stages of production, often locating them in different economies/geographies, provided benefits such as lower costs, economies of scale, specialisation, and higher efficiency. Globalisation saw a sea change in manufacturing production, with China becoming so dominant that it is often referred to as the factory of the world.
The global Covid-19 pandemic exposed some of the risks and vulnerabilities of this approach. The lockdowns in China in 2020 were the beginning of a multi-year period of global disruption, dislocation, and bottlenecks. Geopolitical tensions between the US and China, which pre-dated the pandemic, only re-emphasise these risks.
A natural response from multinational companies (MNCs) is to diversify and improve the security of their supply chains. In the initial era of globalisation, efficiency and cost were prioritised. Today, the focus is shifting to resilience and reliability. With China now at the heart of global manufacturing, the natural question for investors is to look at which economies and stock markets may benefit from potential disruption and re-wiring of globalisation. Ultimately, given China’s dominance, any changes are likely to involve a re-allocation of supply chains away from the country.
What are the supply chain priorities for multi-national companies today?
Predicting how firms will make decisions over the location of future supply chains is clearly complex and determined by a combination of factors. The lesson from the mass migration of production to China is that firms are attracted to countries that offer large pools of cheap labour. Structural reforms, tax incentives and trade deals to improve the business environment are clearly also attractive. Not only does this offer MNCs a chance to tap into an immediate source of low-cost workers, but it can also give access to long term growth markets. Destinations such as India clearly offer these opportunities in the same way that China did.
However, the rapidly changing global economic and political backdrop means that many other complex factors will also influence the decisions of MNCs. For example, in a more severe scenario, geopolitical concerns may encourage MNCs to exit Asia altogether. Or those producing goods considered crucial to national security may be forced to onshore facilities to reduce the risk of external interference in supply chains.
The energy transition is also a new consideration. Many emerging market (EM) economies suffer from power shortages that have the potential to curtail production, while the source of energy will also be an increasingly important consideration for firms in their supply chains. Developed markets have pressed ahead with carbon pricing, the cost of which is rising. In order to protect domestic firms from these additional costs, more countries are likely to follow the EU’s lead of creating ways to tax goods produced in places that have high carbon emissions. As things stand, the Carbon Border Adjustment Mechanism (CBAM) is likely to severely penalise countries such as India that still rely heavily on fossil fuels to generate power. The more that these additional factors drive the decision-making of firms rather than the basic inputs of cheap labour and friendly business environments, the less efficient supply chains will be.
Which economies might be beneficiaries of changes or diversification of supply chains?
According to our research, the majority of the top 20 economies are emerging market economies.
Our scorecard suggests that India is the most attractive market for MNCs looking to diversify their manufacturing exposure. By 2028 it is forecast to offer the largest pool of working age labour. Other factors supporting its ranking are the relatively lower labour costs and relatively high productivity – albeit this is measured at the total economy level. Productivity for tradable sectors such as manufacturing is difficult to find, and likely to be weaker. However, India scores poorly on business freedom.
Vietnam is the second ranked market. Relatively low wage costs, competitive productivity, and working-age population all make the economy an attractive destination, even if the business freedom ranking is less favourable. South Korea ranks well, underpinned by its business freedom ranking and productivity scores. Regional peers Thailand and Indonesia also feature, with wage costs and demographics supportive.
The frontier markets of Bangladesh, Kenya and Pakistan rank in the top 20 in large part due to their lower wage costs and favourable demographics.
Central and eastern European markets also feature in the top 20. These are led by Poland, but Germany, Romania, the Czech Republic, Lithuania and Hungary are also present. Productivity is an important driver of the ranking for most markets. Business freedom is also supportive.
Mexico, often cited in relation to nearshoring, ranks 17th. Competitive wages and demographics are its main supports. Germany and the US also rank relatively highly, with high levels of business freedom making up for more expensive labour costs.
Of course, a scorecard approach has its limitations, which we discuss in the paper. For example, Mexico’s proximity to the US is not captured.
How can you capture these potential opportunities?
De-globalisation appears set to be a long term, multi-year theme. There will be significant nuance in terms of the impact on different countries, sectors, industries and stocks. Our research provides a framework starting point for investors to understand some of this detail, and further work is warranted. Importantly, it does not signal a peak in China’s economy, as its ranking in our scorecard emphasises. What is clear though, is that regime shift heralds change in the global economy, and this will have ramifications for economies and markets.
Further reading : Globalisation reset: which economies and markets stand to benefit?
