Thursday, 19 July 2012

Re-shoring issues may slow Asian growth

In any discussion on the economics of global trade the opposing camps rarely deal with the impact that shifting foreign trade patterns can have on socio-political issues, not just for the present but, more disturbingly, also for the future. One of these dichotomous debates is the off-shoring versus re-shoring manufacturing issues currently being exploited by the American presidential candidates. A key issue, however, that could decide if the re-shoring back to the homeland will outvie the off-shoring trend of recent years will be logistics, by which I mean all the forces that can impact the global supply chain. Some of those forces are impossible to foresee accurately but are, nevertheless, highly potent, while others are of a more sinister nature. These include natural calamities, fears over rampant intellectual property theft and ubiquitous, staggering corruption.

Off-shoring, of course, is nothing new. It has been part of the global trade scene for over 100 years but with one big difference. In the past, when manufacturing centres were set up in another market, they were confined largely to industrialized, developed countries. Over the last few decades, however, there has been a huge shift of such jobs to developing countries, or what was called the Third World. This has led to substantial job losses in countries where businesses outsourced to cheaper countreis like China. In the 10-year period, 2000-2010, America lost nearly 6 million manufacturing jobs, many to off-shoring. The adoption of JIT delivery techniques, however, over the last two decades or so, has exposed the vulnerability of the global supply chains to natural calamities like earthquakes and floods. Other risks yet to test the JIT model include pandemics, catastrophic crop failures and political upheavals.

These concerns are are now encouraging global corporations, in particular, to redesign their global supply chains to make them more resilient to unquantifiable but serious shocks. This means re-shoring back to the mother country or at least near-shoring to eliminate the threats to JIT supplies posed by natural calamities,  which could worsen if global warming accelerates.

The prime reason driving the trend to off-shoring was and remains the much lower production costs in developing countries. That advantage, however, has diminished as costs in these countries, especially China, have risen sharply to close the costs gap. In 2005, for example, Chinese production was 31% cheaper than in advanced nations, according to one group's calculations. By next year that gap is likely to be only 16%. Add on the logistics costs of shipping half way around the world, which could be 5-10% of sales values, and in many cases it would make sense to re-shore at least some production back to the homeland country.

Global corporations are now considering a change of tack on off-shoring of manufacturing, which if realized could slow development in poorer countries. According to an online survey by Boston Consulting Group, some 37% of manufacturers with sales over $1 billion and about half of those with more than $10 billion of sales plan or actually are considering bringing production back from China to America. Other corporations, however, are choosing to switch from China to other, cheaper sources in the Far East, but these countries are just as prone to natural calamities , like the floods in Thailand this year which seriously hit global businesses geared to JIT component supplies.

There are many other reasons driving even medium-sized businesses to re-shore back to their homeland, and possibly others yet to be tested. These include serious concerns over staggering intellectual property theft in China, poor quality, demands for large orders which imposes higher costs on importers and thus negates the JIT principles, unreliable supplies and long delivery times. The last of these places importers at a disadvantage to nimbler, locally-based producers, able to react more quickly to changes in customer demand.

Lest it be thought otherwise, outsourcing is not inherently deleterious to the global community. Far from it. When corporations outsource to cheaper countries they do not do so just because labour costs are much lower. They also look to develop sales opportunities in new markets, which does not only enhance their own earnings. Germany, for example, has done well from its exports of luxury cars to China because the rapidly-growing Chinese economy has created many Chinese millionaires, a phenomenon greatly helped by foreign countries outsourcing production to China. It is a classic example of how growing global trade is of mutual benefit.  Perhaps the greatest single benefit of outsourcing has been China's major role in helping to keep the lid on Western inflation rates.

Never underestimate customer power 

The rush to outsource, however, should not be based purely or largely on lower production costs without careful consideration of all the relevant issues. If customer considerations are ignored the results could be dire. In Britain, many functions have been outsourced to Indian call centres. This has led to customer backlash for the simple reason that customers had difficulty understanding the Indian accent. Now, companies like BT, Britain's biggest telephony/broadband supplier, is re-shoring all its call centres back to
Britain before year's end.

Businesses may feel dismissive about future, dimly perceived political threats arising from their off-shoring activities. "Our business is business, not politics," they might declare, but they would be crass to ignore the latent risks from political upheaval, even within their homeland countries. When people have had a taste of high living standards, whether earned or not, they don't like losing it through persistently high and rising unemployment. In such circumstances, scapegoating of multi-nationals could arise, and governments could be forced to re-evaluate how they could arm twist companies to keep jobs in their own countries. Worse still, perhaps, people-power could lead to crippling repercussions for off-shorers through widespread boycotting of their goods.

In a savage indictment of a long-term stagnant economy, Japan's young, unemployed graduates are a disturbing pointer of what could await other advanced, industrialized countries. In a country of 127.8 million people the suicide rate is 24 per 100,000, one of the world's highest, and it appears to be linked to socio-economic negative factors. Data analysed between 1985-2009 found that suicide rates were significantly correlated with unemployment rates. About a third of the suicides were in their twenties, including many graduates seeking jobs unsuccessfully.

Pundits are often fond of mouthing mantras like the need to improve maths and science among the middle-skilled and medium-waged occupations, but that is easier said than done and try telling it to the well-educated Japanese graduates still looking for jobs after years. Corporations that ignore these warning signs risk unimaginable consequences.