Is Nearshoring the Next Big Growth Theme for Emerging Markets?

12 March 2024

8 min read

The disruption and dislocation caused by Covid-19 taught us many lessons. Perhaps one of the most enduring lessons for global businesses was the fragility of their supply chains – many of which were at the mercy of one supplier and one market. Now companies are looking to future proof their operations, and well-positioned emerging markets outside China are set to benefit.

In the 2000s, global exports rose to about a quarter of global GDP and global trade grew to about half of world GDP and most of us benefited through the creation of a global middle class and a global economy. During this expansionary period, companies increasingly moved their manufacturing operations to the cheapest and most efficient countries, while other companies benefited from sourcing goods in these lower-cost markets.

But then Covid-19 hit, creating a demand shock which highlighted the fragility of the entire global trade system.

The manufacturing supply chain squeeze that emerged during Covid had many manufacturers and global policy makers considering operational and regulatory changes that would reduce the reliance on offshore manufacturing in general, and China in particular.

Supplies of everything from building materials to car parts were scare. A squeeze in China became a stranglehold in many global markets habitually used to sourcing cheaper goods and services from the behemoth market. This was particularly true for the US – a market that imported $435b of goods from China in 2020 alone.

Coupled with fluctuating geo-political tensions between the two countries - and heightened by threatening global issues such as Russia’s invasion of Ukraine and tensions in the Suez Canal - the call to better insulate the US from external factors was loud and clear.

And it wasn’t just the US – the rise of these concerns was evident across all major markets, with European countries acknowledging they were too dependent on Russia for natural gas and all markets realising they were too dependent on Taiwan for semiconductors - critical to the world’s technology needs.

This led to two new prioritizations for many of the world’s largest organisations – shorter supply chains and more diversified supply chains.

In some cases, this led to a trend towards onshoring or “re-shoring” as manufacturers faced pressure to bolster employment in their home countries, while reducing their reliance on extended global supply chains.

In the US, for example, reshoring operations added an estimated 350,000 jobs in 2022, accounting for 38% of the 1.6 million jobs added to the US economy from reshoring since 2010 – a significant acceleration of the trend.

But reshoring in the US is complex. The time-intensive task of decoupling with China involves the costly construction of new US operations, not to mention the obvious discrepancies in the price of labour. Consumers still want low prices and companies can’t charge more just because they are manufacturing in a higher cost market.

So many companies – often lured by large government subsidies – have taken steps to diversify their supply chains to other Asian nations such as India, Vietnam, Indonesia and Thailand – in a move dubbed the’ China plus one’ strategy.

Global giant Apple, for example, announced in September last year that it would start producing its iPhone in India, adding to its capabilities in China, the Czech Republic and South Korea. And many more emerging markets are set to benefit.

The chart below shows the five-year annual growth of goods exports (in US dollars) - from 2017 to 2022 – for a number of low-labour-cost emerging countries. Markets like Cambodia and Bangladesh are not easily investible; however, Vietnam, India and Indonesia present more diverse and liquid investment opportunities.

Goods Export Value

2017–2022 CAGR (Percent)

Past performance and historical analysis do not guarantee future results.
As of December 31, 2022
Source: IMF and Statista 2022

Spotlight on Vietnam

Vietnam, in particular, has key advantages for labour-intensive manufacturing and supply chain diversification. With a growing disposable income, low labour costs, continued investment in infrastructure, a strategic location on major trade routes, and an attractive business environment – backed by supportive Government policy – the Asian nation is emerging as a major beneficiary of the China plus one strategy.

Recently the country has entered into 15 free trade agreements with partners across all continents. Samsung now produces nearly 50% of its smartphones and tablets in Vietnam and local manufacturing by footwear giants Nike and Adidas has seen Vietnam become the third-largest shoe producer globally.Corporate income tax breaks for high-tech companies and specific fit-for-purpose industrial zones have also helped.

Over the past four years, average annual real GDP growth in Vietnam has outpaced both emerging and developed markets, coming in at 4.6% – higher than emerging markets overall at 3.6% and global developed markets at 2.5%. At AB, we see the strong economic growth in these Asian export winners bringing a range of investment opportunities, not just directly in the export sector, but also indirectly in a range of industries benefiting from this overall growth – including real estate and consumption - buoyed by the emergence of a new middle class.

But while the shifting of supply chains to other Asian markets – like Vietnam and India – may help solve the diversification issue, Asia still presents a tyranny of distance. This brings the trend of “nearshoring” in regions like Central & Eastern Europe and Latin America into focus – where companies can produce more of their goods closer to the ultimate end-markets.

To supply Europe, companies are establishing hubs in countries like Turkey and Poland. In the US, this has seen a move towards Mexico and Central America. At AB, we are particularly interested in the growth of nearshoring in Mexico.

It’s worth noting that the economic relationship between the US and Mexico is not new. The first North America Free Trade Agreement (NAFTA) came into force in 1994, creating a free trade zone for Mexico, Canada and the US. Today, under its new name - the US Mexico Canada Agreement- it remains the most important feature in the US Mexico bilateral commercial relationship. But against this already beneficial backdrop, we have seen manufacturing within Mexico supercharge over the past four years.

A closer look at Mexico

According to the US Bureau of Economic Activity, Mexico last year accounted for over 14.8% of U.S. imports, while China’s share dropped to 13.8%. This is the first time in 20 years that the US has imported more total goods from Mexico than China. On an annualized basis, Mexico now exports more in value to the US than any other Asian manufacturing country: Mexican exports to the U.S. reached US$522 billion in the 12 months to end-September 2023, while Chinese exports to the U.S. declined to US$476 billion.

China isn’t about to disappear as a supplier to the US, but incremental investment in manufacturing is shifting elsewhere.

US Imports – Mexico vs China

Past performance and historical analysis do not guarantee future results.
Quarters may not sum to annual totals because of rounding.
As of December 31, 2023
Source: US Bureau of Economic Analysis using Tukan

For obvious geographical reasons, US manufacturers gain greater control when they move their operations from China to Mexico. The proximity reduces travel time for goods, prevents lengthy bottlenecks at multiple ports and the favourable time zone, and more Western-style culture, makes business negotiations and operations easier.

Mexico also makes sense from a national security viewpoint. Although Mexico has faced its fair share of political challenges, the US has historically had an easier relationship with its southern neighbour – a neighbour who values its relationship with the US and is likely to want to maintain and increase its commercial connections.

The availability and cost of labour is another key factor in Mexico’s favour. Labour costs in the US clearly outstrip those in both China and Mexico but China has seen significant wage inflation. As the chart below shows, China’s manufacturing costs have increased by more than 200% since 2010 while Mexico’s cost of labour has only risen about 20%.

In fact, many Chinese exporters are now building a presence in Mexico themselves. A closer look at the manufacturing domicile of many of China’s big manufacturing brands such as BYD, Hisense and TCL TV now reveal “Made in Mexico” labelling - helping China find tariff free and lower risk access to the US market.

The increased activity in Mexico is generating a range of investment opportunities which, like the opportunities in Asia, extend beyond the manufacturing sector into sectors benefiting from the additional investment such as real estate, transport and building materials.

Average Annual Manufacturing Salary in USD

Past performance and historical analysis do not guarantee future results.
As of December 31, 2023
Source: Mexican National Institute of Statistics and Geography, Federal Reserve Bank of St Louis, Statista. Data as at 2Q23 for Mexico

As these trends increase, many commentators are reflecting on the so-called deglobalization of global markets. I see it slightly differently – not as deglobalization but as a necessary evolution towards a more balanced and resilient global framework, where more economies benefit from global growth and more companies and consumers are insulated from future market shocks.

As an investor in emerging markets, it presents many thought-provoking opportunities. As always, at AB our grass roots research and long-term commitment to emerging market investing means we are well placed to access trends like nearshoring. As an active, value-orientated and contrarian investor, we see strong investment potential to invest in companies benefiting from these trends. Our investment approach – incorporating both fundamental and quantitative research – will support our search for quality businesses with attractive outlooks at compelling valuations.

For more information on our emerging market strategies, please contact our institutional client group at Aust_ClientService@AllianceBernstein.com

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.

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