Supply Chain Dependence Makes Reshoring Harder – McKinsey

Reshoring and “near-shoring” American supply chains out of Asia (namely, China) will be difficult due to the massive dependency on offshored manufacturers, a new McKinsey Global Institute report says.

Importing economies rely on three or fewer nations for their main share of global trade. The U.S. imports primarily from China, Mexico, Canada, and Europe, but China sells us more goods than all three – which are more concentrated on commodities, autos, and pharmaceuticals. Since the Trump-era on trade began in earnest in 2016 and continues to this day, the U.S. economy has not systematically diversified its origins of imports, according to the McKinsey report titled “The Complication of Concentration in Global Trade.”

In a world that demands resilience, firms and policymakers are reexamining supply chains and trade relationships. Informed reimagination of what comes next requires a granular approach, both in mapping concentrated trade relationships and in deciding on action—whether to double down, decouple, or diversify. Not every concentrated relationship is a source of vulnerability. Nor can every product be substituted. Decision makers can develop a portfolio of actions to derisk growth by tailoring the option by product and trade corridor, McKinsey report authors wrote.

Some 40% of global trade is between a partner country and one or two other sources, rather than a multitude of sources. In minerals, 50% of all trade by value is in products that are supplied by three or fewer countries. Russia leads on Nickel. Congo leads on Cobalt. China leads on most rare earth minerals.

For some products, this concentration makes sense because there is no other natural producer. Oil isn’t pouring out of the ground in Germany like it is in the Middle East. Natural gas is easiest to get via pipelines, something the Europeans learned the hard way with their over-reliance on Russian piped gas. Now they are scrambling desperately to diversify.

China is the world’s largest soybean importer. They get mostly all of it from Brazil and the United States, with smaller portions coming from Paraguay (via Brazil ports), Argentina, and to a lesser extent, Russia. The United States gets almost all of its solar cells from China and a handful of Southeast Asian nations, of which most are subsidiaries of Chinese companies. To solve this problem, for example, China has asked Russia to produce more soy, and China is expanding its own soy farms. The U.S. has imposed tariffs on Asian solar to keep domestic producers in line with the lower cost of production there and now has production tax credits for local manufacturers in order to diversify away from China and Southeast Asia manufacturing.  But it takes government action, oftentimes, to make that happen as companies rarely want to shift supply chains, especially after building up relationships with offshore partners for years.

In the case of the U.S.-China “trade war”, if policies restrict flow of goods between countries, such concentrated trade relationships end up creating new levels of geopolitical and supply chain risk beyond the appetite of most businesses. See Apple with all of the Covid lockdowns in China, getting the company to reconsider its partnership with Foxconn. Apple products are almost entirely made in China.

Businesses exposed to one-way flow may need “new domestic sources of production,” McKinsey recommended.

See CPA’s new Domestic Market Share Index to gauge the penetration of U.S. producers in their home market.

The government plays a major role here. The Department of Energy recently supported specialty chemical and battery manufacturers in their efforts to develop low cobalt cathode formulations for lithium-ion batteries used in EVs. This is all in an effort to become less reliant on imports for EV batteries.

McKinsey recommended businesses and governments take a scenario-based approach to stress-test and refine initial findings from the most dependent supply chains in order to identify and prioritize areas for action.

Some sectors to watch here at home include the local pharmaceutical market.

Last year ended with numerous highlights about shortages, whether it was the infamous baby formula shortage caused by the FDA closure of an Abbotts Lab facility, the only one in the country making baby formula, to recent announcements of shortages of amoxicillin and Adderall. The U.S. drug supply chain, especially for generic medication, is almost wholly reliant on labs in India and China. Together, Indian and Chinese generics account for 90% of all prescriptions written in the U.S., according to a CPA report published this week.

Growing U.S. dependence on China and India for widely-used generic pharmaceuticals creates serious risks to national security and patient safety. China now accounts for 95% of imports of ibuprofen, 91% of imports of hydrocortisone, 70% of imports of acetaminophen, and 40 to 45% of imports of penicillin.

“There is a growing consensus in the U.S. and many other advanced economies that we must move away from globalization, and towards more localized economies, less reliant on global supply chains or untrustworthy countries for vital goods,” says CPA chief economist Jeff Ferry. “Many can see the necessity for greater localization, but can’t imagine what it will look like. Will it make goods more expensive? Will there be duplication? The most obvious starting point is that each nation must balance its trade. This would lead not only to greater equality but greater variety, as different nations would pursue different paths to production for competing products.”

CPA member and reshoring advocate Harry Moser said the U.S. “needs to create the conditions in which companies see the advantage of investing in the United States.”

Moser lists four steps that need to be taken to help make reshoring an option in an article written for Forced Distance Times this week.

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