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Kristen Hallam

Companies are finding that supply chain disruption is not receding and the reliability of inputs such as transportation is not returning to normal. We see a need to invest in resilience projects that cut risk and improve profitability such as reshoring.

Reshoring, of course, has its challenges. To discuss these challenges, we are joined by the following analysts from S&P Global Market Intelligence: Aries Poon, Head of Asia Pacific Insights and Analysis; Rafael Amiel, Director, Latin America and Caribbean Economics; and Sam Parkin, a Senior Economist with our Pricing and Purchasing Team.

We're going to start with a high-level overview and then we will dive deeper into labor and infrastructure and then delve into responses to these challenges and what we're watching. Aries, let's start with you. What would you say is the APAC narrative on reshoring?

Question and Answer

Aries Poon

So the driver behind reshoring has been evolving. And in terms of today's context, it has been about the competition between U.S. and Mainland China, where some of the manufacturing facilities in Mainland China, which is owned by Chinese and owned by other multinationals are being relocated to ASEAN, India, Eastern Europe and Mexico. The main reason is in order to continue access to the U.S. market.

But in fact, adding additional facilities outside of China happens for more than 20 years. But back then, it was because of China's rising production cost, and these facilities are looking at where they can have cheaper labors and cheaper raw materials.

Kristen Hallam

And Aries, what would you say are the main challenges of reshoring to the APAC region?

Aries Poon

Thanks for the follow-up question. In fact, the reason I brought up the brief history of reshoring is because up until the current period of the U.S.-China competition, China Plus One strategy has been there, but it was very slow. It picked up the pace in recent years primarily because the businesses have to do so, much less because of commercial consideration such as cost because otherwise, they would lose access or they would have reduced access to the U.S. markets.

And what that tells us is if we take out geopolitics from the whole reshoring calculus and that we can see that in East APAC, so China Plus One destination, such as ASEAN and India, they actually have some lacking in terms of labor skills, in terms of infrastructure, in terms of a proximity to end market because those alone were not sufficient to be attractive for these businesses to relocate out of Mainland China. But I have to say because right now, we see the reshoring is focusing on more of the high-tech sector, which makes the labor skills become an even more urgent requirements for that movement.

But one more thing about geopolitics is all these China Plus One destinations, they are treading the political landscape very, very carefully in order not to antagonize either U.S. or Mainland China. One of the reasons is China remains a top market for these locations and also the top source of FDI. It also can't afford to lose access to the U.S. markets.

And also, internal politics might play. We all know that this year is a heavy year for elections. And newly elected governments will have to strike a balance between responding to local politics while making sure that they are in a place to maximize trade gains or the investment gains from both China and the U.S.

Kristen Hallam

Let's move on to Latin America for a high-level overview, particularly Mexico. Rafael, what is the reshoring narrative for your region?

Rafael Amiel

Mostly the reshoring activities are happening in Mexico. Mexico really is a country that geographically is the best choice for the United States in terms of setting up land or reshoring. The relationship is long. Now that -- after the Free Trade Agreement of North America, the initial NAFTA and now the USMCA, the revised Free Trade Agreement, give Mexico a tremendous advantage geographically in terms of how they know each other, how they operate, how the plants operate and ship to the United States, which is mostly ground.

So just to give a little bit of context, Mexico reshoring is happening now, especially in those products where the United States is putting higher tariffs because of trade issues of Mexico and has taken advantage of that already. But for the first time since 2002, U.S. imports from Mexico has been larger than from China. So the picture for Mexico looks good.

Kristen Hallam

And Rafael, what would you say are the main challenges to reshoring to Mexico in particular?

Rafael Amiel

Yes, in our baseline scenario, we incorporated reshoring activities, and we added increased investment, increased foreign direct investment in the coming years. But we added in a fashion that we call soft reshoring or mild reshoring because there are challenges.

One of them is infrastructure. Mexico will need to build roads. Mexico will need to increase its supply of energy, especially electricity. Mexico will need to address the issue of water. So infrastructure is a big issue that can be overcome with the investment coming with the capital inflows, but they need to have, first, the political will to do so. So there are issues also from the political standing of Mexico wanting to be energy sufficient and not to allow the private sector of foreigners to enter freely in the energy market.

Another constraint that near-shoring faces in Mexico is labor supply. We assess that the market is a little tight. We assess also that workers may come from Central and South America, skilled workers may come. Mexico needs to prepare and open up to process those visas for those workers that could come. So it's not impossible, but it has to happen yet.

And the third constraint for Mexico as an optimal or ideal reshoring location are the operational and security risk, which are basically red tape, costs, corruption and the violence that happens in the country.

Kristen Hallam

And you brought up labor there, which sets us up to bring Sam into the conversation. Sam, what is the labor narrative when it comes to reshoring?

Sam Parkin

So there are 2 elements to labor. The first one is labor costs. So recently, what we've seen is higher labor costs in the U.S., Mexico, Eastern Europe, Western Europe, and this is because of inflation. So higher inflation has actually flowed into wage growth, and this is propelling wages up. This has been aided somewhat by minimum wage increases. So we've seen that in Eastern Europe, and we've seen that in Mexico.

Now in Asia, it's not as much the case in that it still had inflation but not as much, and so wages haven't been as high. However, that's not to say that wages aren't growing high in Asia. Generally speaking, there's more investment, there's greater domestic demand and there's greater labor demand because what companies are doing is tapping into cheap labor and exporting items and goods outside.

The other element is labor market complexities. So what we've seen, generally speaking, is a decline in vacancies and a decline in labor demands. And this has been present globally almost, so it's been present in the U.S. and in Western Europe. And it's been present in Eastern Asia as well. So what we saw was maybe Q1 2022, we saw very high vacancies as economies recovered from the pandemic. What we've seen then is the declines as interest rates have risen and global demand has lowered. And as a result, vacancy rates have lowered, and this is portraying lower labor demand.

On the other side, we have labor supply. Again, generally speaking, we've got the U.S. and Western Europe seeing labor shortages in their respective regions. And in Asia or -- and Eastern Asia, I should say, what we're seeing is low unemployment rates. So roughly between 1% and 3%, generally speaking, apart from India, which is seeing a higher unemployment rate.

But broadly speaking, these Eastern Asian countries are seeing lower unemployment rates, and what this means is that there's a lack of labor availability really. And this is why we saw really high vacancy rates during 2022, the start of 2022. And that's because we've got high vacancies, high demand for this low cost of labor and yet we've got this low unemployment rate, so that labor supply isn't there.

The final thing to consider really is skill shortages, we touched upon it slightly. The U.S. and Western Europe seriously see skill shortages. In Eastern Asia, it's a bit different because when you move production there, you kind of know what you're seeking and know what you're desiring in terms of skill level. However, you're still seeing low skills labor markets like India and Vietnam.

Kristen Hallam

And let's stay with you, Sam, and zoom in on the regions that we're focusing on today. So what would you say the labor picture is like in APAC, particularly?

Sam Parkin

So it's a mixed picture in APAC, I would say. However, it has common themes. Common themes are a lack of skilled workers, you've got a low unemployment rate and you've got a desire for low-cost labor. Malaysia has a high skilled workforce, but with that comes a higher labor cost within the country. It's similar to China actually. The unemployment rate is roughly around 3%, so there's a little bit of scope for labor availability here.

If we look at, say, India, the unemployment rate is 9%, so it's almost an anomaly. It's much higher than other Eastern Asian countries. However, this is unskilled labor. With India, it's still got strong hiring intentions, and this is posing upward wage pressure within India. And this is because of strong domestic demand, and there are some -- I'm not saying loads, but some infrastructure improvement.

Finally, Vietnam has a low cost of labor. However, it's got a low skill base. It's also got a low unemployment rate. There's a lot of demand in Vietnam because of the cheap labor, of course, but because there's high investment because of some infrastructure increases as well. So what you'll find is -- again, labor demand as interest rates start to subside and ease and global demand improves, you'll find that there will be strong competition for this labor in Vietnam, especially considering how reliant Vietnam is on exports.

Kristen Hallam

Aries, thinking about what Sam just shared with us, what would you say are the factors that are influencing labor markets in APAC?

Aries Poon

Sam has made a very good overview of some of the key China Plus One destinations and the labor market situation. I think there are 3 things that are -- we're looking at here. One is the government's strategy in education, and then the rural workforce and urbanization, and lastly is about gender.

And I think for education, it takes time. You invest right now, but you might see a certain level of skill laborers being graduated on mass maybe in 15 years or 20 years and in the last wave of reshoring when factories are moving into Vietnam and other places because of low cost, not because of geopolitics. And back then, we see Malaysia, Vietnam, in particular, they are doing very well in terms of positioning their educational system in order to provide high-level, skilled laborers. In that sense, actually, Malaysia has been doing very well.

Another thing is about rural workforce because I understand in most of the unemployment metrics, it doesn't include rural workforce. It doesn't really reflect the population that is in agriculture and farming. That also speaks to another challenge for Asia Pacific as some of these countries are still predominantly having population working in the rural sectors.

And so I think the government is also trying to push for urbanization. But again, it is not just any policy that can push for urbanization. Usually, people urbanize because they are being lured by the wealth prospects and employment prospects in cities. And that also comes with many other different moving factors such as FDI, such as the business environment and tax and all of that.

Finally, it's gender. I think gender is a very big factor in Asia Pacific, in particular, because many cultures do not encourage mothers to work. So we're essentially eliminating half of the population from eligible workforce. Now I understand, for example, in Japan, they are already trying to encourage some mothers to work.

But it's not that simple because it actually speaks to the entire social welfare system, childcare system, even schooling system in order to create an environment that is actually sustainably possible for women as a category. Not individual woman, but women as a group to be able -- to be in the workforce. And also, without certain gender, then you might also lose some certain skill sets that might be needed in a digital economy. So I think these 3 might be some of the key drivers in some of the phenomenon that Sam had described just now.

Kristen Hallam

Good points there, Aries. Sam, coming back to you, what about Latin America, Mexico in particular, what does the labor picture look like there?

Sam Parkin

So focusing on Mexico first, what I mentioned earlier is high wages, and this is in response to higher inflation and somewhat stronger investments. This is going to gradually fall through 2016 levels as inflation continues to form. Rafael mentioned about lowering employments. What we're seeing there is with this increased investment and moving production, we've seen unemployment gradually fall down towards kind of mid-2% level.

The skill level of Mexico is between China and Thailand. So I would say it's a good alternative for China, somewhat in Thailand, moving to kind of the rest of Latin America, South America. Brazil, Colombia and Peru, what we've seen as high wages. Again, this is in response to higher inflation, and this is gradually falling. It's not just going to drop off. It's going to be a gradual fall, especially after industries and sectors are looking to recapture real wage losses that they sold previously. Unemployment rates in these countries are higher, and so this implies that labor availability is greater. However, of course, it's not as opposed to the U.S. and Mexico is more desirable because of a higher skill level, for instance.

Kristen Hallam

Rafael, what economic factors would you say are influencing labor markets in Latin America, Mexico, in particular?

Rafael Amiel

The labor market is tight because Mexico has been growing a little bit more than ever as in the past 2 years. But I have to add that in terms of the minimum wage policy, the government of Mexico had -- in the past 6 years, have been very aggressive increasing the minimum wage. And this has been pushing up labor costs generally. Not just minimum wage, but in the pyramid of wages, they have gone up.

And the -- another factor that constrained the supply of labor is migration. So at all levels, unskilled workers migrate. And recently, in the past few years, it appears -- not official numbers yet, but it appears that migration has increased. So this has shortened the supply of labor and increased the wages and salaries in Mexico.

Kristen Hallam

Let's pivot now to infrastructure. Aries, what infrastructure-related challenges do we see in the APAC region?

Aries Poon

Infrastructure like ports and stable electricity, they are very key to all kinds of manufacturing activities. In fact, in order to be a prominent China Plus One destination for Southeast Asia and India, these 2 are becoming more urgent than ever. As I mentioned about the impact of election cycle, making long-term planning less effective in the past, and I think that has been seen in where the infrastructure level is today.

For example, in India, it still doesn't have a single deepwater port. And in Vietnam, we still saw brownout, which is electricity supply stoppage, even late last year and in the northern part, where there were a concentration of technology and semiconductor factories. And just like education, if you didn't take the time 20 years ago, then now you have to play catch up.

There is one complexity though, who is going to fund this infrastructure? Now for some countries like India, they probably can do it themselves. They have deep pockets, and they have a very determined government and policy priorities, so that probably is not a problem. But when we look at other countries, for example, Vietnam or maybe even some other countries in Latin America, they would likely to -- turn to some countries that have deep pockets, and they have been doing international lending and investment.

And another thing is natural disasters. It might not be catastrophic. It might not have lasting implications of supply chain. But still, these are costs that you need to take into account. And for typhoons, they're not only stopping electricity, they could actually create safety, personnel safety for the people who work in those places.

Kristen Hallam

Rafael, let's talk about Latin America. You've already touched on this a little bit, but what infrastructure-related challenges do you see there?

Rafael Amiel

It's usually a challenge but many times, it is also an opportunity and it depends on the global business cycle. The policy, the political cycle, a country with some macroeconomic management is always going to attract investment in infrastructure, which is relatively easy. It requires just capital, that doesn't require lots of technology to -- new technology to be developed.

In Latin America, the needs are very wide in terms of roads, ports, even in connectivity, in telecommunications and also supply of electricity and water. We see that as part of the opportunity and as part of the growth story and the growth picture that we have for many countries in the region, including Mexico. It's as we discussed, there's -- Brazil is a very open field to build infrastructure. They are working on this and the abundant natural resources that Brazil has and Mexico has. And other countries in the region open the roads for building infrastructure, which is much in need, I would say, and then productivity growth will follow once the infrastructure is there.

Kristen Hallam

So now we've touched on labor, we've touched on infrastructure, we've touched on geopolitics and some of the domestic operational risks. Let's talk about the responses that we're seeing to these challenges. Sam, let's start with you. Can you tell us about responses to the labor market challenges?

Sam Parkin

Yes. So Aries touched upon it earlier in educational reforms. I think these are very important. So you've got educational reforms occurring in Vietnam. So there's a push to get people in school, achieve their education, get degrees, et cetera. In India, this is the same. You've got a push for it -- to get people back into school and in schools and finish them, but you've also got a couple of other initiatives.

The first one being the formation of Ministry of Skill Development and Entrepreneurship, and the second one being the Skilled India Mission. And the second one, it was -- it had an ambitious target of upskilling 400 million workers. So again, it's about pushing these low-skilled countries and trying to upskill the civilians, the people there to attract more manufacturers and to attract more investment.

The issue that these countries are facing -- and this is global as well, but the issues that these countries are facing is that there's competition for skilled workers. I mentioned earlier that Western Europe had -- has a lack of skilled workers. And what they're actually doing is they're addressing their immigration policy to try and attract skilled workers from outside the EU.

So for instance, Germany has this new Opportunity Card. So it's going to be a big challenge for the likes of India and Vietnam to actually retain their workers, their skilled workers, so that there's not a brain drain. And we see a brain drain of sorts in Eastern Europe actually. So what these countries need to do is they need to, of course, upskill their population, but also retain them within their own country.

Kristen Hallam

What else should we be out -- watching out for on the labor front in the near term?

Sam Parkin

I think the immediate worry for me as a labor market analyst is analyzing and kind of monitoring as these occurs, how global demand will react. Now if global demand reacts very quickly to interest rates easing, so optimism improves, general international demand improves. What we'll see is vacancy rates skyrocket. And for these countries, it will create upward wage pressure, and so that's what I'm going to be looking for in the immediate term.

Another one is minimum wage increases. And Rafael touched upon it with Mexico, we've had a number over the last few years. I'm going to be looking forward and looking to see and keeping an eye on where we see indications perhaps of another minimum wage increase, although it's quite hard to measure. It's the same in Eastern Europe. So you're seeing it in these places where you expect production to be moved, and it's something to keep an eye on for labor costs, for sure.

Kristen Hallam

Rafael, let's move over to Latin America again. What responses are you seeing from governments there? And in particular, what has Mexico been doing to address reshoring?

Rafael Amiel

Well, as part of the Free Trade Agreement, of the USMCA agreement, Mexico and the U.S., they hold this high-level economic development dialogues continuously. And the U.S. and Mexico have met several times, and the U.S. has shown interest and they have agreed on the specific sectors. And then the government of Mexico is working on these areas as to be able to provide and supply the U.S. manufacturers. But yes, this is what is happening.

In terms of education in Mexico and the U.S. and the -- especially the north of Mexico has always been looking up into the U.S. and preparing to provide the skills and the labor that the manufacturing oriented to the U.S. requires. So on that, there is nothing new that has happened, but it's there.

Kristen Hallam

And Rafael, what else should we be watching out for in the near term?

Rafael Amiel

Mexico will have general elections in June. And certainly, there will be a change in administration. And given the current President's charisma and his level of authority, we assess that this is not going to happen with either candidates.

So we see more opportunities. We see a new government that will be a little bit more flexible to talk and allow the private sector to take on larger projects. So that's a plus. But yes, there is uncertainty about the elections in Mexico that are coming in immediately. And also, there will be elections in the U.S., that may change the picture as well.

Kristen Hallam

Aries, what about in the APAC region? What are governments doing there to address reshoring challenges?

Aries Poon

So one of the main things that the biggest countries in ASEAN have been doing is trying to be in the economic partnerships with China and U.S. separately. Malaysia, Singapore, Vietnam, Indonesia, Philippines and Thailand, they are in both the RCEP, which is Regional Comprehensive Economic Partnership, and the IPEF, Indo-Pacific Economic Framework for Prosperity. And for Malaysia, Singapore, Vietnam, they were also in the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, which is a framework that includes EU.

Now -- so what we see is these ASEAN countries, they know well enough that this an insurance of whatever that might happen between U.S. and Mainland China in the future is if they're in both camps and that will likely make sure that their market access or FDI sources and all that would not be severely impacted if the dynamics of the politics between U.S. and Mainland China change for the other direction in the future. So that's one.

The other one is I want to talk about migration. Oftentimes, we look at whether countries can attract talents into the country or they can train their own talents. But what happens, for example, with the Philippines and India and all that, they were well-trained students, so well-trained population, they actually decided to go elsewhere because of high wages or because of different prospects, and that is the brain drain that I'm referring to.

And I find the governments in Asia Pacific has been in a tough spot on that, mainly because when you look at, for example, the Philippines' economy or even the Pakistan economy, they rely heavily on remittance. And the remittance comes from some of the very smart people who are earning very high salary in developed markets and send the money back home. And that is actually a main part of GDP.

So the government has to balance between having this stable and possibly growing source for the economy versus having these people to be physically in the country to offer the value that they don't or they can't have currently. I think it could be a substantial challenge for countries where they have a lot of population working overseas.

Kristen Hallam

And speaking of that, Aries, what else should we be watching out for in the near term? For example, any elections like Rafael mentioned?

Aries Poon

I think that's the elephant in the room, right? The U.S. presidential election. Reshoring is a very costly exercise, and there is no way to go about it, but you kind of have to do it. And I think what businesses are looking at is we don't need to go full blown on board right now. We just need to do the bare minimum that we need to -- in order to maintain access with the U.S. market.

But what if the rules -- so what if the rules of the game change? What have tariffs change? What if the restrictions take on a different format because of a change in administration in the U.S.? And I think all these will be something that we all have to watch very closely over the next 6 to 12 months or even beyond actually.

Kristen Hallam

Thank you. Right. Well, we've given you a lot to think about today, and we are committed to continuing the conversation. We're doing deeper dives into our 2024 themes on our weekly Economics & Country Risk Podcast. You can find more thematic coverage and connect and -- on our blog. Thank you to Aries, Rafael and Sam, and thanks to you all for engaging with us, until next time.

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