The “Great Reallocation” Revisited

Economic and business implications of the changing global and regional supply chains will probably remain a heated topic over the next few years. Besides Mr Jerome Powell’s recent speech singling the future policy direction of the Fed, a research article also caught much attention at the Jackson Hole Economic Policy Symposium during the past week. Authored by Professor Laura Alfaro from Harvard Business School and Professor Davin Chor of Dartmouth College, Global Supply Chains: The Looming “Great Reallocation” was probably the first academic research piece that systematically documents patterns associated with the US policy-driven supply chain restructuring, especially those that are China-centered, using detailed product- and firm-level data.

The paper starts by showing that historically the US has been mostly importing from other high-income economies, such as Japan and Canada, until the 1990s when emerging markets, represented by China, started to gain more market share. And this is also a period during which the US established itself as an exporter of upstream products and an importer of final goods – the traditional “assembled in the South and consumed in the North” type of global value chain that we are all familiar with. However, the past five years, with intensifying anti-globalisation sentiment, have involved a significant change to the US-centric supply chain: China’s share of US commodity imports peaked at 21.6% in 2017 and has since fallen to 16.5% in 2022, with Vietnam and Mexico being among the main beneficiaries of the US’s sourcing away from China. Product mix data suggest that during this process, Vietnam gained ground in telephone sets, apparel and textiles, and Mexico increased its exports to the US in automobile parts, glass, iron, and steel products. 

This reallocation process was accompanied by shifts in the US position in the global value chain as well. The authors find that the upstreamness of US imports rose slightly since 2017, implying that more finishing stages of production (such as assembly) are now being performed within the US, resulting from strong policy push of recent US governments to bring the manufacturing sector back to the US. 

What are the economic consequences of this “great reallocation”? The authors argue that the US policy goal to reduce reliance on China may not even be achieved as data suggest that the US’s reshoring towards Vietnam and Mexico is significantly correlated with China’s trade and FDI in these economies, implying that the US could well remain indirectly connected to China through its trade and GVC linked with third-party countries. Second, which is probably more alarming, empirical evidence shows that imports from Vietnam and Mexico in fact possess higher unit cost, suggesting higher production costs in these locations: the analysis shows that a 5 percentage-point decrease in China’s share in US imports would be associated with a 9.8% unit-price increase for commodity imports from Vietnam and 3.2% for imports from Mexico. This counters the rationale of many MNCs’ strategic decisions to shift production activities outside of China – producing in other lower-income economies might not even be cost-efficient. 

The conclusion of Alfaro and Chor’s study echoes that of the Economist newspaper article that I shared with you a couple of weeks ago: the current US government industrial policies are pushing its “friendshoring” and “nearshoring” partners to increase their economic ties with China, and more seriously, are probably contributing to the increasing prices and inflation in the domestic market. This research also calls for a more articulated analysis of welfare tradeoffs of industrial policies, as the authors stated: “There is the concern that the costs of following through with current US industrial policies may be broader and more extensive than publicly realized. The effective revival of manufacturing hubs requires integrating dependable, efficient supply chain networks and transportation systems with an adaptable, skilled labor force. Moreover, attaining optimal efficiency levels for certain sectors requires sufficient demand or scale to build specialized production facilities. The announced delays to the construction of TSMC’s semiconductor plants in Arizona, arising from a shortage of skilled labor, is a case in point (Financial Times, 20 July 2023)”

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