March 28, 2024
In the last couple of months, you’ve probably heard the term “nearshoring” in a lot of conversations. Most often, it is paired with discussions of international commerce, logistics, and economic outlooks for the near future in North America and beyond. You likely heard of it with some political discussion hinting at coming changes in the structure of the global economy and major shifts in international supply chains. But before delving into the complexities of the term and its implications, it is crucial to define it.
What is the meaning of nearshoring?
In the broadest of terms, nearshoring refers to the process of relocating a part of a company’s supply chain to a new country closer to its intended market. In doing so, a company can cut down transportation costs by taking advantage of a country’s proximity, as well as simplifying cross-border interactions by dealing with similar time zones. The nearshoring strategy also allows companies to avoid potential shocks to international trade that could impede the flow of goods, such as inefficiencies in international ports or a health crisis inhibiting access to an intermediary country. By being close to a desired market, transportation costs decrease, and the impact of potential shocks is lowered.
“Nearshoring refers to the process of relocating a part of a company’s supply chain to a new country closer to its intended market”
But the logic behind nearshoring is not just a matter of proximity. It is also often the case that, by relocating production to a country closer to the ideal market, one is able to exploit cultural affinity, and even political intimacy in the form of free trade agreements or strategic tax incentives. Countries sharing a border, for instance, tend to also share a common history and, at times, even a significant shared population in the form of immigrants. Thus, it might be easier to understand the regulations of countries closer to a company’s ideal market or to have existing contacts with experts that might help understand such affinities.
At its core, one must think of the nearshoring trend as one deeply tied to a desire for efficiency. By relocating, a company is looking to reduce costs——be it in terms of transportation, salaries, or operations— and, at the same time, decrease potential risks from setting up shop in a distant country.
“Through nearshoring, companies can reduce costs while, at the same time, decreasing potential risks from setting up shop in a distant country”
A Brief History of Nearshoring
To understand the nearshoring strategy, and why it has come prominent in recent months, one also has to look back to the history of international trade as well as its internal logic. In doing so, , the nearshoring trend will appear as the most recent step in the long development of cross-country commerce.
First, we must comprehend the theoretical undertones behind commerce, which, to a certain extent, explains why the nearshoring trend is now a prominent force. Economic theory, most prominently expressed by the British economist David Ricardo, explains that, under a world of free trade, countries will naturally produce products that are “most beneficial” to them. So, in a simplified model, if a country has an advantage in producing cars and another in producing computers, they could devote their resources to their specific advantages and trade with the other for their production.
Yet, for most of human history, trade was limited to a handful of countries neighboring one another. Supply chains, in this early form of trade, were rather simple, and the global economy lacked the necessary tools to fully develop. Despite the existence of commercial vessels and the beginning of air freight, most countries had focused on internal development and protectionism rather than engaging in commerce. It wasn’t until after WWII that the international community began opening its doors to the free flow of goods through the creation of the General Agreement on Trade and Tariffs (GATT), which later became the World Trade Organization (WTO).
Growth of global exports
(Data from Our World in Data)
“What followed were decades of growth for international commerce and economic development”
What followed were decades of growth for international commerce and economic development. When Ricardo first expressed that nations would focus on whichever product they had an advantage, he thought of entire goods, famously arguing that Portugal and France would grow wine while America would do the same for corn. Yet the years after WWII saw Ricardo’s maxim taken to an extreme: It wasn’t just that countries focused on different products, but rather different stages of manufacturing. The process of making goods was broken into smaller segments, and—at least in theory—each was allocated to a different country based on efficiency. In efforts to cut costs, assembly lines were taken global in a process commonly referred to as “offshoring”—placing a part of the supply chain in a foreign country with talent pools better suited for manufacture and, most likely, with reduced labor costs. Thus, by the end of the 20th century, supply chains became complex systems requiring international trade.
Global trade, however, is also a source of immense volatility, having to deal with the political systems of dozens of countries while also navigating across complex international trade agreements. Sure, costs might be reduced in theory, but they can increase given unforeseen circumstances, the absence of political stability, and the increased costs stemming from trade disruptions. By offshoring, one is inherently accepting heightened risks, be they political (such as recent trade disputes between the United States and China), or a natural phenomena (think of the impact of hurricanes to cargo-carrying vessels or of hurricanes to freight planes). The 20th-century experiment did yield complex supply chains, but it also made them highly sensitive to disruptive events.
“Global trade, can be a means to reduce costs, but it is also a source of immense volatility, forcing a company to deal with the political systems of dozens of countries, while also navigating complex trade agreements”
Nearshoring emerges as a modern response to the above problems. Companies, adapted to a world of international trade, are now seeking to lower potential risks while also maintaining the advantages of cross-border supply chains. The tendency has been towards regionalization and the exploitation of countries with similar cultures (some key examples are those of Central America, Eastern Europe, and Mexico, the last of which will soon be explored). As we saw, the basic idea is to maintain the gains of trade while reducing existing costs. That is, to maintain a model where a number of countries can produce different parts of a product based on their particular advantages and the desired labor costs a company seeks. At the same time, they lower the propensity for trade disruptions to occur and decrease transportation costs.
Nearshoring Today: US and Mexico
The clearest example of nearshoring today has come from the United States in recent months, as the country seeks to relocate much of its existing supply chains away from China. This, in part, is a result of increased tensions between the two countries.
Over the years, China has grown into a significant competitor of the US, while also challenging its status as a global hegemon by becoming the strongest economic force in Asia, as well as a prominent presence in other regions. Not to mention disputes over political ideology and increased US accusations of intellectual property theft from China. What once was a flourishing trade relation has now slowed down.
Thus, the United States now hopes to disentangle its economy from that of China and, to do so, has set its eyes on Latin America. More specifically, it has found a potential partner in Mexico, given the country’s proximity, stability, and preexisting trade deals that make it an ideal partner. Similar to China, Mexico has an economy with a high propensity to manufacturing while also maintaining low labor costs. Yet, at the same time, Mexico is significantly closer to the United States and already has a prominent trade agreement with the country (the newly refurbished USMCA). And, at the same time, the country is located with relative proximity to Central America and South America, which could become potential new markets for companies to explore or a new region to establish complex supply chains.
Given the above, Mexico recently became the largest trade partner to the US, surpassing nearly two decades of Chinese leadership. There’s still much terrain to be covered for nearshoring to become the norm across Larin America. But, thus far, it seems to have made an initial mark in Mexico’s economy and promises millions of dollars in potential trade.
Monthly share of US imports
(Data from Bloomberg)
According to the US Census Bureau, Mexico recently became the largest trade partner to the US, surpassing nearly two decades of Chinese leadership.
Besides Mexico, there have also been historic trends towards Eastern Europe. As Western European countries seek to position their supply chains in more cost-efficient countries, Eastern Europe has always been an attractive destination—more so after the fall of the Berlin Wall and the collapse of the Iron Curtain.
What is an example of nearshoring?
Finally, to fully explain what nearshoring is, we can use an example from a couple of years ago involving the technology company Dell.
During the presidency of Donald Trump, the United States began a conscious trade war with China seeking to lessen the country’s trade deficit with their largest commercial partner. The main strategy followed by the US was to impose significant tariffs on key goods imported from China. This, in turn, hurt American companies that, years prior, had set up shop in China seeking lower labor costs and increased efficiency. Such was the case of Dell which found itself potentially facing long term costs if tariffs were kept in place.
Looking for more amicable countries, Dell decided to shift some of its production from China into Mexico, where the US had an existing trade agreement that, despite being renegotiated by the Trump administration, promised more stability than the ongoing trade war with China. In doing so, they became one of the first companies to discover the potential Mexico offered for nearshoring.
Besides avoiding the potential instability stemming from a trade dispute, a company like Dell could soon discover the many benefits Mexico had to offer. To start, the country’s close proximity to the United States makes it ideal for cutting down transportation costs. On average, a container from China takes 26 days to reach their destination, while in Mexico, transportation ranges from 1 to 3.5 days to reach major cities in the United States. Not to mention that Mexico has a long history of trade with the United States and recently became the country’s largest trade partner, surpassing imports from China, and Canada (also in North America, and a signatory to a free trade agreement with the US). All of this while Mexico maintains an expertise in the manufacturing sector—roughly 17.4% of the country’s economy was dedicated to manufacturing alone at the beginning of 2023—and opens the door to developing complex supply chains across countries in Central America and South America. Thus, putting all these factors together, nearshoring to Mexico becomes not just a plausible scenario, but one of many advantages.
“On average, a container from China takes 26 days to reach their destination, while in Mexico, transportation ranges from 1 to 3.5 days”
What is nearshoring?
In sum, nearshoring is a process seeking to make supply chains less costly, more efficient, and risk free. At its core, it’s the relocation of a company’s supply chain to a country of close geographical proximity in a bid to reduce costs and avoid potential disruptions often tied with international trade. But, most importantly, it’s a force that promises to change international trade after years of a global expansion.
