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Reshoring

Opinion: Now is not the time to be tempted by home comforts

A company with wide geographical diversification will tend to be more resilient to major events, so temptations to retrench in the current environment should be resisted, writes Investment Monitor's Sofia Karadima.

The Covid-19 pandemic has made multinational companies rethink their global footprints, and more specifically consider shifting their operations closer to their headquarters or home markets. This ‘reshoring‘ or ‘nearshoring’ comes as companies are looking to waterproof their investments by mitigating risk and future disruptive events that could lead to another collapse of just-in-time supply chains, as happened in the initial Covid-19 outbreak in March 2020.

Despite the advantages that reshoring or nearshoring could provide, investors should resist the temptation to consolidate their activities in one region and instead retain some level of geographical diversification, as this is a much safer strategy in the long run.

Don’t put all your eggs in one nearshoring basket

To start with, there are concerns that a concentration of risk will emerge if all operations are moved to one region or to the neighbouring countries of the home market. Should this region be hit by a disruptive event that leads to a shutdown of operations or production, then the company has no alternative sites or plan B to continue its activities.

What is more, if companies start withdrawing investments en masse from other regions and bringing operations back to their home markets, then this brings with it a rising risk that other companies will follow suit, leading to a deglobalisation trend. Emerging countries such as China are important outbound investors as well as destinations for investment, so any trend that encourages a retrenchment from widespread global operations can ultimately harm developed countries too.

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With this scenario in mind, it becomes clear that investors can experience the advantages of foreign direct investment (FDI) and international trade by seeing investments as a team sport rather than an individual game. This is because of the interconnectedness of the global economy, as each country’s economic growth is paired in an active manner with the economic development of other countries and the expansion strategies of multinational enterprises.

Looking for a plus one?

Geographical diversification remains the best strategy for companies to move forward in the post-pandemic world, but there should be a renewed focus on how to achieve best practice here. This is where a ‘plus one’-type of strategy emerges as a key solution, given that it can combine a reshoring with geographical expansion.

This could happen through investors reducing part of their business in one country, without exiting this country, and reallocating these resources to reshore or to launch a new business in another country.

Of course, launching new business operations during a time of aggressive cost-cutting can be difficult. The large decreases in global FDI flows since the outbreak of the pandemic suggest companies are taking a wait-and-see approach before deciding to expand to new locations. Data from the UN Conference on Trade and Development (UNCTAD) shows that FDI dropped dramatically  in 2020, by 42% to an estimated $859bn, from $1.5trn in 2019.

However, there is greater caution being shown towards some markets than others. UNCTAD’s latest Global Investment Trends Monitor reveals that east Asia has fared better over the past year than most regions when it comes to inbound investments, suffering only a 4% decline, while most other world regions saw double-digit declines in FDI. In fact, east Asia was the largest host region for FDI in the world, accounting for one-third of the global total in 2020.

There is good reason for this. Maintaining operations in east Asia, and more specifically in China, can be a profitable option for investors given the low costs and the increasing size of its internal market, with the middle class still growing. However, long supply chains can be easily disrupted, while depending on products, parts or pieces produced in a certain geographical area can bring a high risk of failure in times of crisis or disaster.

In a bid to reduce their exposure to China without exiting the market entirely, companies could take advantage of the China-plus-one or China-plus-two strategy. This involves keeping a production site in China but launching other facilities elsewhere.

By doing this, investors could enjoy the benefits of geographical diversification while reducing risk and boosting the economic growth of more than one country. This is key as most countries, especially developing ones, see FDI as a significant tool to speed up their economic development, receive industry-specific expertise, benefit from a transfer of technology, battle unemployment and move closer to achieving the UN’s Sustainable Development Goals – particularly when it comes to eradicating poverty and hunger, and improving gender equality – due to the skills gained through jobs created by greenfield FDI projects.

The world is in an uncertain phase and risks are high, but retrenchment ultimately benefits no one.

Home page photo by Kevork Djansezian/Getty Images

Sofia Karadima

Sofia Karadima

Senior editor and researcher

Sofia Karadima is a senior editor and researcher at Investment Monitor, focusing on financial and business services, and ESG investing.