Nick: Hello, everybody. This is Nick Robinson from abrdn and you're listening to the Emerging Markets Equity podcast, the show that explores the factors that underpin our thinking on emerging markets. We ask our guests the big questions from key individuals to evolving trends in order to identify and profit from opportunities in the region. In today's episode, we're going to talk about the trend of nearshoring and how the changing structure of global supply chains is impacting the companies and economies of emerging markets. To discuss this, I'm delighted to be joined today by my colleague, Gabriel Sacks. Gabriel has been on the team for 15 years, and as well as having worked out of our Sao Paulo office. He's just recently returned to London after several years based out of our Singapore office. So he's witnessed that firsthand how some of these structural shifts have occurred. Gabriel, welcome to the podcast. It's great to have you on.

 

Gabriel: Thanks, Nick, looking forward to our conversation today.

 

Nick: Great, well, let's get going. So, I suppose for most of our careers, a dominant trend in the global economy has been globalisation, and the increasing specialisation of economies. So, you know, obvious examples, being manufacturing moving to China, call centres moving to India, you know, that kind of thing. But more recently, in the last five years or so, we've seen a Trump presidency and then the pandemic, and we're beginning to see a bit of a reversal of this. So perhaps we could start with defining nearshoring what it means, is it globalisation in reverse, and why is it occurring?

 

Gabriel: Sure, well, there's no denying that nearshoring has become a hot topic in financial markets. And it's coming up in many of our conversations with corporates in emerging markets, you know, at its core nearshoring is really just another way of describing the process of outsourcing, but one that's more selective in terms of which countries are eligible for that work, with a particular emphasis on proximity to end customers. And aside from, you know, the benefits of accessing lower labour costs, nearshoring has additional benefits such as lower shipping costs, reduced communication barriers, given that the work is typically done in similar time zones, and also improved quality control. In terms of your question of why it's occurring. You know, I think there's at least two important factors driving nearshoring. The first is obviously, geopolitics as you highlighted, particularly the deteriorating relationship between the US and China, where both countries are looking to reduce dependency on each other. And the other is the impact of COVID, which evidence the need to create more resilience in global supply chains and diversified sourcing. And to illustrate this point, you know, you might remember that during COVID, you saw many labour shortages, ports being clogged up ships held at sea, as well as severe factory closures across Asia. So creating a second manufacturing base is one way of getting around these issues and future proofing your supply chain. COVID has also accelerated the ability to work remotely, which for some industries has improved flexibility to work from different locations. But you know, just as you mentioned, nearshoring is just one way in which the outsourcing process has evolved with other terms such as Friendshoring, or localisation, the other ways of describing that process of bringing manufacturing or service provision closer to home, either in friendlier countries or indeed to your own home market. And then that's largely to reduce political or other operational risks. I think ultimately, this is part of an overall deglobalisation that the world is going through. And it's driven both by the private and the public sector and tends to be inflationary as well, which is another I guess, hot topic at the moment.

 

Nick: Yeah, I think we'll certainly get on to the inflation issue a little bit later on. But I suppose thinking about nearshoring and the changing kind of structure of supply chains as companies and economies start valuing manufacturing in more friendly and convenient locations. Yeah, which countries and sectors are likely to benefit the most from that trend?

 

Gabriel: Yeah, I think the most obvious or the most cited example is Mexico, given its proximity to the US, and in particular, the northern region of Mexico. And, you know, we have several companies across our portfolios that benefit from that, from that be it airport operators, regional banks or real estate investment trusts. One of the key plays on this theme for us has been an Industrial real estate investment trust in northern Mexico, which is really focused on warehouses for global multinationals. And that company has seen a clear uplift in demand and pricing over the last few years as a result of nearshoring trends, and actually, in their latest results released, they did announce that they'd be accelerating the expansion of their warehouses from, you know, five years to sort of three years. And this demand is really driven by large automakers, for example, like Tesla, or other automakers. So, you know, only this week, we saw Kia announced plans to expand its plant in Nuevo Leon state to focus on EVs and they're planning to spend about 1 billion US dollars and create over 1000 jobs. And, you know, it really is happening, you see, and the latest trade data from the US, Mexico has overtaken China to become the US top trading partner for the first time ever, with over 15% share of total US imports. And that compares to Canada at 14% in China at 13%. And you know, if you compare this a year ago, Mexico was 14% and China was higher at 18%. So you know, Mexico is clearly a clear beneficiary of this. Meanwhile, you know, Southeast Asia has been seeing increased foreign direct investment, particularly from large conglomerates in the more developed Asian markets, such as Korea and Japan, who are also looking to reduce their reliance on China. An example of this is Samsung, which has very large production facilities in Vietnam, which is a country that that has been growing exceptionally fast as one of the best hubs for tech and consumer electronics manufacturing, globally. And actually, what you see in Asia, which is quite interesting is a bit of a race going on between governments really trying to enact structural reforms to reduce constraints for nearshoring attract business and foreign investment. And you'll see different countries benefit in different ways. You know, Indonesia, I think, has a good chance of developing its capabilities as an industrial hub, given its abundant natural resources. So it's focusing on supplying commodities such as nickel for EV batteries, while countries like India, on the other hand, still benefit from their great demographic trends with an unmatched ability to supply engineers or tech graduates at scale and at a reasonable cost, which should ensure that it maintains its status as a global hub for IT services, but they're not stopping there, you know, they're doing they have a made in India strategy, which is really aimed at grabbing more market share in manufacturing and the tech supply chain.

 

Nick: You mentioned Indian IT services, which is as we know, as investors in many of these companies, they've been huge beneficiaries of,globalisation. But within the tech sector, at least, there's another huge trend at the moment, which the market is getting very excited about particularly few days post the earnings report from Nvidia, which was quite incredible. Yeah, this this trend of artificial intelligence is really moving to the forefront. And how's that likely to combine with the trend of working from anywhere within the Indian IT services companies?

 

Gabriel: Yeah, that's a really good question. I think you really have to separate the two issues, I think, you know, the work from anywhere development has really allowed IT services companies to further diversify their sort of basis or their supply or their hubs. So, for example, in the United Services companies are setting up centres in Latam or Eastern Europe to be closer to their clients. And it's also helped them actually benefit from a cost perspective, which, interestingly enough, despite you know, deglobalisation what you're actually seeing in, in IT services, outsourcing has increased, you know, clients have become more comfortable with companies having their workforce elsewhere, because they're more comfortable that you know, these people can work, it's secure, and the client confidentiality won't be breached. So, you've actually seen it services companies reduce on site presence in their clients headquarters and increase outsourcing. And that's been accelerating as well, because of really tight labour markets in the US and places like UK and Europe. I guess, just to illustrate that point. I think, you know, if you looked at the largest IT services company, globally, they have announced that they would be moving to a 75% remote working versus 25% office. So again, that's another cost benefit where they're reducing their office space. But just changing tack, I guess, on the question of AI. You know, I think it presents both an opportunity and a threat to these companies. It's clearly an opportunity for those companies that were born in the digital age or those that are doing more complex digital transformation projects for clients, but it can be a risk for those businesses that are doing more traditional outsourcing, you know, think of simple call centres or help desks, which are quite low value add. And those companies could see themselves disrupted quite rapidly if they haven't already been disrupted given, you know, that that kind of work has been a legacy type of work for many years. So the end result of all this is actually further automation, productivity benefits, and likely consolidation in the hands of the highest quality players. I personally don't feel that AI will lead to mass layoffs. But it probably will lead to slower pace of hiring for IT services firms, and certainly for a portion of the IT workforce. You could see some of them left behind if they aren't really skilled.

 

Nick: Yes, I certainly sounds like a potential disruptive force for those companies. And you mentioned a little bit about some of the governments in Asia tried to enact reforms in order to remove some of the constraints to nearshoring. Perhaps you could just talk us through what some of the other constraints that companies have, when they're thinking about the nearshoring.

 

Gabriel: Yeah, you know, there's several constraints to nearshoring and localisation, particularly when it's driven by policymakers rather than a natural economic forces. These include the sort of obvious things like language barriers, lack of adequate skills in the labour force, or a poor supply chain ecosystem, be that in terms of the actual suppliers of raw materials, or the logistics, infrastructure, all of which means that when you relocate, you do end up with higher production costs. You know, the other major constraint is geopolitics, which you know, for certain strategic industries, such as high-end chip manufacturing, is an extremely difficult process. And I think Taiwan is the perfect example of this where, you know, it's a small country, but it's created a very deep and complex tax cluster that's been built over many decades. And it's extremely difficult to replicate that elsewhere. And the dominance of TSMC, in particular, in high end chip manufacturing, is the best example of that. And what you're seeing is US in particular, but other Western markets, try and bring that supply chain back to the US soil. And that has become an issue of national security. And has also brought about things like the chip Act, which is providing almost 300 billion US dollars in new funding to boost research and manufacturing of semiconductors in the US.

 

Nick: Yeah, it's funny, you mentioned Taiwan, when I was a kid made in Taiwan generally stood for, you know, plastic rubbish that that you get given at Christmas yet today, they're home to some of the most advanced semiconductor manufacturing on the planet. So it's a really great example of a country that's managed to move up the value chain, staying on Taiwan Semiconductor, as they start to diversify their manufacturing in terms of geographies. What does this mean for costs and inflation? I think I read that Taiwan semi are looking to charge 30% more for chips that are manufactured out of the US. And so there must be examples of many other companies that are doing similar at higher cost.

 

Gabriel: Absolutely. Yeah. So TSMC, has actually in the past, tried to set up facilities in the US, but they largely gave up because production costs are so much higher. And again, it doesn't have that ecosystem that is so tightly knit in, in Taiwan. So yeah, even accounting for the large tax breaks and other subsidies that the US government is offering to lure the company to the US, you know, it is very likely that you'll see higher prices for semiconductors that are manufactured domestically. So that's something that TSMC themselves have acknowledged. And I think something that the US government is well aware of, when again, it's an example of fact that this process of deglobalisation is inflationary, you know, you're to an extent duplicating an existing supply chain, which will cause inflation and possibly dent corporate profit margins as well, but it's something that policymakers have decided is strategically important and clearly for those, those companies like TSMC, you know, they need to be seen to be doing something about this given how many customers they have in the US.

 

Nick: You mentioned Mexico, earlier as a as a beneficiary. Do you think that extends into Brazil also and the rest of Latam?

 

Gabriel: I think it should, you know, I'm Brazilian by background, and, you know, I'd love to see Brazil capitalising on this, but it hasn't really happened in earnest. I think Mexico is the best example. I think there are other examples like Costa Rica, but it is a very small market. And I guess it's more for things like IT services. But yeah, I think Brazil should have a part to play in all this particularly from a Friendshoring rather than nearshoring perspective. But there are several things that are holding it back. I think the volatile politics is an issue with lack of clarity on foreign policy in particular, you see, the new government hasn't been doing a very good job on this front and has been ambiguous and things like, you know, the Russia Ukraine conflict, for example, there's also significant red tape and bureaucracy in terms of Brazil's complex labour and tax laws. And again, that sort of slightly, but the further distance that Brazil has to Europe and the US does mean that logistics costs are higher. But you know, there are positives as well, I think Brazil has ample resources. It's got a large population, which gives it critical mass, as well as a fast developing tech ecosystem, particularly around fintech. And it's a diversified economy, you know, so it should have the means of offering a reasonably healthy supply chain for different industries. And I think that the renewables supply chain in particular, which is at the moment very dominated by China, and Asia, you know, possibly could have a role to play in Brazil. And you could combine that with as well, the element of carbon credits as well, which I think Brazilis really a leader in despite all the noise, it is a leader in renewables. So that could be quite exciting. And hopefully it comes through.

 

Nick: Yeah, I mean, I was find Brazil quite an incredible country in terms of renewables. I mean, yeah, 80% of their power generation comes from renewable sources, you know, the enormous, powerful rivers they have all over the country able to provide all that power. In Southeast Asia from where you've just relocated, which markets would you be more positive on as beneficiaries from the trend? Yeah,

 

Gabriel: Yeah, I've been a big bull on Vietnam. You know, I think at the stock level, it's harder to get access to. But I think from a top-down perspective, it is a clear winner, you know, rightly or wrongly given its one party state has a pretty stable political system that is actually quite friendly to the west. And it helps direct infrastructure development where it's needed and helps develop the country from a strategic point of view. It's also an extremely urbanised country with a high density, lot of hard working labour force. And it's already got a thriving export market with several trade agreements with the likes of the EU. So it's a country that has been doing its homework in terms of, you know, setting the stage up for becoming an export hub. And you've seen foreign direct investment, over many years be very healthy at sort of 5 to 10% of GDP per annum. So I think it's got a good chance of mimicking the experience of China in terms of becoming one of the key world's key manufacturing bases. But yeah, as I said earlier, you know, different countries should benefit in different ways, there is a bit of a race going on. And, and I think as a side note, for example, Singapore has really been cementing its status as the financial and services hub for Asia now that Hong Kong has become less independent politically. And, you know, it's been able to attract capital flows and talents, which should benefit the economy over the long term. I think it's a good example of the shifting tides in the global economy and, and the changing flow of capital people, etc. So I think it is, you know, again, different markets stand to benefit in Southeast Asian and as a region provided, geopolitics doesn't get too out of hand in terms of, you know, generating real conflict between China and the US, you know, Southeast Asia stands to benefit as a whole.

 

Nick: Yeah, I think on Singapore, you know, anecdotally, we do hear a lot from our colleagues in Singapore, how crazy the property rental market has become there, since Singapore has now got the status as a financial hub in the region so I suspect that it must be a bit of a relief to move away at least to be slightly calmer property market in London?

 

Gabriel: Well, yeah, I guess, you know, both are very expensive, but I think one of the interesting data points I got while I was leaving is, you know, I was only in my flat for two years and the rent went up 65% for someone who was coming in from Hong Kong. So and actually you seen stamp duties for foreigners or expats I can't remember what the number is, but it's something like 20, 25% down so it's extremely, extremely high. Because you know, as a small place they do need to protect the locals and avoid too much capital coming in. Giving Singapore status as a safe, safe place for your capital with lots of countries around, where, you know, the politics is a bit, a bit more, more uncertain put it that way.

 

Nick: Yeah. Well, we've I guess we've spent most of the podcast talking about the beneficiaries of nearshoring, including those Singapore landlords you mentioned, perhaps, you know, we can finish just on the other side of that and talk about which markets are most likely to suffer? And I suppose particularly China, potentially, given the historic dominance of the manufacturing sector there. Is China likely to suffer? Or do you think that's going to be counterbalanced a bit by their own efforts to try and localise as much as possible?

 

Gabriel: Yeah, it's a great question. You know, I think you've been talking a lot about these really significant moves in the global world order, as it were, but you know, it moves at a relatively slow pace, I think China still accounts for almost a third of global manufacturing. And there really is no single country that can replicate its scale and efficiency. So China is not going anywhere in the short term, you know, given how embedded supply chains are, the these things can't change overnight. But you know, all the things that we've been describing, I think, is where the marginal investment or marginal capital is going, and it is going elsewhere. So it is potentially a negative for China. I think, you know, Chinese corporates themselves are being rational and looking to set up shop elsewhere, partly as a way of circumventing sanctions. So they have been quite active in investing in Indonesia, Vietnam, and even in Mexico. And, you know, I think the Chinese have been deliberately trying to shift the economy to a more services oriented economy, consumer driven economy, with less of a focus on infrastructure development in particular, but also to an extent less manufacturing. But the other point you make about localisation is extremely important in China. And it's something that the government for many years has been trying to increase the country's self sufficiency, be that in terms of access to resources, manufacturing, or high end technology. So we see many industries where national champions are emerging and where there is top down sort of command to try and replace foreign firms be that in terms of software development, for example, so replacing ERP software and for from Oracle and SAP, or be it in terms of semiconductors, renewables, or medical equipment, to name a few. So you know, it is a negative for China, but it also throws up many investment opportunities for us in China. So it's not all bad. But it'll be interesting to see, you know, how these countries manage these forces over the next few year.

 

Nick: Well, great, yeah know, certainly that's an interesting point. And certainly, I feel like we spent a lot of time looking at opportunities in China from that localisation perspective, and there are some really great businesses that that you can invest in. And I think that's a that's a good point to draw the podcast to a close. So the only thing really left for me to do is thank my guests, Gabriel thanks. Thanks very much.

 

Gabriel:Thank you, Nick.

 

Nick: And thanks to everyone who took the time today to listen in. If you enjoyed today, then please download our other podcasts from our website or wherever you normally get your podcasts. Watch out for our next episode and tune in.