The Great Reshoring of American Industry
MyEListings' markets and economics editor and creates content about global macro events and their impact on US commercial real estate.
There is a trend afoot in the US economy to re-shore industrial functionality that has been outsourced to other countries in the past few decades, most notably to China. This trend, along with others, is helping to drive solid bids for industrial property in the US. Here we explore the macro drivers behind this trend to get a better idea of its shape and power.
How It Started
Offshoring was a natural offshoot of the world enabled by US sponsorship of international trade. Under its hospices, countries could now trade freely with each other with the US’ blessing, and this represented a sea change (pun wholly intended) in the global economy. As long-distance maritime supply lines became ubiquitous, various countries pursued policies that enabled them to specialize in particular aspects of the value chain.
Under normal circumstances, this does not happen. Free trade, in theory, is much preferred to constrained trade; however, transaction costs such as geopolitical and physical transport risk prevented it until the US created the Bretton Woods system in 1945. Until that time the world system was based on empire, and the problem with empires is their implicit need to expand. This necessarily led to both world wars, which process the US and its allies sought to eliminate in seeking the agreement.
How It’s Going
The ability to trade freely with other nations with no need to worry about piracy or interdiction by other entities on the high seas meant that countries could invest in their own comparative economic advantages. This tended to feature manufacturing and assembly for certain demographic and developmental profiles, most notably China’s.
Off-shoring began in earnest in the 1970s but hit its stride in the 90s and 2000s. American labor was becoming highly specialized and therefore expensive. Relatively low-value inputs like textiles manufacturing and electronics assembly could be done much more cheaply, therefore, by sending the work offshore, thus offering a sizable cost advantage to companies that did so.
Today, the macro forces that brought about these shifts have themselves shifted. Countries overplayed their hands, failed to recognize the fragility that underpinned the artificial system, and have been left wanting as the geoeconomic tide has ebbed. Moreover, technology has advanced to the point it can competitively displace cheap foreign labor in many instances.
Implications of the Macro Perspective
Seeing the big pieces from far above allows for a perspective few can see, and can enable a higher degree of predictability at lower levels. Gaining a better understanding of the optimization problems inherent in economic activity, where paths to business objectives aren’t simple straight lines between two points, but rather optimally-determined paths subject to constraints imposed by the economic landscape.
These constraint-optimized paths tend to look like “S” curves when graphed mathematically, with high uncertainty at the bottom, a very steep upswing in the middle, and diminishing returns to scale nearer the top. This shape is very similar to other problems such as adopting new technologies, which suggests a similar problem structure.
What Problem Are You Solving For Projects by Investing In Them?
Many investors misunderstand the true problem they’re meant to solve, and this can lead to investment dogma, groupthink, and underperformance.
As a rough parallel, let’s look at how the optimal path for driving from point A to point B is propelled by optimization around existing constraints. The actual rules drivers must obey are very simple - don’t hit other vehicles, don’t hit stationary objects, and stay on the road. The objective is to get from A to B as quickly as possible, subject to these constraints. In observing the problem through this lens, we can start to see how the optimization problem exerts itself in a more complex fashion when global forces affect local returns.
Micro-Drivers With Macro Impact
Few investors understand the impact the drive for luxury has had on the world’s progress. When Colombus set sail in 1492, he wasn’t going to find a new world, but a new route to obtain the luxurious spices for which the wealthy of his day had developed quite a taste, and whose supply had been halted due to the sacking of Constantinople by the Ottoman Turks in 1453.
This dynamic is still very much in play in the modern era, but it has been both leveraged and expanded. More people than ever have developed these tastes, and in having done so, have laid the foundation for a negative feedback loop that cushions the sale of US assets, while potentially driving technological progress as well.
The drive for luxury has been uncorked through democratization, and this has occurred through the mechanism of global free trade. Never before have so many had access to so much. That genie is not likely to go gentle into that good night, having experienced the outside of the bottle. Once people experience an uptick in quality, they tend to want more of it, but take it away and very bad things could happen.
Thus, as Americans, in particular, discover that the only world they’ve known, where each year brings more and better and generally less expensive things for consumers to enjoy has become less so, it is reasonable to expect this drive to assert itself in the aggregate.
Quantity Demand Vs Quality Demand
When consumers experience an uptick in quality, they typically seek more of it. For example, a freshly-minted college graduate might wear the same 3 cheaper suits each week, at which point he begins seeing success and decides to buy a nicer suit. What does he need tomorrow? Another nicer suit, because it feels like a let-down to go back to the lesser ones.
This dynamic seems obvious until you consider the occasional prevalence of fears in the marketplace about ‘saturation.’ This term applies to quantity demand; however, when quantity demand becomes saturated, consumers tend to increase their quality demand, and the process regenerates at a higher quality level. This mechanism is responsible for both Columbus’ desire to regain access to teas and spices to satisfy the elites of his day, and being an important driver of demand for industrial property in the US.
The US Formation Experience: The Gift That Keeps Giving
US geography is so incredibly advantageous that it essentially dictates whoever inhabits the North American core will, in time, dominate the planet economically. Large ocean moats on two sides, deserts, mountains, and gulf to the south, and forests, lakes, and tundra to the north, flanked by friendly neighbors give the US unparalleled physical security. The largest contiguous tract of arable land on earth sits in the North American midwest and neatly overlays the longest contiguous navigable waterway system on earth. This is meaningful because transporting goods over water is a small fraction of the cost by rail or road, and this gives the US a built-in cost advantage.
As inhabitants of the original colonies began to make their way west, they found they could homestead along these waterways, grow crops, and could then easily get them to market if not export them to the wider world for hard currency. These advantages gave the new nation decided leverage in its growth trajectory and served to cement in the new nation’s psyche the idea that each succeeding generation would have it better and in more abundance than the last.
These factors combined in time to create a distinctive American attitude, one which correspondingly tends toward hysteria if forces from outside the US ever reach over and touch Americans on anything other than precisely their own terms. Then, in the ensuing freakout, we tend to completely rearrange the world order by virtue of our mass. We see this pattern in the following examples:
- Pearl Harbor - we responded with such force that we wound up incinerating two Japanese cities and purposefully crafting a replacement world order to the one that had been, with ourselves squarely at the top.
- Sputnik launch - we completely upended and retooled our education system, then built the space program that today is an order of magnitude larger in scale, scope, and success than other nations combined.
- 9/11 - we invaded and occupied two countries for nearly two decades while seizing the world banking system and remaking it to US liking and control.
This is just how Americans are. We freak out over 197 of every 3 important things, and in the process, we wind up breaking and recreating the world order. As the world now de-globalizes and populations start to shrink in the rest of the world, depriving Americans of their luxuries ought to really create a stir. If we can’t get the next iPhone iteration, our premium arabica coffee, or our Amazon prime same-day delivery, we will predictably pitch a fit.
The Writing Is On The Wall Already
Manufacturing is already returning to the US, and it’s a slimmed-down, fighting weight form of its former self. Even industries like textiles are able to relocate production in a fully-automated form to the US. Japanese, Korean and German manufacturers, particularly auto manufacturers, have already figured out they need to co-locate alongside their consumer base if they’re to succeed, and are among the largest purchasers of US industrial property, therefore.
Recap and Conclusion
- The US currently has the strongest demographic profile, consumer base, and security position in the world. As such, US trade partners, in their need to access this consumer base have learned to co-locate manufacturing and logistics facilities alongside this base.
- This set of incentives is likely to become stronger as the Eurozone, China and Russia implode demographically, and therefore become economically and geopolitically less important to the bigger picture.
- Technology continues to compound and evolve, enabling greater output for less input, and in many ways, this trickles down to a persistent bid for industrial and logistics property.
- Democratization multiplied by US geography and formation experience mean more people have been exposed to luxuries they now take for granted, and the world is rightly concerned about how the US might react if this were to occur for an extended time. History shows this is a valid concern.
- This along with rising bond yields implies higher cap rates and demand for US industrial and logistics property, as the US industrial plant roughly needs to double in output in the next five years if Americans are to maintain access to the lifestyles to which they’ve become accustomed.
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