Protectionism is the kneejerk reaction of policymakers in the face of grim economic forecasts and geopolitical tensions. This is bad for global trade which encourages activities to be carried out on the basis of comparative advantage.
How are businesses responding? Lashed by uncertainties from all directions, attention has been turning towards reshoring activities as a way to mitigate future supply chain disruptions, as well as to manage the customs duty bill.
At the same time, in the UK, a consultation on freeports has been extended to July 2020. The government lists the following objectives for UK freeports: establish freeports as national hubs for global trade and investment across the UK, promote regeneration and job creation, and create hotbeds for innovation. Could freeports facilitate the race to bring manufacturing back home?
Why things are how they are, and why they cannot stay that way
As discussed in my previous article (Lessons learnt from COVID-19: the cross border part of supply chains is overlooked, vulnerable and complex. What can be done about it?, April 2020), COVID-19 helped to expose the weakest point in supply chains: at the border. Businesses are now faced with broadly two options: deal with the problem and build resilience where supply chains cross borders, or eliminate the problem and bring manufacturing activities closer to the end consumers.
Why are businesses manufacturing abroad in the first instance? There are three attractive factors for manufacturing elsewhere, and their benefits have so far outweighed the cost of having to transport goods across long distances. First, the availability of skills and labour in the quantity required at a cost that is lower than what would be available in the destination country. Second, the infrastructure surrounding the manufacturing facility, creating a cluster effect. Third, attractive policy packages including but not limited to tax incentives.
However, increasingly, cost is no longer the only concern for businesses. In light of growing geopolitical tension and fearing future disruptions on the same scale as the current pandemic, the idea of reshoring production is gaining momentum. This, in theory, would shelter businesses from erratic customs policies dictating restrictions and as well tariff rates on the import of goods, it would also mean the final product is made closer to the end consumer.
How would it work in practice? I believe it depends on whether similar benefits can be replicated or replaced by something else, resulting in a palatable trade-off between producing abroad cheaply and reshoring production. This would require thinking outside the box. Could freeports give businesses the opportunity to test out their reshoring strategy while minimising the cost of doing so?
Freeports as a tool to encourage reshoring manufacturing activities
Going back to the UK government’s objectives, the hope is that freeports would create jobs and act as national hubs for global trade across the UK. Introduced effectively, freeports could replicate the cluster effect by encouraging similar types of manufacturing activities or particular industries to form clusters at different freeports. This could bring economies of scale for the required infrastructure, potentially reducing some of the costs associated with reshoring. Another way freeports could help to manage the cost of reshoring activities is to introduce appropriate policy packages. For example, by allowing production taking place in freeports to count towards UK origin calculation. However, there would need to be mechanisms in place to deal with the potential displacement of existing domestic economic activities.
One of the main constrains is going to be labour regulation, which is emphasised in the EU’s demand for a level playing field in the ongoing Brexit negotiations with the UK. In any case, for businesses relying on labour-intensive production, the cost of onshore production will likely still be higher than producing it in, for example, China then shipping the goods to the UK. In the long run, automation could help to bring the cost down. For businesses engaging in less labour-intensive activities, the benefit of producing closer to the end customers might lure them to reshore activities, especially if freeports offer even more enticing incentives. However, change would take time, and businesses will want to see what types of policy packages are on offer.
Freeports, free zones and so on have been implemented across the world to varying degrees of success. What is clear is that today’s free zones are dealing with yesterday’s challenges. There is a window of opportunity for the UK to design and implement the freeports of tomorrow. I have previously written on what freeports of the future could be (Thinking Outside the Zone, TradeWatch, October 2019) to offer better policy packages to businesses wanting to reshore activities. In Thinking Outside the Zone, free zones are examined in a new light, starting from what problems are pertinent post Brexit, and how free zones or freeports can help alleviate these challenges to benefit businesses, government and the UK economy through the effective usage of existing technological solutions. Whether or not the government has the ability or willingness to think outside the box to create the next generation of freeports remains to be seen.
What are the alternative options?
Where reshoring is not possible or feasible, it might be best for businesses to focus their efforts on exploring alternative options. Namely, how to make existing supply chains as resilient and agile as possible. The starting point should be visibility.
In the short-run, businesses need to have visibility on what is crossing the border and at what frequency. Data on the movement of shipments can be gathered from external sources, such as government databases or from commercial partners. Internal data can also be used, but it may be incomplete so it is recommended to cross-check with data from government sources where possible.
Analysis based on a business’ trading profile will help it make strategic decisions in the long run. Automating parts of the supply chain may help reduce the labour cost and thus make reshoring a viable option in the future. All these decisions are built on a solid foundation of reliable and timely data. Time should be spent wisely on doing the most effective activities, rather than following the trend.
The trending response to increasing protectionism and volatile trade environment is to consider reshoring activities, and some may also wish to decouple certain manufacturing countries from their supply chains.
Freeports may well be a catalyst to help achieve this in the long run. But this response won’t solve every business’ challenges. What decision-makers should be doing is to critically examine the existing supply chain as well as the effectiveness of the customs processes and controls, and decide if, in the first instance, they should simply improve the cross-border supply chains they already have.