Northern Nearshoring: Why Canada is well-placed to help diversify U.S. Supply Chains

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Jill Hurley
Director, Global Trade Consulting
Livingston International

For several years, relying heavily on production in China has represented a certain degree of risk to American businesses. Significant challenges with red tape, as well as concerns about government corruption, intellectual property theft, and forced knowledge transfer have hounded U.S. businesses for more than a decade.

The risk of relying on China for production became even more evident with the outbreak of COVID-19, when lockdowns forced the closure of factories and stopped service at key ports, creating massive delays in the production and transport of goods destined for U.S. shores.  

While businesses had already been exploring the idea of diversifying manufacturing operations away from China in recent years, the global pandemic has put pressure on companies to speed up the process. In recent weeks, similar closures and supply chain disruption have emerged out of China and Vietnam—the latter of which has captured about half of the capital flight from China due to the U.S.-China trade war—and have served as a reminder that global supply chains have not yet reached a true post-pandemic “new normal.”

What manufacturing destination alternatives to China exist? There are a multitude of manufacturing centers across the globe; yet, for U.S. businesses, their northern neighbor might just be their best bet.

Challenges in Offshoring to China 

Since becoming a member of the World Trade Organization in 2001, China has become the world’s factory. Loosened state regulations and access to an enormous, young, and inexpensive workforce made it the perfect destination for manufacturing operations. Over the years, China was able to adapt to new technological changes and manufacture complex products such as electronics and printed circuit boards. 

However, China’s rapid growth wasn’t sustainable. The speed and value by which China was able to manufacture products declined as its population grew. As China’s workforce became more skilled, employees demanded higher wages. In addition, and as noted above, the omnipresence of cybersecurity threats, forced knowledge transfer, and intellectual property theft increased the risk of doing business in China.  

The ongoing trade war between Beijing and Washington and its widespread tariff barriers further disincentivized sourcing from China. The trade war (and its collateral damage) led businesses in the U.S. and elsewhere to start considering relocating their manufacturing. 

Post-Pandemic Offshoring Challenges

As China began recovering from the COVID-19 pandemic in mid-2020, factories reopened and orders began making their way to customers. However, disruptions related to backlogged inland transport and congested ports impeded shipments; a purchasing boom (especially through e-commerce) exacerbated the container shortage. That caused delays in the arrival of goods coming from China to Europe and the U.S. 

To mitigate the effect of the container shortage, shippers began investigating the option of air freight only to find it impractical for bulk goods and a costly means of transport. 

Ports in the U.S. (especially those in California, which handle half of the ocean traffic from Asia) have witnessed massive backlogs throughout 2021. The National Retail Federation called on President Biden in June to address the logjam at ports. 

The container shortage wasn’t the end of the disruption, though. A grounded container ship blocking vessels in the Suez Canal (a vital trade route) in March 2021 further held up shipments. In June 2021, the Delta variant of COVID-19 struck China’s Guangdong, a major shipping hub. To halt the spread, authorities in China shut down manufacturing, once again creating delays in the arrival of goods on U.S. shores.

Experts predict it will take at least a year to recover from the cumulative effect of shutdowns, increased demand for goods, shipping delays, and an exponential increase in the price of shipping. Building a sustainable, efficient, effective supply chain means overcoming these challenges. For many companies, nearshoring manufacturing operations reduces these obstacles. 

Nearshoring Considerations 

Moving manufacturing operations out of China (or, reducing dependency on China for manufacturing services) is a major step towards improving the resiliency of a supply chain. 

Before the pandemic, many U.S. businesses made use of the just-in-time model, which saw goods moved with great precision and punctuality to ensure business continuity while reducing the burden and cost of storage. However, the global pandemic gave businesses pause. “Just in time” became impossible with varying lockdowns around the world. In response, many have begun shifting all or part of their supply chains to a just-in-case model, with built-in redundancies and contingencies to maintain business continuity in the event of production shutdowns or transport delays. 

A critical component of the just-in-case model is the use of nearshoring or bringing core production closer to home to ensure greater access to and reliability of suppliers while also reducing time in transit. 

However, for businesses investigating nearshoring, it’s critical to consider whether the infrastructure in the new sourcing country supports a just-in-case model. 

Many U.S. companies have recognized the importance of the just-in-case model, and have begun investing in Canada, their neighbor to the north. Statistics Canada noted that in the last quarter of 2020, U.S. investment in Canada (including mergers and acquisitions and reinvested earnings) reached $4.8 billion—a major increase from Q4 2019, in which U.S. companies invested $656 million.

These investment trends reflect sentiments among U.S. executives. Research from PwC shows a growing number of U.S. business leaders see Canada as crucial to their growth; between 2019 and 2020, the number of decision makers who believe Canada represents an excellent investment opportunity doubled. During that same time period, the number of executives who see China as critical to corporate growth decreased by 30%. 

While Canada offers a number of obvious advantages, such as close geographic proximity, seamless transit and comparable business culture, there are other, often overlooked, benefits behind Canada’s attractiveness as a supply source. 

 Canada As a Nearshoring Destination 

Labor 

One of the critical factors for businesses looking to supplement or supplant production in Asia will be labor. This will be particularly true for industries that rely heavily on highly skilled labor. Canada boasts a highly educated workforce, more than one-third of which is made up of professional, scientific and tech-related jobs. The high skills of the Canadian workforce have allowed the country’s manufacturing sector to flourish and become integral to global value chains. 

This has not been lost on U.S. businesses, who have been using Canada as a rallying point for value-add production. In fact, prior to the pandemic, the U.S. was the destination for more than half of Canada’s intermedia-goods exports, demonstrating the degree to which America’s northern neighbor had become integral to U.S. supply chains. 

Reduced Barriers to Trade

The U.S.-China trade war has resulted in increased landed costs to U.S. businesses (the total cost of importing goods, including duties, taxes, shipping and customs administration). Today, there are few products from China for which tariffs do not apply, resulting in increased cost of goods and reducing market competitiveness. In addition, soaring freight rates have added to the overall cost of moving goods across the Pacific. Then there’s the ever-present risk of sudden and unanticipated shifts in trade policy that could result in the embargo of select goods or goods from certain origins, or an increase in tariff rates. 

Conversely, the recent implementation of the United States-Mexico-Canada Agreement (USMCA) ensures goods can move through the Canada-U.S. border seamlessly and duty free (for almost all goods). Moreover, the trade agreement, which was an update to the North American Free Trade Agreement (NAFTA), established greater harmonization of regulatory requirements, reducing the administrative and legal burden associated with moving goods into Canada from the U.S. and vice-versa. 

Infrastructure

One of the key challenges for U.S. businesses looking to diversify their supply chains will be finding sourcing markets that offer comparable trade and transport infrastructure to China. Beijing has invested heavily in upgrading China’s seaports, airports, railways and roadways to facilitate its export-driven economy. While many U.S. businesses have shifted production to other parts of Asia, they have discovered the infrastructure in those countries is often inadequate to support the recent surge in trade activity.

Similarly, Canada has put significant emphasis on creating fluidity of transport across the country and across the Canada-U.S. border. Exports account for one-third of Canada’s GDP and imports another third, meaning the facilitation of trade is a cornerstone of the Canadian economy. The Canada-U.S. border, which remained uninterrupted during the pandemic, is the most porous international border in the world. 

Moreover, the potential for a merger of Kansas City Southern and one of Canada’s two major rail lines presents the possibility that a truly continental railway network could be in place in the near term, establishing even greater ease of transport. In addition, Canada’s port infrastructure may also be a source of relief for B2B businesses looking to move goods from Asia-Pacific to customers in the U.S. Using a recently introduced program by U.S. Customs and Border Protection, businesses can make use of the more generous threshold for low-value goods incorporated into the new USMCA to ship items from Asia to Canada, before transporting them by ground—and duty free—across the Canada-U.S. border.

Growth Sectors for Canada 

A recent report from Invest in Canada, an arms-length Government of Canada organization dedicated to promoting investment in Canada, showed that for foreign businesses, Canada presents particularly advantageous opportunities for firms in advanced manufacturing and clean technologies.

There is a symbiotic relationship between advanced manufacturing and clean tech in Canada. The latter has seen widespread growth and innovation throughout the country, particularly in the energy and resource sector. These emerging technologies will become increasingly in demand amongst U.S. businesses as they move to reduce their carbon footprint and adopt an ESG model (environmental, social and governance). 

This is already occurring in the automotive sector. U.S. automakers are now in the process of retooling Canadian production facilities to manufacture electric-powered vehicles. Additional investment is being made by foreign automakers in fuel-cell products in response to Canada’s focus on becoming a leader in hydrogen and fuel-cell technologies.

An editorial in the May 2021 issue of Manufacturing Automation points out that Canada’s advanced manufacturing sector is ripe for investment: 40% of manufacturers use advanced technologies in their processes, and GDP growth in this field rose 3.7% between 2017 and 2019.

Cleantech Group, a San Francisco-based consulting firm in the industry, ranked Canada as second in the world for clean tech innovation. While cleantech is an emerging technology, the robust infrastructure in Canada proves these innovations makes an excellent nearshoring investment. 

In short, investment in clean tech is fuelling investment in the manufacturing of eco-friendly products, making Canada a particularly strong locale from which to develop products of the future.

The events of 2020 have shown it’s time for U.S. businesses to build contingencies and redundancies into their supply chains to minimize the risk of disruptions. While China remains a critical sourcing market for many firms, investment in regionalization will create long-term benefits in the form of improved business continuity and sustainability. 

Canada’s skilled labor, investment in infrastructure and liberalized trade regime, in combination with its flourishing clean tech and advanced manufacturing sectors and its proximity to the U.S. makes it an ideal nearshoring option for firms looking to diversify their global supply chains. 

Jill Hurley brings a wealth of expertise in the development and implementation of import/export compliance programs, compliance audits, export licensing requirements, supply-chain security, the preparation, submission and oversight of penalty mitigation projects and assistance with U.S. trade remedies, such as anti-dumping and countervailing duties, and intellectual property orders.

For more information on Livingtston International and their cross-border services, please visit their website at www.livingstonintl.com. The website includes a 2021 Trade Landscape portal - a resource for businesses looking to better understand the global trade environment (issues, trends, policies, etc.).