Canada’s low labor productivity level brings the risk of losing investments to Mexico, as the nearshoring boom moves supply chains to North America. Canadian labor productivity fell 1.8% in 2023, its third consecutive year of decline. Reuters, April 30, 2024.
What is the nearshoring boom?
Nearshoring occurs when a foreign firm decides to locate in another country closer to the country in which it plans to sell it output. The nearshoring boom is the move by Asian firms to move production to North America. For example, China’s largest EV maker, BYD, is reviewing potential locations in Mexico for a factory that would allow it to bring its electric vehicles into the United States. Honda, the Japanese EV maker, has announced plans to build factories in Canada to produce its electric vehicles. The incentive for both BYD and Honda is to shorten their supply chains.
What are the other types of shoring?
Three other types of shoring are offshoring, onshoring, and reshoring.
Offshoring occurs when a domestic firm locates in a foreign country to be close to the final buyers of its output. For example, in 2019 when the EV market in China started to boom, Tesla, the U.S. producer of EVs, opened a factory in Shanghai that assembles cars for the China market. The incentive for Tesla to assemble cars in China is to shorten its supply chain.
Onshoring occurs when a firm locates its production inside its own domestic country. Onshoring arises when the good is produced under domestic conditions such as wheat, the good produced has a short life such as raspberries or it is a service that is unique to the domestic market such as legal service. If the good produced has an international market, then it is an exported good.
Reshoring occurs when a firm that previously located its production in another country shuts down and bring its production back home to it domestic country. Some U.S. electronic manufacturers and software developers have brought their activities back to the United States to reduce supply-chain risks and to protect intellectual property.
Why is nearshoring in North America booming?
The nearshoring that cuts supply chains to North America is booming because the U.S. and Canadian governments have announced new policies that change the incentives that producers of goods they import face.
The United States has imposed big tariffs on many goods and components—for example a 100 percent tariff on Chinese electric vehicles. The Chinese manufacturers of electric vehicles are considering building factories in either Mexico and Canada.
Governments of Canada has announced a new 10 percent supply-chain investment tax credit for foreign firms that build factories to produce electric vehicle in Canada.
These policy changes create incentives for firms to locate in either Mexico or Canada and they are incentives for nearshoring in North America to boom.
How do foreign firms choose between Mexico and Canada as the place to invest?
Each firm will locate in the country in which it will gain a comparative advantage against U.S. producers. Comparative advantage is determined by relative opportunity costs of the activity. A firm will locate in Mexico if it gains a comparative advantage against the United States or in Canada if that gains the firm a comparative advantage against the United States.
Does labor productivity determine opportunity cost?
No! The news clip seems to imply that labor productivity will determine in which country Chinese and Japanese electric vehicles will locate.
Labor productivity is the average number of EVs produced per worker. Labor productivity tells us about how productive a worker is, but it tells us nothing about the opportunity cost of using Mexican or Canadian workers to produce an electric vehicle.
Opportunity cost of producing an EV is the highest-valued alternative that must be given up to get it. If BYD’s opportunity cost of producing an electric vehicle is less in Mexico than in Canada, then BYD will build its factories in Mexico. IF Honda’s opportunity cost of producing an EV is less in Canada than in Mexico, Honda will build its factories in Canada.
Now take a short quiz to ensure you understand what you just read.