Economy

Staying Hooked

China should be vigilant to the shift of manufacturing processes out of the country while it continues to upgrade its business environment to appeal to foreign investors

By Shen Jianguang Updated Nov.1

2020 has brought unprecedented challenges to the China export market. The coronavirus outbreak and the coming US presidential election has escalated Sino-US tensions, which are spilling into all areas including trade, finance, technology, military and ideology. For China, the risk of foreign companies shifting manufacturing away, or “de-Sinicization” of supply chains, is also increasing. In a move to reduce reliance on China for certain medicines, in July the Trump administration announced that it was using the Defense Production Act to give a US$765 million loan to film maker and tech firm Eastman Kodak Company to produce generic drugs. In April, Japan allocated US$2.2 billion out of its stimulus package to companies shifting production out of China. The European Union is also exploring ways of bringing some manufacturing processes back. 　

In China, optimism usually dominates discussions about shifts in supply chains. The theory is that China boasts a complete supply chain, a huge market and sound infrastructure, so it need not worry. The truth is that China’s exports to the US have dropped quicker than expected in recent years, and a considerable proportion of its exports of labor-intensive products has shifted to nearby Southeast Asia. As Sino-US trade woes intensify, Mexico is exporting more high value-added commodities to the US. It is a trend China cannot afford to ignore. 　

Declining Exports

US imports from China have been in steep decline in the past four years. Among the top 15 categories of commodities exported to the US, the market shares of 14 have dropped. They include both labor-intensive commodities like bags and shoes and technology products such as smartphones and computers. 　

Before Sino-US trade friction escalated in 2018, the fall in China’s imports to the US was seen in labor-intensive products. China’s market share of the US’s imports of bags, shoes and sweaters were 64 percent, 53.7 percent and 37.7 percent in 2015. In 2017, the share dropped to 58.2 percent, 47.9 percent and 33 percent. In contrast, the export of labor-intensive products from Southeast Asia to the US climbed. 　

Between 2015 and 2019, the market share of the US’s imports of bags from ASEAN member states surged from 16 percent to 33 percent. The switch stems from the increasing cost of labor in China compared to Southeast Asia, and as China is trying to develop a more sustainable economy, paying more attention to environmental protection and the intensive use of natural resources.　

While downplaying its advantages in cost, China actively sought to update and modernize its industrial structure accompanied by a shift to the export of higher value-added commodities. This not only offset the pressure of weaker exports caused by the shift of supply chains to Southeast Asia but also led to a change in the domestic manufacturing base. Between 2015 and 2017, imports of certain technology products to the US from China climbed. China’s smartphone market share in the US rose from 60.9 percent to 64.1 percent. Even though China’s market share in apparel exports was squeezed by Southeast and South Asian countries, it has become a major exporter of high value-added capital goods like textile machines. 　

The bigger challenge comes from the trade friction between China and the US. The US started imposing additional tariffs on imports from China in 2018. The list of affected goods continues to grow as it imposes tariffs on more Chinese goods, rising from US$50 billion worth of imports to goods worth US$300 billion. The tariff rate also rose steadily, a blow to China’s high-end manufacturing. In 2018, China’s technology exports to the US fell. China accounted for 60 percent of the US imports of computers in 2017. The number dropped to less than 50 percent in 2019. China accounted for 67.6 percent of US imports of office machine parts in 2017, which halved to 30 percent two years later. 　

Mexico is the main beneficiary of the decrease in China’s exports of high value-added commodities to the US. In 2019, China’s exports of computers and computer components dropped to US$44.8 billion from US$50.3 billion in 2017. The reduction of US$5.5 billion is smaller than the increase in Mexico’s exports of the same products to the US in those two years, which rose from US$20 billion to US$27.2 billion. 　

On July 1, The United States-Mexico-Canada Agreement (USMCA), which replaced the North American Free Trade Agreement (NAFTA), officially took effect. This agreement constrains any of the parties from entering free trade negotiations with a non-market economy, stipulating that the other parties can terminate their involvement in the USMCA if those negotiations result in a free-trade agreement. This is predicted to further erode the competitiveness of Chinese commodities in North America. 　

Shifting of Supply Chains

In addition, the US’s crackdown on China has extended from trade to science and technology. The US Department of Commerce is adding more Chinese companies to its Entity List, restricting them from access to US technology. 　

On August 6, the Trump administration issued an executive order that would ban TikTok, a short video app owned by ByteDance, from operating in the US unless the Chinese technology company sold it within 45 days. Another executive order he signed on the same day said it would ban transactions on WeChat within the US, a messaging app and payments app owned by Chinese tech company Tencent. 　

The decoupling has spilled over to soft technology. The UK, France and Japan also have, one after another, either excluded or sidelined Chinese tech giant Huawei from their 5G telecommunication networks. China faces the risk of being excluded from the global technology industrial chain. 　

Meanwhile, the US is encouraging American firms to move out of China. White House economic adviser Larry Kudlow called for American companies to pull out of China in April and suggested the US pay all the moving costs for plants, equipment, intellectual property, structures and renovations. It is not just talk. The US has already offered loans as incentives to attract companies back. 　

In July, Japan unveiled a list of 57 companies that will move their manufacturing bases back to Japan, among which most are engaged in protective materials, medicine and medical equipment. 　

Despite China’s advantages, the risk of the removal of supply chains should not be underestimated. Proper policies are needed to cope with this.　

In the short term, China should enhance the countercyclical macro-adjustment of its economy, expand demand and stimulate domestic market vitality. At a time of weak demand and insufficient orders, stronger macroeconomic policies are needed to counter the impact from the pandemic and expand demand for companies, particularly small- and medium-sized enterprises, and help them restore production and operations. 　

China could consider targeted supportive policies for manufacturing industries that suffer sizeable gaps in external demand, such as textiles and apparel, electronic information, electronic machinery and other sectors to sustain the enterprises and maintain employment. The country could adopt tax reductions or exemptions, fiscal subsidies and other support measures to assist export-oriented companies in exploiting the domestic market, while encouraging domestic e-commerce platforms to sell quality exports in the domestic market. 　

In the long run, China should further deepen reform and opening-up and speed up the process of digitalization across industries. In a step to cope with the shift of supply chains outside of China, it should move to hasten talks on the trilateral free trade agreement with Japan and South Korea and make good use of the Belt and Road Initiative. Meanwhile, China needs to keep optimizing its business environment, enhance the protection of intellectual property (with substantive punitive measures on habitual and willful infringements), increase its appeal to foreign investors and encourage cooperation between transnational enterprises, to gather broader support in countering anti-globalization. 　

China also needs to speed up the removal of restrictions on market access for foreign and private enterprises to allow more room for social investment and unleash the vitality of private investment. Last but not least, it needs to support the acceleration of its industrial transformation and upgrading, particularly toward digitalization and the remolding of industries with smart technologies, to achieve the goal of reducing costs and promoting efficiency. These will all boost China’s global competitiveness and position in the supply chain.　

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Staying Hooked