How are global companies spreading their China bets?

21 Feb 2023 , 12:49 PM

In the aftermath of the COVID crisis and the strong zero-COVID policy adopted by China, most countries realized that the world economy was hopelessly dependent on China to feed the supply chain. From bulk drugs and chemicals for pharma industry, to components for automobile industry, to metals for various applications and even batteries and solar panels for EVs; it was all about China. The COVID pandemic underlined the risks of such an approach; forcing global companies to look at diversifying their supply chains.

How China emerged as the factory to the world

The China story, effectively, began not more than 36 years ago when Matsushita Electric Industrial of Japan started outsourcing electronics manufacturing to China. What began as an experiment in 1987 to manufacture cathode ray tubes (CRTs) for its National and Panasonic television brands, became the biggest manufacturing story. China had just opened up its economy to private investments under Deng Xiaoping in 1979 and their biggest selling point then was cheap labour. In year 2021, China exported electronic goods and components worth $1 trillion, accounting for over 30% of the global export of such electronic components. China had clearly arrived.

It was not just cheap labour that attracted global investors to China over last 30 years. China built capacities across industries, of absolutely global scale and they could accommodate scores of gigantic foreign companies in manufacturing. China had the ecosystem that could handle scale with speed and at economical cost. Apart from world class physical infrastructure, the entire approval process for new factories company formation, land acquisition and labour procurement was done with unmatched pace and efficiency. With quality infrastructure, low costs, disciplined labour and a rule-based system; China had all the advantages. Then, what exactly went wrong?

COVID pandemic largely changed the narrative

In the last couple of years, global companies are increasingly looking at alternative destinations like India, Vietnam, Thailand, Malaysia, Philippines and Indonesia. The problems for China began with COVID and its stringent zero COVID policy. However, the actual narrative is much more complicated.

1. The stringent lockdowns by China created a crisis for most industries ranging from chemicals to pharmaceuticals to automobiles and solar energy. Global companies realized, for the first time, that the overt dependence on China to feed the global supply chain had major downside risks too.

    

2. The stand-off between the US and China has been going on, even before the COVID crisis. Since 2017, the Trump government had imposed stringent sanctions on imports from China to reduce the trade deficit. Also, the US had accused China of not respecting IP of US companies and had also red-flagged serious security breaches by China.

    

3. In the last few years, China had been making geopolitical noises in the South China Sea and there have seen repeated complaints of encroachments from Japan, Thailand, the Philippines and even Malaysia. China also indulged in sabre rattling with one of the closest US allies, Taiwan, making US companies uncomfortable.

    

4. Lastly, in recent years, most American companies including the likes of Apple and Boeing felt that the risk of overt China dependence was too high. That gets more pronounced considering that global companies today have effective alternatives like India, Vietnam, Thailand and the Philippines to fall back upon.

Has China really lost manufacturing share in recent years?

One would be inclined to believe that this debate over an alternative to China as a manufacturing hub may have arisen only due to external factors. However, the reality is that Chinese labour is gradually losing its cost advantage. For instance, between 2013 and 2022 manufacturing wages in China doubled from $4.00 per hour to $8.27 per hour on an average. That had taken away the most attractive factor in China manufacturing, especially when other Asian economies were offering the same manufacturing capabilities at a gross level but with wages as low as $3.00 to $3.50 per hour. So, apart from the supply chain, intellectual property and security issues, there is now a basic cost disadvantage in China too.

What has been the shift that is happening out of China?

• Japan, which was one of the early believers in the China story, has seen the number of Japanese companies operating in China fall from 13,600 to 12,700 (6.7% lower). Clearly, these are signs that the early birds are looking at China alternatives.

   

• Big companies have already started to shift out. For instance, Sony will move production of cameras sold in Japan and the West from China to Thailand. While Samsung will slash its China workforce by 33%, Dell will stop using China made semiconductors by 2024.

How big and how real is the China alternative?

It would be naïve to dismiss the China alternative effort as noise. It is actually much bigger and there is an eminent business logic to it. While the smaller Asian emerging economies may not be able to match up to scale with China, they can be formidable as a combined force. If you add up countries like India, Vietnam, Thailand, Indonesia, Malaysia and the Philippines; it can actually offer a veritable alternative to China.

• The alternative emerging Asian economies offer working age population of 1.40 billion against just 980 million in China. 

   

• These countries put together, have about 154 million people in the age group of 24 to 54 with tertiary education, which is the real demographic dividend to be leveraged.

   

• As stated earlier, the average wage in this segment of countries is in the range of $3.00 to $3.50 per hour, which is less than half the wage rate in China today.

   

• The merchandise exports of these Asian countries to the US is around $650 billion for the full  year, more than what China exports to the US.

In short, for American and European companies there is the advantage of lower costs, established production facilities, friendly government regulations and a sizable domestic market. More importantly, there is already an existing trade relationship that the Western companies share with these countries.

Can India offer a model here?

One question that does arise is that if global companies rely on multiple partners across multiple Asian economies, how do they synchronize the different regulations, tax systems and supply chains. There are 2 possible models.

• The first is the Japan / Korea model. Japanese companies like Sony, Kawasaki and Mitsubishi have been building supply chains in Southeast Asia for over 25 years. South Korean chaebols like Hyundai, Samsung and LG are also now doing this in a very efficient fashion. The result is that the non-China investment of south Korea today is as large as the China investment. 

   

• The second model is the India model; the one that Apple is deploying to reduce its China dependence. Apple has got its mega Taiwanese contract manufacturers like Foxconn, Pegatron and Wistron to invest heavily in Indian factories. India’s share of iPhones made is expected to rise from 5% today to 25% by the year 2025. 

It is not just Apple. Google is shifting production of its latest Pixel smartphones from China to Vietnam even as Samsung is also shifting its chip factories to Vietnam. However, replacing a hugely knit market like China may be tougher than imagined. The shift out of China will not be total; bit it would be partial. But, it is happening nevertheless and the good news is that India (thanks to its PLI policies) is at the centre of this shift.