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September 18, 2020

Asia

CHINA: The latest evidence on supply-chain migration

BY Gabriel Wildau

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( 5 mins)
  • Evidence of large-scale supply chain migration away from China remains scarce.
  • Covid-19 appears to have slowed or even reversed the decline of China’s global export market share low-margin consumer goods, while consolidating market-share gains in capital goods.
  • But in the medium term, rising costs, geopolitical tensions, and industrial policies from rival economies may still challenge China’s status as the world’s preeminent exporter.

The possibility that the combination of geopolitical tensions and the global pandemic could force manufacturing supply chains to exit China remains a hot topic. In May, we argued that clear evidence of a supply-chain exodus was scarce and that a large-scale exodus was unlikely. The latest evidence on this issue reinforces our view that diversification towards a “China plus” is the dominant trend, while few companies are abandoning or even substantially reducing their reliance on China for manufacturing and sourcing.

Trends in China’s export market share

China’s share of total world goods and services exports reached an all-time high in 2019 and will remain roughly stable through 2021, according to OECD data and forecasting. Looking only at goods exports, China’s global market share peaked at 13.7% in 2015 but has declined only modestly since then, reaching 13.2% in 2019, up from 12.8% in 2018, according to data from the United Nations Conference on Trade and Development.

Beneath the headline figures, the situation varies across sectors. In consumer goods, China’s global export share fell from 46% to 42% between 2018 and 2019, while Southeast Asia and Latin America gained market share, according to research from Baker McKenzie. Within consumer goods, Chinese market share losses were concentrated in smartphones, household electric goods, and furniture. Meanwhile, China has gained global market share in capital goods like machinery for energy, mining, and infrastructure – due partly to the Belt and Road Initiative.

Covid-19 impact

Even in categories where China had been losing market share, the pandemic may have slowed or even reversed this trend, at least temporarily. Chinese export growth has repeatedly outperformed expectations in recent months, due to two main factors. First, while Covid-19 depressed overall global demand, the pandemic boosted demand for specific goods – including medical supplies and home office products like computers and furniture – where China was already the leading supplier. Second, Beijing’s effectiveness in controlling the pandemic allowed China’s manufacturing sector to recover earlier than competitors in the US, Europe, and Southeast Asia. After cratering in February, China’s factory output had already reached about 95% of pre-pandemic levels by February and had exceeded those levels by August.

China’s early recovery from Covid-19 may also have accelerated the pre-pandemic trend of Chinese market share gains in exports of capital goods. In recent years, market share gains in capital goods largely balanced out losses in consumer goods. In December, state-owned CRRC Corp won a EUR 50mn deal with the light rail system in Porto, Portugal’s second-largest city, becoming the first Chinese company to win a train contract in the EU. More recently, sales of pandemic-related items accounted for all of China’s export growth in March through June – outweighing year-on-year declines in exports of other products. But in July and August, non-pandemic items, including capital goods, made a positive contribution to overall Chinese export growth.

Beyond the speed of its recovery, China’s manufacturing sector also demonstrated impressive flexibility during the pandemic. The breadth and abundance of existing supply chains gives China an advantage in adapting to changes in global demand. Textile factories were able to retool quickly to manufacture medical masks, drawing on existing supply chains and expertise not only in textiles but also in chemicals and machining, which are required for a mask’s non-woven fabric layer and its plastic and carbon filters.

Multinationals remain committed

A recent survey by the American Chamber of Commerce in Shanghai indicates that foreign companies remaining committed to China. Among more than 200 US companies who responded, 85% do not intend to shift any production out of China, while 15% are moving at least some production out of China. Of this latter group, more than half plan to relocate less than 20%, while only 2% plan to move all production away from China. Anecdotally, foreign executives in China say that they received substantial assistance from the government to help them restart factories.

Data on US foreign direct investment into China also suggests an enduring commitment to the Chinese market. Such FDI ticked up slightly in 2019 compared to 2018, and the long-term trend is remarkably stable, with annual value remaining within the USD 13-15bn range every year since 2012. This stability contrasts with Chinese FDI into the US, which has collapsed since 2016, due to a combination of Beijing’s tighter capital controls and increased US government scrutiny of inbound Chinese investment.

Challenging outlook

China’s status as the world’s preeminent export power still faces risks and uncertainties. Rising wages and environmental compliance costs will continue to push low-margin industries towards lower-cost countries. The global economic contraction resulting from Covid-19 has forced cost-cutting at many companies, making them reluctant to invest in new supply chains. But as corporate earnings recover, companies may become more willing to make long-term capital expenditures. If US-China relations continue to deteriorate, trade with China could become politically toxic or simply unprofitable due to additional tariffs. Finally, the US, EU, and Japanese governments are all considering expanded use of industrial policy to encourage domestic production, using incentives such as low-cost loans, tax incentives, cash subsidies, and long-term supply contracts.

Beijing is well aware of these risks, as reflected in the government’s new “dual circulation” economic strategy, which focuses on boosting domestic demand to hedge against the uncertain outlook for foreign demand. Still, the most likely outcome remains that decoupling will occur selectively in industries like semiconductors, artificial intelligence, and medical supplies, while China will remain central to most industrial supply chains.