Post-pandemic politics would struggle to pull production out of China – here’s why

As of 2018, 28.4% of global manufacturing outputs came from China. That is the same as the US, Germany, France, Italy, and the UK combined. Before the pandemic, the US had already led a gentle push away from Chinese manufacturing, starting with 5G technology. The alternatives have been unimpressive, and few have followed the US’s lead.

This struggle is exemplified in the case of Foxconn, which after billions in subsidies and investments from local governments, years on has still failed to materialise a factory in the US. Now, the pandemic poses big questions on how to protect supply chains in times of global emergency. It begs the questions, can production quickly move out of China? What are the challenges Chinese manufacturers face? And how could these present risks, or possible opportunities, for the West?

Shanghai Port. Credit: Caixin

Does “Made in China” only mean cheap labour?

  • Local supply networks mean production times can be cut by weeks

A way to see China’s domestic supply chains is as a network. One story illustrates this particularly well. When drones were fashionable, many American investors tried to bolster US drone manufacturers. However, they ultimately could not beat China’s DJI, who now have a 90% market share in the US. Was it merely a race to the bottom in costs?

3D Robotics’ former Chief Revenue Officer told Forbes several years ago that it was “much more difficult for a Silicon Valley-based, software-focused company to compete against a vertically integrated powerhouse manufacturing company in China.” Whereas DJI could purchase all drone components locally and create finished products quickly, US manufacturers had to buy parts from many places, including China, losing weeks in the process.

Qin Shuo, who works for Z.H.ISLAND, shared a personal story which illustrates these strong networks when he visited a furniture company in Huzhou, a city in Zhejiang province. There, almost all of the company’s furniture was exported, half of which was to the US. In Anji County, which neighbours Huzhou, there are between two to three thousand SMEs that buy from this furniture company. “In just 20 minutes I could have every component shipped here to be assembled,” one SME CEO told Qin.

What we see here is a powerful “network effect”. A network effect is a value added to a service by the more users it has; the more users that join Facebook, the more valuable the platform is. Here, with the case of China, the number of manufacturers creates a highly efficient system through not just low costs, but also time-saving supply chains. This helps keep Chinese manufacturing highly competitive.

  • Manufacturing is specialising and producing higher-quality products at still low prices

Specialised regions have developed over time in China’s vast domestic market. For instance, supply chains of top companies in Guangdong and Zhejiang provinces rarely overlap. Guangdong supply chains can almost be contained wholly to the Pearl River Delta, which surrounds Hong Kong. Likewise, the Zhejiang supply chain is often completely held in the Yangtze River Delta surrounding Shanghai.

These manufacturers have also become more sophisticated. Long gone are the days where China produced mainly low-quality products. Manufacturers have been able to combine low-costs and high-efficiency to become competitive in the global market.

  • The workforce remains competitive

Low wages have kept Chinese labour competitive over the past few decades. There is also no freedom of association to create trade unions, and the right to strike was removed from the constitution in 1982. But low costs and lack of rights are not the only factors keeping it competitive; as Chinese manufacturers have become more sophisticated, so have the skills of the workforce. Meanwhile, in the West, an older manufacturing workforce and the general upward trajectory of working standards have widened the gap of competitiveness.

Why political isolation of China would hurt Chinese manufacturing

  • Chinese manufacturing relies on a globalised world to produce certain items

Chinese manufacturers still rely on core equipment and parts produced in countries such as Japan and Germany. The same goes for semiconductors, which are not yet produced of high enough quality in China. Last year, amid their trade war, Japan stopped selling South Korea three critical chemicals for the production of semiconductors. China is just as vulnerable – if American 3M glue were to stop being sold to China, there would not be a adequate alternative for producing Huawei smartphone circuit boards.

  • Chinese manufacturing needs more time to work on core scientific innovations

The strength of China’s manufacturing industry is in its breadth, not its sophistication. China is steadfast in simple innovations, but weaker in more complex ones. There are some outliers, for instance, Huawei being the leader in 5G technology, but globally China’s industry standards and branding power remains weak. Chinese manufacturing works best as part of a global market.

Current obstacles facing Chinese manufacturers

  • Policies tackling the monopoly of production in China

It is a no-brainer that the political spat between the US and China has disrupted Chinese manufacturers. The web of the trade war is complex, including tariffs, non-tariff barriers, government subsidies, intellectual property rights, security, and more. For Chinese manufacturers already running on slim profits, countermeasures such as anti-dumping duties on mattresses have pushed some companies into negatives. Companies will have to be quick to adjust to changing political climates.

  • Calls to bring manufacturing closer to home

With COVID-19 thrown into the midst, companies in the West are already considering moving manufacturing closer to home, in favour of security over efficiency. Some goods, such as face masks and PPE (personal protective equipment), will be produced domestically. Even within China, provinces and cities were blocked off during the COVID-19 outbreak, leading local governments to consider producing food locally in the future.

  • The cost-effectiveness will not always be competitive

For all the “advantages” of Chinese labour, China has already started to lose out to cheaper labour markets such as Vietnam. Attitudes towards factory work in China are changing too. Whereas factory work was once a valued tool for social mobility, younger generations have become more reluctant to work in manufacturing.

What China needs to change to address these challenges

  • Chinese manufacturers need to bring their model to overseas markets

Chinese manufacturers could start to globalise and move into markets closer to Europe and the US, such as Morocco, Turkey, and Mexico. Manufacturers can enjoy local policies too. For example, in Egypt, exporters are eligible for a tax rebate of 8-12% of the total value of products when 40% of the components are of local origin. Of course, producing overseas also comes with its challenges in management, labour, and law, all of which we are already seeing some Chinese manufacturers struggle with in Africa.

  • Sell more at home

For Chinese manufacturers wanting to pivot from exporting to selling within China, there is vast potential. China’s under-30 population is around 400 million. Whereas older generations grew up in more scarce times and spend less, younger people are big consumers with growing pockets. However, for manufacturers, the shift will require localisation and competitive branding and marketing.

  • Resources and profits are still concentrated in state-owned enterprises (SOEs) – private enterprises need a fairer game

Entrepreneurship in China will also need to be protected if manufacturers are to sell more at home. Although traditional business practices of wooing officials and the like are being discouraged, resources and profits are still being eaten up by giant state-owned enterprises. Qin Shuo puts SEOs at 108% larger than private businesses in 2018. Continuing to reform and open up could help unravel China’s development path and open opportunities for improved international relations. 

According to Xinhua, new policy guidelines released by the Communist Party Central Committee and the State Council in April express that the market rather than the state should decide where land, labour, tech, capital, and data resources go. China must have a sense of urgency. Promises of fairness will need to move from rhetoric to action for the country to adapt to a post-pandemic world.

  • China needs to continue to reform and open up

Although China’s economy has continued to grow since economic liberalisation began in 1978, under the leadership of President Xi reform has stagnated. Both Chinese and foreign companies are facing more political controls. The party has also increased representation and control over SEOs and even directed some mergers. Although the latter changes were made under the context of an anti-corruption campaign, they have made China the “least open” since reforms began, according to China expert Pei Minxin. A balance will have to be struck for China to continue to benefit from a global market.

Adapted from (Chinese): https://mp.weixin.qq.com/s/QWUJgFux8_8NbpDTu254Bg

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