Why the two most popular manufacturing alternatives to China aren’t as flawless as the media makes them out to be

Vietnam and India have long been touted as manufacturing alternatives to China. This year, their governments have been welcoming foreign investment consideration relocation from China. However, the two countries aren’t quite the exemplary options that some make them out to be.

The world has long relied on Chinese factories and firms to provide all kinds of goods, from plastic toys to electric cars. But COVID-19 has highlighted some underlying issues in this model, most prominently how to meet demands and deliver essential products when items are predominantly produced in one country which can be cut off when disaster hits.

For some, trust in China has weakened too, fuelling support for some of the precepts of the Trump administration’s trade war. Many others are taking measured steps by implementing “China Plus One” policies – selecting some low-risk or high-reward programs to try outside of China while maintaining a base in China.

Some, however, are attempting to take more severe measures. In April, Japan presented a budget proposal, which included US$2.2 billion to reform Japan’s supply chains. A month earlier Prime Minister Shinzo Abe had expressed political will to diversify Japan’s supply chains away from China, stating:

“There are some concerns over the impacts of the decline in product supply from China to Japan on our supply chains. In light of that, as for those products with high added value and for which we are highly dependent on a single country, we intend to relocate the production bases to Japan. Regarding products that do not fall into this category, we aim to avoid relying on a single country and diversify production bases across a number of countries, including those of the Association of Southeast Asian Nations (ASEAN).”

A car factory in China. Credit: Bloomberg

Prime Minister Abe sees the plan as an adjustment, not a severing, and opportunity to utilise Japan’s alternative to China’s Belt and Road Initiative (BRI) – the Free and Open Indo-Pacific (FOIP) strategy. The plans may remain purely political rhetoric, though. In a recent article in the South China Morning Post, five top manufacturers including Toyota said that they had no plans to leave what they see as a critically important market, a move that they say would be unnecessarily expensive and disruptive.

Despite the potential risks of manufacturing in China and the incentives to find alternatives, why are firms reluctant to leave? We take a look at two of Asia’s most popular choices, Vietnam and India.

Vietnam – not quite the low-cost goldmine China once was

Vietnam seems keen to grasp the opportunity posed by calls to diversify supply chains. Last month, Prime Minister Nguyen Xuan Phuc said that the country is “getting ready to receive foreign investors who want to either invest in new projects or move their production from other countries to Vietnam.”

Vietnam is not a new destination for manufacturing. Since the nation’s Doi Moi reforms towards a market economy in the late 1980s, total annual exports in Vietnam have increased on average by 18.1%, and the industrial sector now makes up around 34% of GDP. It is a major producer of electronics, clothing, footwear, and furniture.

In March, Apple began producing some of its AirPods in Vietnam as part of plans dating back as far as 2018. Last year, Samsung shut down its last factory in China, instead opting for lower-cost Vietnam (and India). Many of Apple’s suppliers, including Foxconn and Pegatron, and iPad maker Compal Electronics, are also expanding operations in Vietnam.

The integral benefit of the Vietnam market is its cheaper labour. Minimum wages in Vietnam are even lower than its more impoverished neighbour Cambodiacurrently between US$132 and US$190 per month. Other benefits of manufacturing in Vietnam include the country’s strategic location, financial incentives for investors, and its collection of free-trade agreements, including one with the EU.

Vietnam’s factory worker salaries are significantly lower than China’s. Credit: Sourcify

But comparisons between Vietnam and China must be put into perspective. China has a significantly larger workforce than Vietnam’s, reflected in the countries’ 28% and 0.27% respective shares of global manufacturing. Moreover, Shanghai’s container ports can process 40 million containers per year, whereas Vietnam’s biggest port, Ho Chi Minh City, can only process 6.15 million.

Capacity for expansion is in question too. Vietnam is currently struggling to cope with rising electricity demand. Last year, the Ministry of Industry and Trade told Reuters that the country would start to face severe power shortages from 2021. Further issues include land pricing, logistics, and the availability of trained workers.

Another advantage China has over Vietnam is its fast-growing domestic consumer market, meaning companies that manufacture in China can often sell some of their products in the country – China accounts for about 15% of Apple’s total revenue. Although Vietnam has a growing middle class, it is still a much poorer country than China, with a GDP per capita closer to countries like Ghana and Papua New Guinea.

Finally, Vietnam is not immune to the doubts some have of China. President Trump has previously labelled Vietnam as the “worst abuser” for its significant trade surplus with the USA. According to the US government, the trade deficit with Vietnam was $39.5 billion in 2018, a 3% increase from the year before, with the services surplus increasing 19.9% from the year before. Although some may find Vietnam a viable location to diversify their supply chains, we cannot expect it to be a top-choice destination for all.

India – regulatory mismatch

India is seizing the opportunity to expand manufacturing too. In a recent short speech, Prime Minister Narendra Modi mentioned “supply chains” eight times and recapitulated the “Make in India” policy, a push to bolster manufacturing in India which Modi introduced during his first term. 

Credit: Lars Kaletta

In April, the new Production Linked Incentive Scheme (PLI) incentive program also came into effect, which offers financial incentives for makers of mobile phones and specific electronic components to start up or develop their existing domestic manufacturing capacity in India. The program will give tech manufacturers a 4-6% incentive on incremental sales of goods manufactured in the country for five years starting from August 1 this year.

Although around 50% of India’s working-age population is out of the labour force, growing participation and China’s shrinking workforce mean that by the year 2050, it is estimated that India’s workforce will be comparable to that of China’s today (over 800 million). 

Labour costs are favourable too, at one-third of China’s. In addition to salaries, Dr Mukesh Aghi, CEO of the trade group, US-India Strategic Partnership Forum (USISPR), points out that India has an English speaking and highly-skilled workforce, as well as a burgeoning middle class.

The US is India’s top trading partner and already provides almost 40% of generic drugs sold in the US. As for technology, according to the Indian government, the country’s share of global electronics manufacturing has gone from 1.3% in 2012 to 3% in 2018.

But Indian manufacturing does not operate entirely independent of China. Taking India’s drugs manufacturing as an example, almost 70% of its bulk drugs and intermediates – the chemicals that make a finished drug work – are imported from China. In total, a fifth of the global supplies of medications that are off patents rely on bulk ingredients from China, indicating the challenge some industries have if they want to cut China out of their supply chains.

Dr Mukesh Aghi also points out that while messaging and policies are well-intentioned and welcome for foreign multinationals, there is often a mismatch at the implementation level. India’s federal structure means rules that affect industry vary from state to state. In the past, labour regulations in some states have come out as ordinances, not laws passed by state legislators, which means nothing is stopping future state governments from revoking the ordinances of the previous government.

If you are setting up a factory in an Indian state like Uttar Pradesh, you are not planning your business around the schedules of single political terms; instead, you are thinking about decades ahead and require regulatory stability to do so. A study by Japanese financial group Nomura found that between April 2018 and August 2019, of 56 companies that relocated supply chains and manufacturing out of China, only three came to India. It seems India has a long way to go before it can lure a significant amount of manufacturing away from China.

If push comes to shove?

A poll this year of over 200 businesses with international supply chains showed that 87% of those who responded said the current situation would force them to “make changes” to their supply chains going forward. However, whether significant changes will be made to manufacturing in China is doubtful. A survey by the American Chamber of Commerce in China, conducted in March, suggests that 70% of firms claimed that they had no intention of moving out of China in terms of production or broader supply chain optimisation.

In the end, mitigating risk for (hopefully) once in a lifetime disruptions or political will is unlikely to override rationality for most businesses. Manufacturers need to figure out how to realign their supply chains, establish which production elements to relocate, what is the market entry strategy, and understand the rules and regulations that govern trade agreements. If even COVID-19 is not budging most companies, it is unlikely much else will.

Markets like Vietnam and India need further reform to attract more manufacturing in the long-term, including compliance with Western safety standards and availability of capital-intensive machinery. The World Bank’s 2019 Ease of Doing Business rankings put Vietnam and India at 70th and 63rd place respectively (China ranks 31st). Before the pandemic, Vietnam and India looked to be taking a slow jog towards manufacturing dominance – might they speed up pace now?

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

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