Moving house is a pain. So imagine how it feels to be moving a factory with millions of dollars’ worth of equipment to another country will different tax and other regulations.
Talk of multinational companies moving their factories from China to another location has been going on for some time. The Covid-19 outbreak has made this discussion more urgent, as companies in China struggle to
restart production, with workers unable to travel back to workplaces in large parts of the country, much less get Chinese-made components delivered to factories around the world. CEOs might have to rethink their supply chain strategy.
Moving production out of China is not a new subject. Labour costs in the country, including wages and social security contributions, have risen in recent years. Hence, some labour-intensive manufacturing operations have already relocated to countries with a plentiful supply of workers, including Vietnam, Indonesia,
Bangladesh and Sri Lanka.
Despite this relocation, China remains the
largest exporter of textile and clothing, according to the World Trade Organisation. It accounted for about one-third of the textile and apparel trade in the world in
2018.
The trade war between China and the United States has accelerated the
relocation, because of the tariffs’ impact on a broad range of products.
Most business executives expect the tension between the world’s two largest economies to continue, regardless of the
outcome of the US presidential election in November. Some production of server motherboards and other hardware has already moved to
Taiwan.
Besides, the fact that US President Donald Trump has threatened to impose
tariffs on goods from a large number of trade partners means that there are few safe havens in an increasingly protectionist world.
In China, the efforts to contain the Covid-19 outbreak are holding up production, as workers have had trouble returning to work following the extended Lunar New Year holiday. Outside China,
carmakers have been forced to suspend production because Chinese-made components are not available.
Some consumer electronic companies might delay product launches, and have already warned of an impact on
near-term earnings. However, although the risks of future outbreaks add to the pressure on companies to diversify production to other locations, and some investments are going to be made outside the country, China should continue to play a dominant role in global manufacturing.
This is because companies, like people moving house, need to weigh up the pros and cons of relocation. Labour and the supply chain are important considerations, but not the only ones.
For example, China’s logistics infrastructure is a key reason that companies are able to afford just-in-time delivery and low inventories. China ranked
26th in the World Bank’s Logistics Performance Index in 2018, right between South Korea and Taiwan – and much higher than Vietnam (39th), Indonesia (46th), Sri Lanka (94th) and Bangladesh (100th).
In addition, some supply chains are clustered around specific regions and they will be hard to break up without generating additional costs and slowing production. Manufacturers should have a backup plan for such regional supply chains, instead of dismantling an existing system and starting a new one.
Another consideration is China’s domestic market. When
China’s manufacturing boom started after its WTO accession in 2001, the goods were destined for developed economies. But now the country has a growing
consumer market of its own.
Therefore, it still makes sense to keep China as a key production location. For example, despite shrinking sales in the past two years, China was still a
bigger car market than the US in 2019. It also has the most mobile phone users in the world. Staying close to Chinese customers is a very good reason to keep production in China.
That said, consumers in China are changing. They are starting to spend more on services, such as health care, education and financial services, thus driving changes in businesses operations and workers’ preferences. Instead of working 12-hour shifts in factories, some people may choose to switch to the service sector.
This means that, in the long run, China will change and upgrade manufacturing and production processes. China is unlikely to lose its status as the world’s factory, but it may take a form quite different from what we have known for decades.
Tai Hui is chief market strategist for the Asia-Pacific at JP Morgan Asset Management
This article appeared in the South China Morning Post print edition as: Companies have good reason to keep their factories in China
