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How Bad Is China’s Manufacturing Exodus?

Yang Jinxi, Qu Yunxu, Du Zhihang and Denise Jia wrote . . . . . . . . .

China’s strict pandemic controls, which are blocking production and logistics, threaten to add impetus to the manufacturing exodus from the country that has been picking up speed over the past decade, international trade experts say.

The COVID policy disruptions add to pressures from rising labor costs in China and worsening Sino-U.S. trade tensions. With low labor costs and surging domestic demand, Southeast Asia and India have become the most popular destinations for investors.

In April, Apple said it started making its iPhone 13 at an Indian factory owned by Taiwanese contract manufacturer Foxconn. Prime Minister Narendra Modi’s government is pursuing a “Made in India” campaign, aiming to turn the country into a global manufacturing powerhouse by cutting red tape and attracting investment.

Still, China retains tremendous advantages as a manufacturing center built up over the past several decades, and its enormous and rapidly expanding domestic market provides a powerful incentive for investment in capacity of all kinds. Southeast Asian nations, and even India, still have enormous hurdles to overcome in competing with China, trade experts say.

So far, most of the manufacturing leaving China has been in lower-end processes and hasn’t hurt China’s dominant position, many industry participants say. But the trend is forcing a transformation and upgrade of China’s manufacturing toward higher-value goods, creating risks and opportunities for domestic manufacturers, they said.

A Chinese trade official said the outflow of foreign trade orders is controllable, and its impact has been limited.

Manufacturing moving out of China is “in line with the law of economics,” Li Xingqian, director general of the Ministry of Commerce’s foreign trade department, said June 8 at a regular State Council briefing. China’s position in global industrial and supply chains is stable as China has a complete industrial system, with advantages in infrastructure, industrial capacity and professional talent, Li said. China’s business environment is continuously improving, and the attraction of the domestic market is still growing, he said.

Uncertain export outlook

China’s exports grew 16.9% in May from a year earlier, accelerating from April’s 3.9% increase and climbing well above the 8% gain projected by economists, customs data showed. China posted a trade surplus of $78.76 billion in May, up from a $51.12 billion surplus in April.

Exports rebounded as COVID-related bottlenecks on production and logistics eased, but the outlook remained uncertain as global consumer demand cools amid economic slowdowns and high inflation.

All manufacturing bases, including China, now face worries about weak demand in developed countries. Inflation in Europe and the U.S. are at the highest levels in 40 years, eroding consumers’ purchasing power and willingness to spend on nonessential goods.

Export orders for delivery in June and July, usually the peak season for booking goods for the back-to-school and holiday seasons, didn’t come in as expected, several people in the export sector said.

Weak demand in Europe and the U.S. was reflected in declining shipping prices, said Lin Jie, founder of Worldwide Logistics Group. Shipping costs from Shanghai to U.S. West Coast ports declined by 5.1%, and to the East Coast by 4.6% in the week of June 17, compared with the same period last month, according to the Shanghai Shipping Exchange.

The drop in shipping rates means clients that placed orders earlier are paying higher transit costs. While this hasn’t led to widespread cancellations, it could affect subsequent orders if demand does not pick up by July, said Zhang Huafeng, Los Angeles chief representative at Transfar Shipping.

It may take until the end of this year for American importers to work down inventories built up last year, said Wang Huanan, general manager of the Xiamen unit of Hailian (China) International Freight. Only certain categories, such as auto parts, clothing and luggage, have relatively low inventories, Wang said.

Last week, U.S. President Joe Biden said that to help curb inflation he was considering lifting tariffs that his predecessor imposed on $350 billion a year of Chinese goods, including bicycles, baseball caps and sneakers, during a tit-for-tat trade war. But it’s not a simple decision, and advisers within the administration are divided on the matter.

Dropping the tariffs would boost China’s exports, but the key is the timing, Wang said. July is traditionally the busiest month for exporters as goods for year-end holidays need to be shipped by then, he said.

China still the world’s factory

Neither Southeast Asia nor India can replace China as the global manufacturing hub in the near future as they are mainly engaged in labor-intensive and low value-added manufacturing, several foreign trade participants told Caixin. They also face problems such as incomplete industrial chains and low labor efficiency to varying degrees, experts said.

To foreign companies, China is not only a manufacturing base but also a huge market, said He Xiaoqing, president of consulting firm Kearney Greater China. In 2020, global companies had $1.4 trillion of domestic sales, far more than their exports of $900 billion, showing the attractiveness of China’s local market, He said.

The share of finished products among China’s exports should slowly decline over time, said Gao Shiwang, director of the industry development department at the China Chamber of Commerce for Import and Export Machinery and Electronic Products. Taking machinery and electronics as an example, higher-value-added integrated circuit exports increased 32% to $153.8 billion in 2021, surpassing those of cellphones, Gao said.

Vietnam, especially, has been one of the biggest beneficiaries of factories leaving China. The country offers manufacturers access to the 10-member Association of Southeast Asian Nations (ASEAN) free trade bloc and preferential trade pacts with countries throughout Asia and the EU as well as the U.S.

In the first five months this year, Vietnam’s exports rose 16.7% year-on-year to $153.29 billion, compared with a high base in the first half of 2021.

China’s outflow of factories to Southeast Asia is mainly concentrated in textiles, furniture and low-end assembly of consumer electronics. From the fourth quarter of 2021 to the first quarter of 2022, about 5% of China’s textile, 7% of household goods and 2% of mechanical and electric goods orders moved to ASEAN countries, U.S. import data shows.

Among Apple’s top 200 suppliers, the number of companies setting up factories in Vietnam increased from 17 in 2018 to 23 in 2020, including seven Chinese mainland companies, according to Everbright Securities.

So far, Vietnamese electronics factories are still mainly engaged in low-end assembly. For example, Apple AirPods and iPhone manufacturer Lixun Precision’s subsidiary in Vietnam mainly produces connectors and computer peripherals. Chinese company Lens Technology makes iPhone glass in its Vietnam factory.

Even though many orders now go to Vietnam, more than half of them come from China, Transfar’s Zhang said. U.S. clients are still actually doing business with Chinese companies, it is just that the goods are shipped from Vietnam, he said.

The export capacity of the whole of Southeast Asia, especially Vietnam, is overloaded and has little room to handle more orders in the short term, Zhang said. In the medium to long term, Vietnam’s rapid growth in the past three years has reached a bottleneck, with diminishing land and labor cost advantages, he said.

Shipping costs from Vietnam and Indonesia to the U.S. are much higher than from China, as those countries have fewer direct shipping vessels, and transit times are about a week longer from Ho Chi Minh City to Los Angeles than from Shanghai, Zhang said. Normally, the shipping cost from a Vietnamese port is $300 per container more than from a port in China. In the first few months this year, the price premium widened to $3,000 per container.

Deng Shengpeng, whose company makes furniture hardware parts in Anji, Zhejiang Province, opened a factory in Vietnam in 2018. The skyrocketing shipping costs this year made it hard to land new orders, he said.

Labor costs are still much lower in Vietnam than in China, but its land cost advantage is diminishing. Workers in Deng’s Anji factory are paid about 7,000 yuan ($1,046) a month and work 10 hours a day, while those in Vietnam make 2,500-3,000 yuan a month and work 8 hours a day. Deng has also witnessed a surge in land prices in Vietnam in recent years. Before 2018, 1 sq. meter of land cost $20-$30. Now the price is $160 per sq. meter, he said.

Chinese companies’ factories in Vietnam rely on raw materials and parts from China. Supply chains blocked due to pandemic lockdowns earlier this year also affected production in Vietnam.

Yang Zhongwei is the production manager of a Chinese router parts maker’s subsidiary in Vietnam. The factory needs to import all of its materials from China, which usually take a week to arrive. In the past two months, materials from Suzhou and Kunshan were delayed by more than a month, causing clients to threaten cancellation of orders, Yang said.

Yang’s company is considering switching to local sourcing, but it is not easy because Vietnam has a weak industrial base and costs are higher. For example, carbon tapes on printers costs about 21 yuan per roll, three times the price of those sold in China on Alibaba’s Taobao, Yang said.

In India, Chinese smartphone makers set up factories aiming at the huge domestic market. With 1.4 billion people, almost as many as in China, and a high proportion of young people, India has drawn Chinese brands including Xiaomi, Meizu, Vivo and Oppo to build factories. Many Chinese phone parts makers have also set up factories there. Now Chinese brands account for nearly two-thirds of India’s smartphone market.

But India has been getting tough on Chinese companies since border tensions escalated two years ago. In 2020, India banned more than 200 apps, many of them Chinese, including the wildly popular video platform TikTok. India accused Xiaomi’s India unit of moving money out of the country illegally.

India does have an edge in software services, thanks to its education system and labor cost advantages, said Li Zhiqiang, managing director of China Telecom India. But in terms of network infrastructure and support, India still lags behind. For example, many Chinese companies’ factories in India don’t have fiber optic coverage, Li said.

India also has a shortage of smart manufacturing talent. India has a relatively successful elite education system, but its training of technicians in high-end equipment operation and maintenance can’t meet market demand, Li said.


Source : Nikkei Asia

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