Source: UN, Gartner, companies
Source: UN, Gartner, companies

China – should sourcing stay or should it go?

10 November 2022

With the rise of globalisation China emerged as an economic powerhouse. Now, as countries look to shake off its stronghold, are we facing an economic iron curtain?

It’s 1979, the year when opening up to foreign trade and implementing free market reforms helped China gain the status of one of the world’s most rapidly growing economies, so much so that the World Bank dubbed it “the fastest sustained expansion by a major economy in history”. Jump ahead 40 years to 2019, and 28.7% of global manufacturing was taking place in China, according to the UN, with the next closest country being the US at 16.8%.

However, what took four decades to build may now be standing on uneven ground. Over the past three years, global supply chains have begun morphing in response to Covid-19 lockdowns and their impacts, and geopolitical tensions, all of which served to highlight the risks of having suppliers concentrated in a single region. “[The pandemic] exposed these really long global supply chains, and the whole dynamic has shifted,” Kamala Raman, vice-president for logistics, customer fulfilment and supply chain network design at Gartner, told Supply Management.

Gartner found that 94% of companies are looking to move out of China and more firms are adopting a ‘China plus one’ strategy; establishing additional options away from the country while maintaining the existing supplier base within it. It could help firms test their options to move away, without the risk of leaving China entirely. Raman said: “China plus one allows companies to hedge their bets, and hopefully to pivot whichever way the world is pivoting.”

And it isn’t just talk. Global tech giant Apple already moved some production of its latest iPhone 14 to India, while a growing number of automotive firms are looking to the Americas. For instance, Honda and LG Energy Solutions have partnered to invest $4.4bn into building an electric battery production plant in the US, with Hyundai, Ford and Mercedes-Benz making similar but separate investments in the region.

These moves are likely to be the start of a chain reaction, encouraging other organisations to quit China. Nils Poel, senior manager of trade and market affairs at the European Association of Automotive Suppliers, told SM such diversification is necessary to strengthen the sector’s global competitiveness, and is “key to safeguarding our economic and social fabric”.

Meanwhile, the World Economic Forum’s (WEF) Chief Economists Outlook states: “In the context of supply chain reconfiguration, companies are shifting from efficiency to resilience and are expected to prioritise localisation over diversification.” As companies put stability ahead of speed, is China too risky for buyers?

The risks of staying with China

China’s zero-Covid policy could have wider consequences for the world economy than Russia’s war in Ukraine, Alicia Garcia Herrero, chief economist for Asia-Pacific at Natixis, argued in the Asia Times. While this might seem hyperbolic, the policy was responsible for halting production at Tesla and Toyota, and 78% of businesses surveyed by the EU Chamber of Commerce in China said it was a less attractive destination for investment due to its Covid response.

China is certainly a more volatile option than it used to be, and the risks are not limited to disruption, as Russia’s invasion of Ukraine highlighted how geopolitical turmoil directly impacts supplies and costs. Raman noted, for example, that many political analysts expected US-China relations to improve upon Joe Biden’s appointment as president, after Donald Trump’s administration placed high tariffs on Chinese imports. Instead, tensions have “become a bigger flashpoint” due to China’s aggression towards Taiwan.

John Manners-Bell, chief executive of Transport Intelligence and founder of the Foundation for Future Supply Chain, argued that for some firms, “it could become impossible” to maintain their supply chains in China. Manners-Bell pointed to how regulations being discussed in the US to place controls on the export of semiconductor technologies to China show how trade and cooperation between the countries is becoming increasingly difficult.

“This is very important. It’s difficult to see a time when the US would place a ban on exporting this technology. But it is possible, and something a lot of companies will be very much aware of,” he said. “But given the tensions that have been growing between the US and China over Taiwan, it’s maybe not so difficult to envision that particular scenario.”

The limitations of the relationship 

One key consideration in relation to working in China is production costs. Anna Bryhe, director of advocacy at Labour Behind the Label, has questioned apparel brands that claim to be diversifying out of China for “ethical or political reasons”, arguing such decisions are driven by the desire for cheap labour. “China has higher wages than many other garment producing locations,” she pointed out. “It seems clear to us that this is related to cost rather than anything more strategic.”

Raman added companies need “very sound business reasons” to undergo a comprehensive diversification out of China, and warned that planning supply chains around current political tensions can be risky. “If the geopolitical currents we have right now get worse you will see a little bit more anxiety. If it gets better, business is business,” she said. “They are colourblind, they are nationality blind – or they would like to be nationality blind – and just go where the costs are lower. It took 20-30 years to move so much into China. So it will take 20-30 years to make meaningful moves out.”

Fundamentally, a move out of China would impact costs and require long-term projects. Intel’s $20bn semiconductor factory in Ohio, US began construction this year, and is not slated for production until 2025. “For the short term, it will be more costly for the consumer,” Manners-Bell said.

However, he explained, “over a period of time, when we see a time where there may be disruptions, if you’re manufacturing just from a single location in China and an earthquake takes out your manufacturing capability, that will have a major impact on your revenues. If you’re able to switch some of your manufacturing to other locations, then you’ll be able to continue production, and that will have an impact on cost in a positive way. But overall, there will be more costs and those will be passed on to the consumer, inevitably”.

A new economic iron curtain?

The fervour to diversify out of China shows how supply chains are inherently reflective of wider geopolitical relations. “Multinationals are realigning supply chains along geopolitical fault lines, risking a new economic iron curtain and further price spirals,” the WEF wrote in its Chief Economists’ Outlook. It is China and Russia that lie at the crux of these fault lines, whose aggression towards neighbouring regions have put global supply chains on edge.

While companies detangled their supply chains from Russia following its invasion of Ukraine, trade with the country did not cease altogether. A report by the Centre for Research on Energy and Clean Air found while the EU, UK and US reduced their imports of Russian gas in the months after the invasion, India, China, the United Arab Emirates and Saudi Arabia increased imports. This divide over Russian gas could shed light on the trading relationships Moscow and Beijing are looking to capitalise on.

“We’re going to see the world break up into two new hegemonies, one of those driven by the US and the west, and the other will be very much focused around Russia, China and countries which fall within its sphere as well,” Manners-Bell said, especially in key sectors such as semiconductors, green technologies and automotive batteries. This will leave a lot of countries, including Latin America, “trying to look both ways” as they balance competing economic interests. “It’s going to be a very difficult situation for those who fall between the gaps,” he said.

The fragmentation of global relations is happening through supply chains, and procurement. While Lina Georgieva, managing director of the International Monetary Fund warned at the WEF Davos conference earlier this year that the world may be “sleepwalking from one Cold War into a new Cold War”, this is still some way off. However, it is clear global supply chains will be at the forefront of these conversations.

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