Why 'China Plus One' could be the answer for global supply chains

2 September 2020

Global supply chains will change post pandemic but a full decoupling from China is “unrealistic”, according to a report.

A report by the International Institute for Strategic Studies (IISS) said disconnecting from China’s supply chain is “economically and, for some countries, politically unfeasible”.

It is more likely that China will remain “a key player” and countries will move towards a “China Plus One” strategy, which focuses on diversification by having a factory in China and another in a developing country in the Southeast Asia region, such as Thailand or Vietnam.

The IISS said: “From a purely economic perspective, businesses and countries that aim to localise and/or regionalise manufacturing, and that currently have supply chains highly interconnected with China, must consider how feasible it is to decouple from the ‘world’s largest factory’.

“A full decoupling from China is unrealistic. The China Plus One strategy seems a more likely scenario, at least for non-essential, basic manufactures.”

As a major international supplier of products, from electronics to industrial machinery and medical equipment, the world’s 1,000 largest companies depended mainly on Chinese suppliers that were quarantined during the pandemic, the report said.

The issue of dependence on China bringing vulnerabilities to countries’ supply chains, especially those high in value and at risk of supply scarcity, was not new, said the report. However, as global impacts have escalated during the pandemic, private and public firms have accelerated mitigating actions, including supplier and logistical diversification, localisation, and increased use of advanced technology for improved forecasting.

Due to the complexity of the interconnecting global supply chain, “swift and massive localisation or regionalisation of supply chains” is unlikely, said the IISS.

The report highlighted several barriers, including economy size, costs and geopolitics. China's economy overshadows competitor countries and provides manufacturers with direct access to 1.4bn potential consumers. Relocating production is also costly and time-consuming. Manufacturers will still require inputs and raw materials imported from China to produce elsewhere, and complex geopolitics impact trade decisions.

The China Plus One strategy could generate opportunities for Southeast Asian developing countries. However, “any strategy to displace Chinese suppliers will have to be threaded carefully in order to minimise geopolitical risks,” said the IISS. 

It recommended using the approach of multilateralism – rather than rivalry – to diversify into other key countries in the region, including Japan and South Korea.

“With regards to localisation of strategic goods, if governments wish to achieve a full decoupling from China (or any external supplier), they will have to provide domestic manufacturers with significant fiscal and financial incentives,” it added. 

Governments may also combine some incentives with tariff increases to prompt industries to localise. However, in any scenario, this will result in consumers paying a much higher price for product reliability. 

Countries which are already working to reduce dependence on China include Japan, South Korea, and the US.

Japan is an example of a country which has considered China Plus One. In April, the government set aside $2bn (220bn yen) in subsidies for Japanese manufacturers to relocate locally, and a further $230m (23.5bn yen) for firms relocating from China to Southeast Asia, according to the report.

South Korea has launched a $95bn (114trn-won) five-year plan called the ‘New Deal’ aimed at reducing dependence on external suppliers post-pandemic by expanding local manufacturing of high-tech equipment to be used in areas of clean energy, telecommunications and technology (mainly AI).

The US has announced plans to work with international allies to restructure its global supply chain, including Australia, Japan, New Zealand, South Korea and Vietnam. Trump also signed an executive order outlining that the government will procure “essential medicines” from US manufacturers to boost domestic production. 

The report highlighted that world trade is expected to fall by between 13% and 32% in 2020.

Initial supply shock from the Wuhan lockdown wiped out $50bn of global exports in February 2020 alone, and subsequent worldwide lockdowns drove global trade to plunge 27% year-on-year in the second quarter of 2020 – even worse than during the financial crisis of 2008, according to the UN Conference on Trade and Development.

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