Some factories might leave China, but the big picture doesn’t matter

China still holds the cards for global supply chains, whether or not Covid lockdowns frustrate businesses in the short term. A worker works on the production line of screens for 5G smartphones at a factory in Ganzhou, east China’s Jiangxi province, 13 May 2022.

Zhu Haipeng | Visual China Group | Getty Images

BEIJING — China is still holding the cards for global supply chains, whether or not Covid lockdowns frustrate businesses in the short term.

Companies and analysts have debated moving factories out of China for years, particularly since labor costs have risen and US-China trade tensions have intensified.

The pandemic has reignited those conversations. Foreign companies talk about executives being able to easily travel to factories in Southeast Asia, but not China. Some point to rising exports from Vietnam as an indicator that supply chains are leaving China.

“Supply chain diversification is quite difficult because people are always talking about it and boardrooms love to discuss it, but at the end of the day people often find it difficult to implement,” said Nick Marro, global trade leader at The Economist Intelligence Unit .

When companies had these talks in 2020, it turned out that “China could stay open while Malaysia and Vietnam went offline,” Marro said. “Really, the deciding factor right now is how China plans to maintain these [Covid] Controls while the rest of the world opens up.”

China’s so-called zero-Covid strategy of quick lockdowns helped the country quickly return to growth in 2020. However, implementation of these measures has since tightened, particularly this year as China faces a Covid resurgence in Shanghai and other parts of the country.

“Substantial” interest in Vietnam

According to the figures, China’s exports rose 3.9% year on year in April, the slowest pace since a 0.18% rise in June 2020, according to official data accessible via Wind Information.

In contrast, Vietnam saw its exports surge 30.4% yoy in April after registering a nearly 19.1% yoy rise in March, Wind showed.

Industry interest in Vietnam is “very significant,” said Vishrut Rana, Singapore-based economist at S&P Global Ratings, in a phone interview. “Vietnam has emerged as a very important supply chain node for consumer electronics.”

China remains the center of the electronics network in APAC.

Visrut Rana

Economist, S&P Global Ratings

However, according to Wind, Vietnam’s April exports totaled $33.26 billion, or about an eighth of China’s $273.62 billion in global exports that month.

“From a Chinese perspective, the churn away from local manufacturing will not be significant enough to really transform China’s role in the entire supply chain,” Rana said. “China still remains the center of the electronics network in APAC.”

Companies are still investing in China

In the first four months of the year, foreign direct investment in China rose 26.1% year-on-year to $74.47 billion, China’s Commerce Ministry said on Thursday. During this period, investments from Germany increased by 80.4%, while those from the US increased by 53.2%.

In contrast, Vietnam saw foreign direct investment fall 56% year-on-year to $3.7 billion in the first four months of the year, Wind data showed. Foreign direct investment from the US fell by 14%.

The recent Covid lockdowns in China have slowed the ability of trucks to move goods across China, while many factories in the Shanghai area had reduced or no production for weeks. Shown here is the workshop of a textile company in nearby Jiangsu Province.

CFOTO | Future Publishing | Getty Images

“It is currently very difficult to match the scale and scale of Chinese supply chains outside of China,” Rana said. Only supply chains for very specific products – like semiconductors or electric vehicle parts – could shift to Vietnam, Malaysia or other countries, he added.

China’s dominance in the supply chain, which has built up over the years, also supports new business models.

One of the better known is Shein. Backed by funds like Sequoia Capital China, the company has combined big data analytics and its supply chain network in China to cost-effectively become an international e-commerce giant.

“China’s advantage in the supply chain isn’t just based on labor costs,” James Liang, managing partner at Skyline Ventures, said in Mandarin, translated by CNBC.

According to his analysis, at least 20% of the selling price of apparel and furniture manufacturers goes into labor costs, compared to just 5% for electronics manufacturers.

China’s advantage is the advantage of having supply chain hubs, which Liang says paves the way for companies to increase efficiency by integrating all of their suppliers into one digital system.

He said his company invested $5 million in a furniture company called Povison in October that is trying to replicate Shein’s clothing model. Additional investment plans have been delayed due to Covid-related travel restrictions, he said.

“A Tale of Hesitation”

Recent Covid lockdowns have also slowed the ability of trucks to move goods across China, while many factories in the Shanghai area had reduced or no production for weeks. This comes on top of Beijing’s policy of mandating a two- or three-week quarantine on arrival in China since 2020 – if the traveler can book one of the few flights.

Shifting activities out of China is difficult, but “our survey shows that there will be less investment in China and more investment in Southeast Asia,” Jörg Wuttke, President of the EU Chamber of Commerce in China, said during a webinar.

He pointed out that it is now much easier to fly executives to Singapore or other countries in the region than to China.

As a result of recent Covid controls, nearly a quarter of 372 respondents to the EU Chamber of Commerce China survey at the end of April said they were considering shifting current or planned investments to other markets.

But 77% said they had no such plans. A survey of US companies in China found similar trends.

These survey results show that “companies don’t want to exit the market but don’t know what to do,” said Marro of the EIU. “Right now it’s more of a story of hesitation.”

“Foreign companies will be upset about this [zero-Covid] Politics, but at the end of the day there aren’t many companies that are going to jeopardize their position in a decades-old market because of a temporary shock,” he said.

Read more about China from CNBC Pro

Even companies like Starbucks, which had suspended forecasting due to Covid unpredictability, said they still expect their China business to grow larger than the US’s in the long run.

Many analysts expect China could start easing its zero-Covid policy after a political reshuffle in the fall.

When asked about the EU Chamber’s survey results on Thursday, the Chinese Ministry of Commerce only referred to the global impact of the pandemic on supply chains. The ministry also said China will improve its services for foreign investment and increase opportunities for foreign companies.

“Reconfiguring supply chains isn’t as simple as flipping a light switch on and off,” said Stephen Olson, senior research fellow at the Hinrich Foundation.

“Of course, if the lockdowns drag on indefinitely, the chessboard would be reconfigured,” he said. “In that case, there will be increasing pressure on companies to consider a shift in supply patterns, and the economic and commercial implications of doing so will be much more favourable.” Some factories might leave China, but the big picture doesn’t matter

Jane Marczewski

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