It’s Not Just U.S. Manufacturers
For now, the frontline of the trade war is between the governments of the United States and China. But the U.S.-China trade relationship is complex and the United States is the largest destination for products made or finished in China. That means this story is not solely about U.S. producers in China and whether they will move to reduce uncertainties. Any multinational producing and exporting from China has reason to re-evaluate how much it’s producing in China, for which markets, and whether now is a good time to diversify.
China is the last stop on the complex manufacturing journey of many products, such sophisticated consumer electronics like your iPad – or even the newest Transformer action figure that was conceived in New Jersey by Hasbro but manufactured in China (Bumblebee is trending for Christmas). Korean or Japanese or European producers whose products are finalized in China for export to the United States are subject to the tariffs on goods entering the United States from China, a situation they’d like to avoid.
Manufacturers of labor-intensive products like apparel have already been looking elsewhere in Asia as labor costs continue to rise in China. China has not substantially increased market access for foreign investors in many sectors, causing foreign investment to slow or flatline in recent years outside of consumer-related opportunities. Investments in industrial sectors are still driven in large part by industrial policy requirements such as forced localization of certain R&D, production or cloud computing activities. With lingering doubts about the worsening investment climate in China, the trade war is hastening decision-making that had already been underway.
Some Manufacturers are Shifting Now
Asian manufacturers in particular have an extensive footprint throughout the region, making it viable to begin reallocating small amounts of production from China to neighboring countries without building new facilities. Taiwan and Thailand are smartly promoting themselves as substitutes for China-based production.
Logistics companies are reporting that distribution centers for consumer products have begun shifting back to Hong Kong or Taiwan from the mainland. This trade diversion of products headed to the United States is likely to face increased scrutiny by U.S. Customs as it seeks to tighten enforcement of rules of origin while implementing the spate of new tariffs on goods from China. As that happens, more value-added production might leave China to become a legitimate export of another country and avoid the high tariffs.
Which Countries Will Benefit?
The Southeast Asian countries including Malaysia, Vietnam, Singapore, Indonesia and Thailand of ASEAN, have been attractive choices for Asia-based production prior to the U.S.-China trade war, but companies who made decisions not to locate or expand production there might start taking a second look.
Having negotiated free trade deals in recent years, China has become a useful platform for limited exports. Nonetheless, many American and other foreign producers have built plants and facilities in China primarily to serve the big and growing Chinese market. But other shifts are underway that might change that calculus too. China’s massive investments under its Belt and Road Initiative are increasing its connectivity with ASEAN countries. It may be increasingly cost effective to serve China from these production platforms while avoiding the complexity of restrictive and unpredictable Chinese regulation on foreign investors. In this scenario, production that moves to other Asian countries might not revert back to China.
A new report by The Economist Intelligence Unit predicts Vietnam, Malaysia, and Thailand could see long term benefits from regional production shifts. The report suggests that major electronics companies have existing manufacturing operations for intermediate components and consumer goods like mobile phones and laptops, making the redeployment of investment and production smoother and cost effective. Thailand and Malaysia have long been competitive producers of auto parts. Having increased their relationships with Chinese auto parts suppliers over the years, automakers might look to “re-diversify,” enabling other regional suppliers to win market share back from Chinese producers. The production of apparel and readymade garments has already been diversifying from China toward Vietnam, Bangladesh, and India, which the EIU expects will be big beneficiaries of U.S. tariffs on Chinese goods.
We’re Studying Our Options
It’s far too soon to know how investment patterns will change. Many companies surveyed or interviewed by the American Chambers of Commerce, research organizations, or news outlets have said the trade war impact has been limited so far, but that their company is “studying its options”.
Investment decisions involve major capital, workforce considerations, tax calculations, and many other factors. Production networks established in China cannot be replaced overnight. Tariffs are often not a significant component of these decisions, but if they are indicative of a much larger set of issues driving the trade war, then the tariffs and how long they will stay on is a question that’s likely to drive new internal corporate discussions about Plans B and C.
China’s Retaliatory Tariffs are Not Helping China
The obvious effect of China’s retaliatory tariffs on U.S. imports is to raise the cost of imported products for Chinese consumers. But there’s another downside. Just as foreign manufacturers could leave China to export to the United States, Chinese manufacturers may be motivated to move more production out of China for the same reason. The Chinese government can certainly step in to control or limit such outflows of Chinese foreign direct investment, but the tariffs may hasten trends already underway. China’s continual evolution from labor-intensive manufacturing to automation, and the government’s emphasis on building competencies in high-tech industries means that lower value-added production in China is already shifting to other markets.
Where everyone sits when the music ends will be the result of hundreds of thousands of company decisions now in the works. What’s even less clear is how much, if any, of the production that leaves China will find a home in the United States, one of the stated goals of this administration.