The pandemic-mitigation measures adopted by affected countries around the world have in some cases led to the closing of borders and heightened concerns about the national-security aspects of pandemic response, which will tend to result in the onshoring of the production of critical medical supplies and pharmaceuticals.
Since many of these medical supplies are produced primarily in China, in the US and elsewhere there is also increasing discussion of a broader “decoupling” from China.
Senior officials in President Donald Trump’s administration have floated the idea that the US government may reimburse the costs of American companies relocating operations out of China, in order to diversify geographic risks to global supply chains and reduce over-reliance on China.
Japan has taken similar steps, announcing that it will provide direct loans totaling 220 billion yen (US$2 billion) for Japanese companies to shift production from China back to Japan, plus an additional 23.5 billion yen to help Japanese companies move out of China to other countries.
How big a threat is this to China’s position as the second-most-popular destination in the world for foreign direct investment (FDI), trailing only the US? Answer: This is principally cheap talk for domestic consumption.
Although US President-elect Joe Biden also talks about bringing manufacturing jobs back home, his choice for secretary of state, Tony Blinken, has minced no words in distancing the incoming administration from the idea of decoupling.
“Trying to fully decouple, as some have suggested, from China … is unrealistic and ultimately counterproductive,” Blinken said at an event hosted by the US Chamber of Commerce during the election campaign. “It would be a mistake.”
China irreplaceable in global supply chain
As Blinken noted, decoupling from China is simply not realistic. China’s comparative advantage is no longer inexpensive labor. In fact, labor costs in China continue to rise.
At the same time, Chinese producers have substantially upgraded their capabilities, first by organizing and coordinating complex supplier networks, managing inventory and performing quality control on materials and components, and second, by moving into production of more sophisticated key components which previously were supplied from abroad.
For example, in 2009, China performed only assembly work for the Apple iPhone 3G, representing 3.6% of the total bill for materials. By 2018, China was producing many of the more complex components for the iPhone X, including the printed-circuit board, battery pack and camera module, increasing its share of the bill of materials to 25% of the total.
This is representative of the overall trends for China manufacturing. Based on figures from the Organization for Economic Cooperation and Development (OECD), China’s domestic content as part of total exports increased from 74% to 84% from 2005 to 2015. This comprehensive ecosystem of the value-added manufacturing supply chain in China will be difficult to replicate elsewhere.
We should expect to see lower-value manufacturing move out of China to lower-cost markets. Many Chinese manufacturers have already been offshoring labor-intensive production to Southeast Asian countries for several years.
Many multinational corporations (MNCs) are doing the same for similar reasons. Now they may make a show of it to feed into the narrative of reducing dependance on China as a rearguard action to protect against potential negative publicity in the US or other home markets.
The China market: too big to ignore
But moving some lower-value manufacturing out of China as part of a pre-existing broader trend is not decoupling. MNCs cannot afford to decouple. The massive China market is just too important to ignore.
- China is Apple’s third-largest market, accounting for 20% of its global sales, trailing only the US and European Union markets.
- General Motors sells more than 3 million vehicles in China every year, making China its No 1 market, eclipsing US sales by more than 200,000 vehicles annually.
- Cummins sells approximately one-third of its engines in China.
- KFC now sells more chicken in China than it does in the US. McDonald’s opened its 2,000th store in China in 2014 and now operates more than 3,000 locations across the country.
- Intel generated more than $20 billion in sales in China in 2019, while Qualcomm’s sales in mainland China and Hong Kong amounted to more than $11.5 billion, more than quadrupling its US sales.
These companies are not going to walk away from the China market. Similarly, other MNCs and even many small and medium-sized enterprises (SMEs) will be unwilling to cede market share in China to competitors that can then leverage their China profits for competitive advantage in other markets around the world.
Capital is flowing into, not out of, China
FDI figures for the first 10 months of the year bear this out. After a first-quarter year-on-year decline in FDI of 10.9%, FDI inflows were up 8.4% in the second quarter to close the first half down only a negligible 1.3% compared with 2019.
For the period July through October, China FDI posted another four consecutive months of increases, including a 25% jump in September, followed by an 18.4% increase in October. For the first 10 months of the year FDI was up 3.9% over 2019.
The kicker is that 2019 was a record year for China inbound FDI. So notwithstanding a serious global pandemic, China is on track for another record-setting year for FDI inflows.
The sound you hear is not the rush of foreign companies stampeding to exit China, as would be suggested by the decoupling narrative, but it is the sound of MNCs and SMEs from all around the world pressing to come in.