US-China Trade War is Reshaping the Global Supply Chain

26 June 2019

On May 9, 2019, the US government announced that the US will increase tariffs on US$200 billion worth of Chinese products from 10 percent to 25 percent, effective Friday, May 10.  Three days later, China retaliated and announced to raise tariffs on $60 billion of US goods, starting from June 1.

 

The escalating trade war between China and the United States has prompted Chinese manufacturers and US customers to rethink the supply chain relationship between the two economies. The new tariff is forcing manufacturers to either swallow the additional costs or pass the difference onto consumers.  Although manufacturers have rich experience in terms of rising wages and rising cost of raw materials, the uncertainty of the trade war has become a special challenge for them. Some companies are choosing a third option: shifting production outside of China.

 

The increasing trade friction between the United States and China prompted manufacturers to shift their production to countries that are not subject to US tariffs.  In fact, more and more companies are relocating their factories from China to other developing countries. Southeast Asian countries, including Vietnam, Indonesia, Cambodia and Thailand, have attracted record foreign direct investments in the past year. Vietnam especially has become at the heart of many companies' manufacturing strategies, which has attracted investments from companies such as Samsung, Daikin, Japan Air Conditioning Group and Techtronic. Some garment manufacturing suppliers of European and American fashion brands have also moved from China to Vietnam.

 

More Global companies are going to decouple themselves from China. For example, Mobile camera maker GoPro and Universal Electronics who manufactures sensors and remote controls, are moving some of their operations to Mexico. Taiwanese computer equipment company Aten International has brought its production back to Taiwan. Danfoss from Denmark is transferring production of heating and hydraulic equipment to the United States. Hasbro is planning to move 60% of its toy manufacturing operations to the US, Mexico, Vietnam and India. Footwear company Steve Madden is moving production to Cambodia. Similar situations also exist in the furniture, apparel and agricultural industries.

 

On the other hand, China has become the world's factory in the past 30 years. Industrial production does not take place in isolation, but rather relies on networks of suppliers, component manufacturers, distributors, government agencies and customers who are all involved in the process of production through competition and cooperation. The business ecosystem in China has evolved quite a lot in the last thirty years. For example, Shenzhen, a city bordering Hong Kong in the south-east, has evolved as a hub for the electronics industry. It has cultivated an ecosystem to support the manufacturing supply chain, including component manufacturers, low cost workers, a technical workforce, assembly suppliers and customers.

 

The trade war has prompted people to fundamentally reassess China's position as a global manufacturing leader. However, moving supply chain out of China is a long and arduous process. The new trade patterns will be largely influenced by three variable: labor, intellectual property and product cycle.  

 

Let's take smartphones and garments industry as a case study:

 

In the smartphone and garments industries, the common challenge of shifting manufacturing jobs to the US lies in labor, including labor costs and the availability of skilled workers. Since 2000, China has narrowed the gap with the United States in terms of the proportion of higher education population. According to the UNESCO Rankings survey, more than 1 million people in China have obtained engineering degrees, while the United States has fewer than 200,000. In the United States, given the significant increase in labor costs and the relatively limited number of highly trained employees, the possible way to increase manufacturing is to increase automation. Importantly, automation will change the type of work for future “line workers” and requires more engineering skills for process control, statistical testing, and basic programming. These jobs often require engineering degrees, and China trains more engineers than the United States.

 

For the mobile phone industry, it is estimated to take five years, $30-35 billion in capital expenditures, to transfer the supply chain to the United States without considering the changes in the production process that may result from any major shift.  Assuming that laborers are still being used instead of more advanced automation, it is estimated that the production costs may increase by 37%. However, since almost all of this increased cost comes from the final assembly of labor, foundries may need to change the design and product development cycles to achieve full automation.

 

In the garment industry,  it may take 5 to 10 years to transfer the supply chain from China to the US, because in the US, there are only about 250,000 manufacturing employees in the industry, while China has 8- 9 million employees. Production costs may rise by 46%, while consumer prices may increase by around 14% (assuming retailer/brand profitability has not changed and there is no impact from foreign exchange).

 

The potential policy shifts in the US and China are aimed at promoting local manufacturing in its own country, which is threatening 25 years of investment in global supply chains. While consumers and exporters in both countries will be affected in the near future, the shadow of the more devastating long-term effects may be approaching: the “decoupling” of two large economies is going to reshape the global supply chain.

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Jamsine Song

Head of risk analysis @ tiidan

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