Leaving China is hard to do

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The trade dispute between China and the United States has forced multinational corporations to consider relocating their operations to other Asian, or even Latin American, countries in order to avoid the rising U.S. tariffs on Chinese imports that are cutting into their profit margins. However, moving production of a variety of popular Chinese-made consumer products—such as smart-phones, ladders, and vacuum cleaners—to countries such as Vietnam is challenging. Looking at the Vietnam example, The Wall Street Journal1 notes that Vietnam has a population around one-tenth the size of China’s, and some companies that have set up operations in Vietnam are having to deal with growing labour shortages.

Also, China has a 15-year head start on Vietnam in mass-producing consumer goods. To deal with the less than optimal manufacturing conditions in many Asian countries, some U.S. multinationals are relocating only parts of their production to various Southeast Asian countries while continuing to manufacture in China for the domestic Chinese market and non-U.S. markets (including, in some cases, Europe where tariffs aren’t as much of an issue). This strategy avoids U.S. tariffs on imports from China while enabling corporations to remain in China where manufacturing conditions are superior to other Asian countries.

Other U.S. multinationals are attempting to convince their Chinese suppliers to shift production out of China. Consequently, a different manufacturing model is slowly emerging that sees production gradually move to other developing countries. Contrary to President Trump’s claims, only a small portion of the output will ever move back to the United States, and only then when automation enables U.S. plants to compete against developing countries with lower labour costs. However, it will take time to make the transition to other Asian countries because, for example, while Vietnam has rock-bottom labour costs, its roads and ports are crowded and inefficient. Similarly, India has a large supply of labour, but most of its workers don’t have the skills that exist in China’s labour forces and India’s rules and regulations for business can be oppressive.

Rapid changes in the network of global supply chains, triggered by growing trade tensions, present the opportunity that Vietnam has been waiting for. Labour-intensive manufacturing of athletic footwear and sweaters started to shift to Vietnam a few years ago in response to rising wages in China. (The Chinese government started to increase the minimum wage a few years ago in response to higher inflation.) South Korea’s Samsung Electronics has already invested billions in Vietnam, and the Vietnamese government is attempting to expand electronics and engineering industries that are further up the value chain, compared with manufacturing of low-value-added textiles. Unfortunately, companies setting up operations in Vietnam quickly run into bottlenecks linked to labour shortages. As in China and most developed countries, Vietnam’s population is rapidly aging—over 10 per cent of its people today are 60 or over.

The Wall Street Journal also highlighted the experience of Pennsylvania-based McLanahan Corporation, which imports pumps from China, as an illustration of the difficulties companies encounter in shifting supply chains from China to other countries. The pumps are manufactured using several dozen different pieces that must be cast with precision to avoid leaks. The firm found it challenging to obtain the required level of precision from factories in Vietnam. Also, the red Dupont powder coating for the pumps was hard to find, there weren’t many foundries in Vietnam to select from, and it was difficult to find quality control specialists. Engineers from China had to travel frequently to the Vietnamese factories to ensure that the product produced was up to company standards.

Company executives eventually determined that it was too difficult to shift the manufacturing of all the pumps out of China and decided to produce in two countries, which allowed the company to avoid only some of the higher tariffs. Other U.S. firms with operations in Vietnam have been inundated with export orders for their products, especially if similar products are manufactured in China and subject to U.S. tariffs. However, some have encountered difficulties in meeting demand because they can’t find enough workers. One manufacturer of pipes and hose for export was able to hire only one third of the workers it required to meet the new demand.

These ongoing challenges suggest that it will be a slow process for some companies to move their supply chains to other Asian countries, such as Vietnam. Some will make the move to escape prohibitive tariffs, but others will decide that the costs of relocating are even greater than the cost of dealing with rising tariffs.

Kip Beckman

Kip Beckman

Principal Economist, Forecasting and analysis

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