Abstract: In this paper, the author explains the reasons why COVID-19 pandemic will hold back instead of accelerating the pace of global industrial chain relocation, which include the inflexibitity of supply chain and China's comparative advantages as a destination of doing business. He also advises against complacency and suggests China to strengthen opening up and enhance IPR protection.
The decline in global demand and different paces of work resumption in China and other countries have slowed down the pace of moving production out of China in the short- and medium-term. Concerns prevail over capital withdrawal by foreign investors and the shift of supply chain out of China due to the pandemic.
Our observation is from a different angle: the layout of the industrial chain depends largely on the business decisions of multinational companies, and this global recession may actually slow down, instead of accelerating the pace of moving industrial chain out of China in the short term, which started since the trade frictions. Why is this?
First, relocation means new investment, but no one wants to invest amid a global recession. It is estimated that it will take two years for the European and American economies to recover and return to the 2019 pre-outbreak GDP level, whereas emerging markets excluding China, such as Latin America, Eastern Europe, and Southeast Asia have many weak links, and are extremely vulnerable to the combined shocks of the pandemic, exchange rates turbulence, and debt. Therefore, the top priority of multinational corporations in the foreseeable future will be to maintain cash flow and reduce investment rather than make new capital expenditures. Some companies planned to invest in new factories outside of China or increase automation investment in their home countries before the outbreak. These intentions now are being postponed.
Second, taking the TMT industry chain as an example. Many global leading companies that have factories in multiple countries and regions feel the differences between China and other countries. In China, the outbreak started earlier and was controlled sooner. But factories in other countries are facing the second round of shock as the virus sweeps the globe, uncertain when the disease will end. China's management capabilities demonstrated in the process of resuming work and production have further proved its manufacturing advantages over other emerging markets: in just one and a half months after lockdown was imposed, the epidemic was put under control, and production capacity almost fully recovered. The application of technologies (such as the colored health codes) and public health management measures (such as temperature checks, mandatory wearing of masks, and installing physical barriers in canteens) and people’s willingness to comply with rules, all make China a more desirable destination than other potential relocation destinations such as Southeast Asian countries, which is currently experiencing a more bumpy production shutdown and supply disorder.
Relocation will be in slow motion in the long term, which can be offset by China's further opening up.
In view of trade friction risks and the rising costs of running factories in China, out of business concerns, some multinational companies may try to diversify and localize the industrial chain to avoid risks caused by over-concentration in a certain region. But this process of diversification, according to our analysis, will be in slow motion, not an overnight move. This is closely related to the advantages and resilience of China's industrial chain. Morgan Stanley carried out case analysis and questionnaire survey in 2018, interviewing 133 industry experts and 75 multinational companies, and found several important characteristics of industrial chain division and cooperation:
First of all, the current division of labor in the global industrial chain is far more complicated than that in the beginning of this century, and supply chain adjustment is bound to be a long, difficult and costly process.
Secondly, China's ample labor supply, developed infrastructure and huge domestic consumer market have prompted the industrial chain of multinational enterprises to gather in China, and its scale effect is difficult to be quickly replaced. China's current share of global manufacturing exports is about 18%, which is equivalent to the sum of the entire emerging Asian markets out of China. Therefore, even if these industrial chains are to be moved elsewhere, there are few economies that can handle this scale. To scatter production in various countries will increase logistics costs and weaken the aggregation effect, which runs counter to the original intention of relocation.
It is hardly possible for other countries to copy this scale effect in the short term.
First, even in the face of an aging population, China's high-tech labor force still grows rapidly. In the past five years, there were nearly 34 million newly graduated university students in China, equivalent to the total number of university students in the Philippines, Malaysia and Vietnam. To move supply chain to surrounding economies, multilateral companies will face a shortage of high-tech labor. Moreover, even though China's labor costs have risen significantly in recent years, it is still more competitive than developed countries (such as Japan and South Korea).
Second, China's industrial chain is more complete. Especially in the Pearl River Delta region, the entire process of R&D, design, production and commercialization can be completed within 10 kilometers. Moving to other countries means starting from scratch, requiring the simultaneous relocation of the entire upstream and downstream clusters. The initial stage will face immense difficulties.
Third, in addition to high-quality workforce, China's R&D capabilities are also increasing. Some European and American companies choose to build factories in China mainly for China's high R&D capabilities, such as ABB, General Electronics, Siemens, Honeywell, among other electronic components and power equipment producers. China has also surpassed Japan and the United States to become the country with the largest number of international patent applications.
As for the world after the coronavirus epidemic (the so-called A.C.—After Corona), there are a lot of market speculations, some of which inevitably take the current impact (temporary adaptive behavior of consumers and companies and the comments of some politicians) as something permanent. But there is one thing that remains the same: no matter how the rest of the world changes, China must have its own business done well. That is, to explore its internal potential through urbanization reform and digital infrastructure construction, and strengthen opening up to attract multinational companies to do business in China and for China.
First, the potential of China's domestic consumer market is still very large, and urbanization 2.0 will help further unlock this potential. If the reform of the household registration and land system can be implemented, supplemented by digital infrastructure to promote the effect of urban clustering, in the next 5-10 years, China is expected to see five super metropolises with an average population of 120 million, equivalent to five Japan. Therefore, even if some multinational corporations no longer regard China as a "world factory", they may shift their business strategy into doing business in China and for China. The attraction of China’s domestic market will promote the two-way flows of FDI, rather than simply the outflows. For example, optimistic about the potential of China's electric vehicle market, Tesla set up a super factory in China, attracting the industrial chain of the new energy vehicle to gather in China. Although Samsung relocated its smartphone factories, confident in the needs of China's smart city digital infrastructure, it invested a lot in storage equipment factories in China. These can partially offset the relocation of purely export-oriented industries.
Secondly, we talked with a number of CIOs of multinational companies and found the following trends: Companies all believe that in the next stage, industries will be more dependent on digital infrastructure, namely cloud services, IoT, remote services, etc. Regardless of whether this judgment will be strengthened after the epidemic, China has been accelerating the construction of new infrastructure such as 5G, data centers, and IoT. The author's research team predicts that the seven major industries of the new infrastructure will receive investment of 180 billion US dollars per year, doubled compared with that in the past three years. The speed of information infrastructure development such as 5G is leading the world. If digital infrastructure becomes a necessity in the world A.C., China's infrastructure advantages for doing business here will be strengthened rather than weakened in the future.
However, the inflexibility of supply chain and the many advantages mentioned above do not mean that China can sit back and relax. On the contrary, there is an urgent need to be alert to potential risks and implement reform and opening-up measures to attract global industrial chain and high-level foreign investment.
First, China should further strengthen opening up, relax market access and equity ratio requirements in many services industries and high-end manufacturing in accordance with the announced roadmap, implement fair and transparent competition policies and industrial policies that treat all Chinese and foreign companies equally with no discrimination.
Second, China needs to enhance protection of intellectual property rights (IPR) and significantly step up punishment for IPR infringement. Considering that Chinese private enterprises now boast vast patents, increasing protection efforts is also in line with China's own industrial upgrading needs.
