Abstract: Since its accession to the WTO, China has integrated itself deeply into the global supply chain and become a global manufacturing center. However, under the impact of the COVID-19 pandemic, countries including the US and Japan have stepped up onshoring of supply chains. Meanwhile, relations between the US and China are strained again. Under the new situation, maintaining the safety and stability of supply chains has become key to accomplishing the "six priorities" for China. Despite rumors that foreign companies are withdrawing from China, Chinese market remains attractive to multinational companies and the pressure of supply chain relocation will be relatively small in the short term. It is worth noting that different industries are under different levels of pressure: first, the relocation of labor-intensive industries have been long underway; second, industries mainly eyeing the US market have also begun to shift their supply chains out of China; third, it is difficult for industries with complex supply chains to relocate.
CF40 experts put forward the following suggestions to China's policymakers on how to address the potential risks arising from the reshuffle of global supply chain: first, recognize that the background of global supply chain reshuffle has gone beyond economic scope; second, create more opportunities for foreign companies to succeed in China; third, improve the role of the financial sector in supporting China's supply chain; fourth, seize the opportunities brought by the new round of globalization propelled by new technologies; fifth, actively participate in international rule-making, including regional economic and trade agreements.
Over the past two decades, the continuous integration of global supply chains has greatly promoted the development of the world economy. Meanwhile, benefiting from globalization, China has become a central hub in the global supply chain and as a result, its economy flourished. However, with the rise of its economy, China has become the only country that poses serious strategic challenges to the US in areas ranging from economy and technology to global influence.
At the same time, relations between China and the US have deteriorated with increasing populism in Western countries. The COVID-19 outbreak has exposed the weak points of Western countries in their participation in global supply chains. Some countries have called on their companies to move out of China. On April 7th, the Japanese government promised to provide 220 billion yen (about $2.2 billion) to help Japanese companies bring production lines back to Japan. The US has also said that the American government should allow companies to deduct the cost arising from moving out of China. In June, President Trump claimed that the US has the option of "a complete decoupling from China". However, faced with the risk of global supply chain reshuffle, China still has very vast advantages, and its market remains hugely attractive to global companies.
I. Chinese market remains attractive to multinational companies
The comprehensive advantage and innovation capability of the Chinese market make it difficult for multinational companies to withdraw from it. First, China has huge market potential. The size of China's consumer market has more than quadrupled over the past decade, from $2.6 trillion in 2009 to $8 trillion in 2019, according to UBS Securities. During the same period, the size of the US market rose from $12.3 trillion to $17.6 trillion. Although China's market is only half the size of the US market, its growth potential is immense. Second, China has a full set of well-developed productions factors and unparalleled advantages in labor, production cost, technology, capital, data and infrastructure.
Third, China is already leading in innovation, especially digital innovation. Companies have to participate in the Chinese market to keep up with the cutting-edge development of digital innovation and build up capabilities. Lastly, the Chinese economy has shown strong resilience. It was among the first to recover from both the financial crisis in 2008 and the pandemic this time.
II. The situations vary for different industries
Along with economic development, China's industrial structure has undergone continuous transformation and upgrading, which is also an important background for the relocation of some industries. The Sino-US trade friction and the COVID-19 pandemic have accelerated the move of supply chains in these industries. The following three types of industries are facing rather different situations -
First, labor-intensive industries have long started moving their production out of China. In the early stage of reform and opening-up, China mainly relied on its vast pool of low-cost labor for processing trade. With the increase of labor, land and environmental costs, some labor-intensive industries have shifted production to South and Southeast Asian countries.
Second, industries with the US as the main export market have also started the relocation process. One such example is consumer electronics. After the outbreak of the Sino-US trade conflict, the US imposed additional tariffs on China, as a result companies aiming at the US market had to move to regions with lower tariffs.
Third, complex supply chains are characterized by clusters of suppliers, which is difficult for other countries to replicate, so industries involving complex supply chains are difficult to relocate. Complex supply chains bring numerous suppliers together and through the manufacturers organize them in an orderly way to create an effective ecosystem. This ecosystem takes a long time to form and is difficult for other countries to replicate. Such industries include smart phones, tablet computers, Internet of Things (IoT) and Artificial Intelligence of Things (AIoT).
III. Two major trends will have a long-term and systemic impact on global supply chains
In the short term, the pandemic and the trade war will not have an imminent impact on China’s supply chains. However, in the long term, two fundamental trends will have far-reaching and systemic impacts on the restructuring of global supply chains and China’s participation in global division of labor:
First, China and the US have both significantly expanded the scope of national security. The COVID-19 pandemic is a global public health crisis. China and the US should have strengthened cooperation. However, due to the tension between the two countries, mistrust has grown. This mistrust has expanded from the traditional military field to medical equipment and infrastructure, among other fields. In the long run, with increased mistrust, China and the US, especially the US, will further expand the scope of national security, which will damage the economic relationship between the two countries, accelerate the decoupling of supply chains, and even form a vicious circle.
Second, if China continues to climb up the supply chains, it may face greater pressure from the Western world. China will maintain a relatively high growth rate, and its industrial upgrading will continue. In the future, China may lead the world in some sectors, which will cause direct competition with the US, Japan, and Europe. This could potentially dismantle the existing global system, transform the global economic model, and bring about profound restructuring of the global supply chain. China needs to get prepared for this possibility, and mitigate and eliminate this risk through cooperative and win-win strategies.
VI. Suggested coping strategies
First, it’s important to understand that the root cause of the global supply chain reshuffle is beyond the economic scope. China needs to look at the problem for a time span of five to ten years into the future. Strategically speaking, the series of challenges that emerged since the China-US trade war were only partly due to economic reasons; more importantly, they stemmed from the growing mistrust between the two countries and the decoupling moves by the US as a result of the mistrust. China-US relations have arrived at a turning point. At this critical juncture, it is important to have a proper understanding of the underlying reasons behind the problems and take targeted measures.
Second, create an open, level playing field for global players and help them succeed in China. This will encourage them to seek long-term development in China. To this end, China needs to step up its economic recovery. More importantly, it should press ahead with reform and opening-up, upgrade the factor market and improve the investment and business environment so that all market players can compete on a fair basis. Meanwhile, policy uncertainties should be reduced. These will give foreign businesses a bigger play in the next wave of innovation in China. Of particular note, foreign high-tech companies should not be forced out of the Chinese market. Moreover, the government should refrain from excessively intervening in supply chain relocations that happen naturally under market forces or imposing unnecessary administrative or regulatory controls. Instead, it should build a sound business environment that can attract and retain market players.
Third, the financial sector should play a bigger role in consolidating China’s position in the global supply chain. Behind the global supply chain reshuffle is renewed planning of global capital. Many multinationals deploy their production networks through global equity investments on a group basis, and these investment and financing activities are largely supported by financial instruments and financial institutions. But Chinese businesses lag behind in these regards.
Fourth, China needs to seize the opportunities in the new wave of technology-driven globalization. This round of technological revolution is based on IT and AI. China should seize the opportunities, intensify efforts in developing 5G, AI, big data, cloud computing and blockchains to accelerate the development of Industrial Internet of Things (lloT) and promote a new round of globalization. Meanwhile, China should be aware of its weak links in the global supply chain.
Fifth, China should actively engage in international rulemaking, including negotiations on regional economic and trade agreements. At present, Western countries still dominate rule-making for global economy and trade, and China is only a rule-taker. In the face of supply chain reshuffle, China must review its role, actively promote the next round of globalization and engage in international rulemaking. The IT-driven globalization tide has significantly lowered the barrier to the spread of knowledge and technologies and benefited the world at large. With its strengths in AI and IT, China should actively participate in global discussions in these fields. Besides, the fair competition between businesses of different types is also likely to be discussed in the making of new international rules, and China needs to have a say in that, too.
