THE INTERNATIONAL MONETARY FUND has sharply cut its forecast for China’s growth this year and next as part of a gloomy mid-year update to its World Economic Outlook.
The Fund is now expecting China’s economy to grow 3.3% this year and 4.6% next, which is 1.1 percentage points and half a percentage point lower, respectively, from its April forecast.
The IMF cites the lockdowns to contain Covid-19 and the deepening real estate crisis, causing a sharper-than-expected slow down in the first half of the year, as the reasons it lowered its forecast. It warns that both could worsen, further reducing growth, while geopolitical fragmentation could impede global trade and cooperation.
The slowdown has already added to global supply chain disruptions.
COVID-19 outbreaks and mobility restrictions as part of the authorities’ zero-COVID strategy have disrupted economic activity widely and severely. Shanghai, a major global supply chain hub, entered a strict lockdown in April 2022, forcing citywide economic activity to halt for about eight weeks. In the second quarter, real GDP contracted significantly by 2.6 percent on a sequential basis, driven by lower consumption—the sharpest decline since the first quarter of 2020, at the onset of the pandemic, when it declined by 10.3 percent. Since then, more contagious variants have driven a worrisome surge in COVID-19 cases. The worsening crisis in China’s property sector is also dragging down sales and real estate investment. The slowdown in China has global consequences: lockdowns added to global supply chain disruptions and the decline in domestic spending are reducing demand for goods and services from China’s trade partners.
Growth of 3.3% would be China’s slowest growth in four decades, excluding the initial COVID-19 crisis in 2020. The official target of above 5% growth seems increasingly out of reach regardless of the infrastructure spending stimulus being poured into the economy.
Higher energy and food prices because of the war in Ukraine are external headwinds beyond Beijing’s control, as is policy tightening by the major central banks to tame inflation. What is in Beijing’s remit, a recalibration of the zero Covid strategy to reduce growth trade-offs, will be minimal at most.
Downside risks include larger-scale outbreaks of more contagious virus variants that trigger further widespread lockdowns under the zero-COVID strategy. In addition, delayed price and balance sheet adjustments in the property sector could cause a sudden, wider crisis or a protracted adjustment with broader macro-financial spillovers. A sustained slowdown in China would have strong global spillovers, whose nature will depend on the balance of both supply and demand factors. For example, further tightening of supply bottlenecks could cause higher consumer goods prices worldwide, but lower demand might ease commodity pressures and intermediate goods inflation.
Overall, the IMF expects slower growth and trade and higher inflation globally. It now puts global growth at 3.2% this year and 2.9% next, although it acknowledges that the risks are ‘overwhelmingly tilted’ to the downside. Its ‘plausible alternative scenario’, in which risks materialize and global growth slows to 2.6% this year and 2.0% in 2023, looks as plausible as its baseline scenario.
THE CHART ABOVE, from the Conference Board in the United States, crosses our desk and throws some light on why there is little evidence of supply chains moving out of China on any scale.
Simply put, the chart shows that there is no ready alternative that offers the scale and scope of China’s manufacturing base. In developing economies, such as those of Southeast Asia (for which ASEAN is a proxy in the chart), the capacity for multinationals to source inputs, labour and transport is a fraction of China’s. Even the United States and the EU combined barely match it, and in both those markets, labour costs are higher.
Moving production out of China will not happen quickly for other reasons, too. Supply chains are misnamed in that they are networks more than linear chains. They take years to put together and have extensive interdependencies. Companies will not willingly dismantle them quickly, even if they duplicate capacity elsewhere to improve resilience.
Further, dual circulation and the shift of China’s economy to being consumption-driven will mean that more of what is sold in China will be made in China. One small example: German car manufacturer BMW has just announced that it will start production of its X5 mid-size luxury SUV in Shenyang for sale in the Chinese market, rather than import the vehicles from its Spartanburg plant in the United States.
THREE RECENT CHANGING of hands of Chinese factories give a glimpse of the emerging shape of the new world of supply chains and highlight the contradictions and competition that lurks within as companies on both sides of the US-China divide navigate between national policy and commercial self-interest.
The transactions are:
the 3.3 billion yuan ($477 million) deal in July by which the fast-rising Shenzhen-based Luxshare Precision Industry bought two electronics assembly plants from the No 3 Taiwanese iPhone assembler, Wistron;
Hunan-based Lens Technology’s $1.4 billion acquisition this month of two factories from Catcher Technology, a Taiwanese firm that makes metal casings for the iPhone. Glass-maker Lens already supplies screen glass for iPhones; and
the buyout announced this month by the No 2 Taiwanese iPhone assembler, Pegatron, of the remaining shares it does not own of Casetek Holdings, and take the unit private in a deal valued at $1 billion. Casetek is another precision metal chassis maker with factories mostly in and around Shanghai.
Two of the companies central to all the deals are not direct participants. They are Apple, the world’s most valuable tech company, and Foxconn, Taiwan’s No 1 iPhone assembler, the leader in contract electronics manufacture in China and long the linchpin of Apple’s global supply chain.
Apple’s CEO, Tim Cook, seen in the screenshot during a 2017 visit to a Luxshare factory that makes Apple’s AirPods, has been plain that his company is seeking to diversify its supply chain. Foxconn’s chairman, Young Liu, has been equally explicit that his company plans to split its operations to serve the China and US markets separately, declaring that ‘China’s time as factory to the world is finished’.
The commonalities in those two views make the Luxshare deal significant on several counts. While it follows a series of investments by Luxshare in Apple component makers, it moves the company to being an iPhone assembler for the first time since it became an Apple component supplier in 2012. As well as marking a significant milestone in its manufacturing capabilities and status, it also breaks the iPhone assembly monopoly of the Taiwanese trio of Foxconn, Pegatron and Wistron.
It also gives Apple some insurance that the iPhones (and other products) it sells in China can be made in China should producing in-market become essential because of deteriorating relations between Washington and Beijing and the import substitution drive implicit in the ‘dual circulation’ policy. China provides an estimated one-fifth of Apple’s global revenue. It needs to be able to defend that. That, in turn, gives credibility to suggestions that Luxhare’s expansion to let it become more deeply involved in Apple’s Chinese supply chain has the US multinational’s encouragement.
It is also worth noting that other US multinationals that Luxshare counts as customers include Microsoft, Google, Amazon, HP and Dell. That is an overlapping roster with Foxconn, which sees Luxshare as an emerging competitor to be taken seriously. Luxshare’s founder, Wang Laichun, was once a ‘factory girl’ at a Foxconn affiliate. A lot of Foxconn’s iconic founder Terry Gou has rubbed off on her, by all accounts. Luxshare’s market capitalisation is now larger than that of Foxconn’s parent Hai Hon Precision Industries, and Wang is now one of the wealthiest women in China.
India and Vietnam
Apple and the other US multinationals still have markets to serve outside China. Those increasingly demand supply chains that are not only non-Chinese but also not global. Foxconn is already manufacturing outside China and increasing its capacity to do so in order to avoid US tariffs on Chinese exports, and as insurance against future restrictions. It already assembles iPhones in India for the Indian market (thus avoiding India’s high customs duties on imported iPhones. Wistron is about to follow suit, one reason it felt able to sell of its assembly plants in China to Luxshare.
One of the new locations that Foxconn is looking at for expansion is in northern Vietnam. There, as it happens, it would be a near neighbour of another plant where Luxshare makes AirPods. Apple will also make some of its smartwatches at Luxshare factories in Vietnam and is considering one for iPhone assembly.
Luxshare, which established a company in India last year, is also reportedly considering building a plant in Mexico, where Foxconn and the other Taiwanese electronics manufacturers like Pegatron have been eyeing new locations, too. Foxconn already has a series of production lines there, which can take advantage of.tariff-free exports to North America under the new US-Mexico-Canada trade agreement.
This reconfiguration of global supply chains into regional and local ones also contains several self-contradictions that reflect the illogicalities of the decoupling of the US and Chinese economies in the tech sphere. Building up Luxshare gives Apple supply chain diversification, local production in China and, as a bonus, some bargaining power with Foxconn. However, Beijing sees Luxshare as a way to diminish the Taiwanese, and especially Foxconn’s sway over contract electronics manufacturing in China, to build an indigenous industry, and to tie in the China business of Apple and other multinationals, more closely to national economic management.
The Lens Technology deal falls into many of those categories, too. It is seeking to follow Luxshare in moving up from being a component supplier to Apple to an iPhone assembler, taking advantage of Beijing’s drive to foster indigenous technologies and the supply chains to turn them into products. Pegatron’s tightening grip on Casetek is a direct counter to that.
New Foxconn or next Huawei?
However, it is Luxshare that Beijing views as the leading candidate to dent Foxconn’s dominant presence. Thus it comes as no surprise that it is a leading recipient of subsidies from the 147.2 billion yuan fund set up last year to upgrade China’s manufacturing capability.
The perversity is that the more subsidies Luxshare gets, the cheaper it can sell its services to Apple, which means the cheaper Apple can sell its products, and not just in China. One risk is that that might put it on the same US radar that has been locked on Huawei Technologies.
REPATRIATING US MULTINATIONALS’ supply chains from China is a nagging obsession for US President Donald Trump. On Monday, he returned to the theme, holding out the prospect of tax credits for US companies that do so, and threatening the denial of government procurement contracts to those who do not. However, China’ anchoring of global supply chains will not be slipped easily or quickly.
Governments in all the advanced economies are now talking about the need for their home companies to diversify or repatriate their supply chains (different things, though conflated in the political discourse). The coronavirus pandemic has revealed their dependence on China for healthcare products and pharmaceutical supplies. However, China’s centrality to global manufacturing across a range of industries from vehicle-making to consumer electronics has been hiding in plain sight for a decade.
China has been the world’s leading manufacturing nation since dislodging the United States from that position in 2010. Accounting for 28.4% of global manufacturing output, it is now more than ten percentage points ahead of the United States, according to the United Nations statisticians looking at the 2018 data, the latest full set available.
The United States is leading discussions with regional allies including Australia, Japan, South Korea, Vietnam and India about co-ordinating incentives for Western multinationals to lessen their value-chain dependence on China. This Bystander does not expect those discussions to go very far, mainly because supply-chain reconfiguration is primarily a business, not a political decision.
Nor is it a decision companies take casually. Manufacturing is long beyond the point where the lowest wages determine the place of production. Building supply chains is arduous. It takes time to find the suppliers, sub-suppliers and sub-sub suppliers who can be trusted to deliver with the quality and reliability at the scale that a multinational requires. Once assembled, such a network of relationships is not cast aside lightly.
Beyond the production chain is an ecosystem of hard and soft infrastructure that has to be in place to make the shipping and logistics work: seaports, airports, roads, railways and storage facilities, and trained staff to operate them efficiently and continuously both inbound and outbound.
Supply chain managers also need to be sure that there is a qualified labour force of adequate size and quality to tap into. Legal, regulatory and administrative regimes also need to exist that are supportive of international business, can ensure that contracts are enforced and can provide the transparency needed for monitoring compliance with international standards in areas like child and forced labour.
Places like Thailand, Indonesia, Vietnam and the Philippines all have some of that and are trying to create more. Yet even collectively, they do not have them on the scale that exists in China, let alone China’s track record in process engineering and innovation.
Those are all reasons that, for all the talk of multinationals moving their operations out of China, the evidence remains anecdotal or small scale. That is not to say that some low-end production has not shifted from China. Even Chinese companies have been outsourcing to regional neighbours.
Nor does it mean that every time a multinational makes a new investment in its production that it will go to China by default. Foxconn, one of the big technology hardware contract manufacturers for multinationals like Apple, is adding capacity in Vietnam and India as well as at home in Taiwan. However, it says it still expects the share of its output produced in China not to fall below 70%. It is currently 80%.
Such decisions are driven more by long-term trends that were in place long before the current trade and technology war between Washington and Beijing and the Covid-19 pandemic broke out.
Changing patterns of global trade, particularly the rise of South-South trade relative to North-South trade, have driven the creation of regional supply chains, often around regional trading blocks. All trade routes no longer lead only to the United States or Europe. These regional supply chains service the markets that have emerged in emerging economies the likes of India, Brazil and most of all, China. It is in East and Southeast Asia that the rise of South-South trade has been most pronounced.
Surveys of US and European multinationals operating in China show scant indication of downsizing of production in China. These firms still see the domestic Chinese market to be rich with opportunity, so they want to produce close to market. All the signs are that when China’s next five-year plan is announced, it will emphasise import substitution and the securing of domestic supply chains. This will make the Chinese market and the necessity of producing inside it, of yet greater importance to multinationals.
Yes, multinationals will do the same in other regional markets, albeit it on a lesser scale. Yes, they will take the reputational brownie points for reducing their carbon footprints through shorter supply chains. And, yes, they will take some of their home and other governments’ bribes to increase the resilience of their global supply chains by building in more redundancy elsewhere than in China.
Japan’s inclusion in its pandemic stimulus in April of 248.6 billion yen (2.3 billion dollars) for Japanese businesses to evaluate their value chains, supports its existing ‘China +1’ policy to encourage production diversification back home or to ASEAN. Beijing responded by reminding Japanese companies in China that it remains a critical market for them and that relocating operations would be expensive and disruptive. That is true for all multinationals.
More blatantly, in March, India offered electronics and pharmaceutical manufacturers a payment equivalent to 4-6% of their incremental sales over the next five years if they switch production from China. Some two dozen companies involved in making mobile phones, including Foxconn and Samsung, have expressed interest, although unpicking what is de novo investment and what is moving from China may prove difficult. Nonetheless, India is considering expanding the programme to the auto, textiles and foot processing sectors.
In the longer-term, technological change, including the application of big data and blockchain technologies to streamline value-chain management, automation to reduce costs, and 3-D printing to allow production at or near the point of sale, may change multinationals’ calculations again. The direst forecast of trade and technology decoupling of the world’s two largest economies may come true, prompting the need for parallel manufacturing worlds with standards and supply chains to match. Even then, China’s sphere would likely be economically larger. But for now, little production capacity will move out of China, even if more of the output stays there.
AS A FOOTNOTE to our earlier observations of the impact of the coronavirus outbreak on supply chains, we read with interest a report in the Financial Times about how one carmaker, Jaguar Land Rover, has been carrying parts out of China by hand in suitcases.
What caught this Bystander’s eye was that the component in the most immediate critical short supply for the company was key fobs of all things. But then, if you cannot get into the vehicle in the first place, it probably does not matter what else is missing.
Joking aside, carmakers from Fiat Chrysler to Volvo are now warning that parts shortages because of disruption to their supply chains in China could force a suspension to production in their plants around the world, in perhaps as soon as a couple of weeks.