Pivoting from China?
How the recent Covid-19 outbreak is making manufacturing firms rethink their approach
1 Apr 2020 | Darryl Yu
Since the country’s economic reforms more than 40 years ago, China has blossomed. From being an industrial powerhouse to eventually establishing itself as the world’s second largest economy, the country has become an integral part of everyday global commerce.
That is why when China shuts down, the whole world pays attention. Following the emergence of the Covid-19 disease from the central Chinese city of Wuhan in late 2019, markets have had to grapple with the stark reality of operating without a fully functioning China. With factories shut and office workers told to stay at home the economy effectively ground to a halt this February. China’s Manufacturing Purchasing Managers’ Index (PMI) dropped to a record low of 35.7 in February 2020 from 50 in January 2020. A reading below 50 indicates contraction in the overall economy.
This new reality is especially pressing on global supply chains which are accustomed to sourcing goods from the country. According to World Bank data, China is the leader in global manufacturing accounting for around 35% of output worldwide. Already battered by the US-China trade war, companies with supply chains established in China are undoubtedly at a watershed moment.
“The revival in the world economy has been brought to a standstill in Asia as a result of the virus. The effects are now rippling through the world economy as supply chains become disrupted. There is also the added uncertainty of the virus emerging in other places around the world,” states Keith Wade, chief economist at Schroders.
The fluidity and uncertainty around the current Covid-19 epidemic has also highlighted the reliance of certain industries on the Chinese economy. “Shuttered Chinese factories are also a problem for countries and companies fastened into China’s manufacturing supply chain. Apple, Nike and General Motors are some prominent American examples. Shortages of some goods will likely result this spring, meaning higher prices for things we buy at Walmart and on Amazon,” says Mark Zandi, chief economist at Moody’s Analytics.
The automobile sector in particular has been disrupted by last month’s industrial shutdown with several companies scrambling to find car parts typically sourced from China. From General Motors to Fiat Chrysler, companies are reporting a shortage of parts. Korean car company Hyundai, the world’s fifth-largest automaker, had to temporarily stop its production lines in South Korea due to a lack of parts. Many of these companies normally run on just-in-time production schedules, meaning that inventory of auto parts is lean and can only be sufficient for between two to 12 weeks.
Other notable sectors effected by the disruption in China include the pharmaceutical industry. While the country itself is grappling to supply frontline medical staff with protective equipment such as surgical masks it also needs to ensure that global medical supply lines are maintained. According to the United States’ Food and Drug Administration (FDA), in 2018 China ranked second among countries in exporting drugs/biologics and ranked first when it came to manufacturing medical devices. However, by late February, the FDA had announced its first drug shortage due to the virus outbreak.
The current viral fear disruption of these supply chains, particularly on the manufacturing side, has prompted several companies to rethink their China strategy and discuss pivoting or diversifying operations to other countries.
In Asia, countries such as Vietnam have been highlighted as the next natural location for manufacturing due to its proximity to China and relatively cheaper labour costs. Already a number of South Korean companies have hitched their wagon to the Southeast Asian nation, Samsung being one of the first companies to setup a mobile phone manufacturing factory in 2008. In 2020, the company was reportedly increasing its exposure to the country, and planning to setup a US$220 million research and development centre in the near future.
The uncertainty around Covid-19 in China has also opened up opportunities for India - with its similar demographic size, on paper it can ideally share the manufacturing burden with China. Already foreign direct investment (FDI) into the subcontinent has grown to US$49 billion, a 16% increase from 2018 according to data from the United Nations Conference on Trade and Development, with a significant allocation towards manufacturing. Indonesia has likewise been mentioned as a notable alternative to China-based manufacturing given the size of the population available to do skilled labour.
While these alternative hubs give manufacturers much needed variety going forward there is undoubtedly a big hole that needs to be filled up if China is left out of the supply chain. For starters Southeast Asian countries would have to step up, taking over the burden from China’s sizeable skilled labour force with a population estimated at 165 million according to China’s Ministry of Human Resources.
Already Vietnam, which has a total population of approximately 95 million, has been facing skilled labour shortages due to the ongoing trade war between the United States and China as companies look to get around export tariffs via the Southeast Asian country. Outside of Asia there is discussion of moving production facilities to areas such as Mexico, however, manufacturers would have to evaluate the overall cost of shifting production away from the large consumer markets of Asia.
The emergence of Covid-19 is also a reflection period for China itself. The country needs to refocus its economy away from the production of low-quality goods and move into service-led functions. Equally, the country needs to move into the production of higher-value products such as technology in line with the government’s “Made in China 2025” initiative.
Though Covid-19 can be argued to be a catalyst in shifting supply chains away from China, it is evident that replacing the country as a manufacturing hub will be a tall task for any nation. While the future is currently uncertain when it comes to the true impact of Covid-19 on global supply chains, it is clear that China will be made to change its ways for the better, the same as it did 40 years ago.