While the coronavirus pandemic wasn’t the start of U.S. manufacturing’s move out of China, it may have ushered in its conclusion, leaving an entirely different trade relationship in its wake. As American companies “reshore” their production facilities, it could lead to further polarization between the two countries.
The coronavirus crisis came at an auspicious time in Sino-U.S. relations. After several years of negotiations, the two countries finally agreed to a “Phase One Trade Deal” on Jan. 15. The ink was barely dry on the agreement when the COVID-19 outbreak began to take its toll: first in China, then in Europe, and eventually in the U.S.
So far, the epidemic has not hampered progress on adaptation of “Phase One” and may, in the short term, actually bolster trade between the two countries. “China has not let the COVID-19 outbreak stop it from implementing the Phase One Trade Deal,” law firm Mayer Brown said in its March 13 document. “If anything, China’s efforts to control the virus have caused it to further relax countermeasures…to U.S. tariffs and other trade measures.”
Indeed, the U.S. has granted exclusions from import tariffs on many vital medical supplies shipped from China. Face masks, gowns, thermometers and other equipment needed to help treat coronavirus have begun arriving in the U.S., though American hospitals still face shortages. But the broader trend points clearly at a broader shift. The dynamics of Sino-U.S. trade have changed. Long before COVID-19, the two countries were on a path of untangling many of the supply chains that had come to define much of the post-Cold War period. The reasons were not political, but economic.
A Volatile Past
For years, low costs of manufacturing made China the destination of choice for western corporations. Between the 1980s and the 2000s, “the largest ever positive labor supply shock occurred,” caused largely by the integration of China into the global economy, according to a 2017 study by the Bank for International Settlements. A “sweet spot” of demographic trends caused a one-time increase of about 120 percent in the workforce available for global production, driving labor costs down.
Long before COVID-19, the two countries were on a path of untangling many of the supply chains that had come to define much of the post-Cold War period. The reasons were not political, but economic.
By the mid-2010s, however, this trend was in reverse. Population growth was declining and the “dependency ratio” of workers to elderly had begun to worsen rapidly. “The sweet spot will now turn sour,” the BIS economists wrote in their paper.
Six years before BIS’s study, Boston Consulting Group argued that “a combination of economic forces is fast eroding China’s cost advantage as an export platform for the North American market.” Rising wages at Chinese factories were at the heart of this development. These were anticipated to slash China’s labor-cost advantage over the U.S. to negligible amounts by 2015, BCG predicted. Taking other factors into account – higher U.S. worker productivity, supply chain, and logistical factors among them – would soon make it more economical to manufacture goods in the U.S. than China.
For Barry Knapp, an economist also versed in trade policy, the dynamic was already starting to shift in 2011, the year of BCG’s study. That March, the Fukushima nuclear disaster in Japan caused what Knapp described as a first supply chain panic. The affected area was home to suppliers of silicon wafers, lithium battery chemicals, and auto parts makers, among others, which were immediately forced to look at alternate arrangements.
Later that summer, floods in Thailand caused another disruption to supply chains. Carmakers and technology companies were impacted. Neither of these disasters affected China directly, with both taking place thousands of miles away from the Chinese mainland. But with many of the parts manufactured in the affected area shipped to China for assembly, the country was looped in by default.
In 2011, China officially surpassed the U.S. as the world’s largest producer of manufactured goods. But by 2013, the country’s manufacturing sector may have peaked, according to McKinsey. Meanwhile, other developments were impacting the cost effectiveness of producing goods in faraway lands. The shale revolution in the U.S. greatly reduced energy costs for domestic companies. For certain U.S. industries, such as plastics and chemicals, the costs of local production were reduced dramatically.
By 2015 at the latest, the idea of exploiting cheap emerging market labor was gone, according to Knapp. Instead, many companies had begun to produce things locally, but on a global scale. This meant manufacturing goods in the U.S. for U.S. consumption and in China for China consumption. “Companies are already all in with that model,” Knapp explained. The only outliers are technology companies, but even there, “at some point even Tim Cook is going to find a way to produce iPhones in the U.S. because you can’t afford to give money away.”
In 2011, China officially surpassed the U.S. as the world’s largest producer of manufactured goods. But by 2013, the country’s manufacturing sector may have peaked.
Then came the 2016 election of President Donald Trump, who from the beginning looked to set new ground rules with trade, meaning less dependence on goods from China. The paradigm shift was intensifying.
Coronavirus Impact
By the time the coronavirus emerged in Wuhan, many corporations were already on their way to moving manufacturing activity out of China.
“Trends that were already intractable for economic reasons were further spurred on by policy,” Knapp said. “It’s not just because of coronavirus. The idea of stretching supply chains around the world doesn’t make sense any longer.”
The moves are widespread and across industries. Companies in two-thirds of global sectors in North America have either implemented or announced plans to pull at least a portion of their supply chains out of China, according to a Bank of America Merrill Lynch Global Research survey.
The crisis appears to have merely exacerbated a trend that had been in place for some time, reinforcing concerns that already existed according to Rachel Ziemba, an adjunct fellow at Center for a New American Security. “I do think this will reinforce a trend for some U.S. companies (and indeed some global companies) to diversify their supply chains, rely less on China as a supplier, and add redundancy to their supply chains,” she said. “Some of these supply chain adjustments have been underway for some time —first reflecting rising costs in China, amplified by the trade war but may be increased by the COVID-19 crisis.”
What Next?
It’s clear the manufacturing-based model that formed the basis of the last four decades of Sino-U.S. relations has shifted – if not been turned on its head completely. Many American companies will move manufacturing activity elsewhere, to the extent that they haven’t already. But this trend will not be universal. “Some companies will continue to source goods and operate in China as they are the most competitive market,” stated Ziemba. “It will depend on sectors and development clusters.”
Many American companies could relocate to other developing countries, depending on the industry. High labor content goods like apparel could move to Vietnam or elsewhere in Southeast Asia. Increasing trade competition has come from Mexico, and in recent years some companies have even moved away from China in favor of Mexico’s labor force, expertise, and proximity to the U.S.
Trade between the U.S. and China will still exist of course, but it will have a different dynamic. For U.S. exporters, China’s changing economy will hold more allure than it did as a manufacturing hub. With a growing middle class and increased contribution from the services sector, China becomes more attractive for U.S. companies in these sectors.
Unfortunately, there will be negative implications as well. “Overall, I see this playing into nationalist concerns and reinforcing the increased trade and investment barriers between the U.S. and China,” said Ziemba.
It will also give authoritarian figures more power. The government in China will have no choice but to take even more control of industry in exchange for investment and other forms of financing, according to Knapp. “This will encourage Xi and other autocrats in the world to become even more autocratic,” he explained.
The Phase One trade deal should be safe, if only because its implementation is in both countries’ interests. “They don’t want things contributing to wealth inequality or capital outflows,” Knapp said of China. “Intellectual property is really important for them to start protecting.”
China’s record on intellectual property rights was improving even before Phase One, as the country found that IP was an integral part in protecting innovation within its own borders. A 2018 survey by the American Chamber of Commerce found 59 percent reporting improvements in intellectual property rights enforcements.
As a result, Knapp expects China “to do a reasonably good job of protecting the rights of U.S. companies. But the idea of manufacturing in China, even for tech companies, is pretty much up.”
The effects of coronavirus will be felt for many years to come. The world and its business practices will likely change in a number of ways, with wide-ranging consequences that have yet to be determined. American companies “reshoring” their manufacturing, and moving production out of China, is a secular change many years in the making. COVID-19 may have just sped up the final act a little bit.
Future Sino-U.S. trade relations will surely be more nuanced than they were during the 35-year “Made in China” period. A lot depends on the direction of U.S. policy and identity of the next presidential administration. It would not be unreasonable to expect further detachment as both countries become more entrenched in their respective spheres of influence. Surely, much commerce and trade will remain, but any thoughts of broader integration can probably be dismissed as fantasy.
Then again, things can change pretty quickly. It was just 2012 when the Obama administration started its famous “pivot to Asia.” The idea seems quaint and hopelessly naïve by today’s standards. But pendulums do swing around, eventually.
