The seemingly unexpected collapse of trade negotiations between the US and China last month hinted that existing Sino-US tariffs may now be the new normal. But recent data reveal that, well before talks broke down in May, China-based companies had already begun bracing for the worst-case scenario. The latest trade numbers suggest that China has been selling Americans fewer goods like computers and auto parts—and that other countries are benefitting from taking up the slack.
What’s at stake here isn’t merely the health of China’s export-focused manufacturing sector (and the many millions of workers it employs). The longer the trade war wears on, the greater the risk China will lose its long-standing role as the planet’s top global manufacturing base. And as more and more foreign investment and technology flow to other nations, China’s chances of becoming a technologically advanced, innovative economy will dim.
Let’s turn to the numbers. Usually, slightly more than 20% of the value of goods Americans buy from abroad are made in China. But in the first four months of this year, China’s share slipped by more than two percentage points. (The value of total US imports barely budged.)
Which countries are stepping in to fill the void? Mexico and Vietnam have benefited the most, followed by South Korea and Taiwan, according to data from the International Trade Commission. This aligns with economists’ predictions, as well as with similar analyses of the trade data.
Countries with the largest increase in the share of imports to US, Jan-Apr 2018 vs. Jan-Apr 2019 (in dollar value)
This has a lot to do with the product categories targeted so far, according to Societe Generale’s Wei Yao. The first two rounds of tariffs—initially on $50 billion in Chinese goods, followed by $200 billion—fell heavily on electronics, advanced machinery, and industrial parts. Since Vietnam already sells electronics to the US, it’s benefited a lot, wrote Yao in a recent note. Meanwhile, tariffs on the latter two categories buoyed Korean and Taiwanese exports, which have long specialized in those sectors.
There are a couple of caveats in order. First off, for most countries, the gains in US import share don’t offset overall losses created by the trade war. And the data trends don’t necessarily mean supply chains are being permanently uprooted from China. Earlier this week, Vietnam’s government revealed that it had discovered scores of Chinese goods fraudulently labeled “Made in Vietnam” (paywall)—on products ranging from steel to agricultural goods.
Evidence of less overtly fraudulent trade diversion tactics have been surfacing too. Chinese exports of electronics parts to Taiwan and Vietnam leapt sharply since last year, according to Yao. This could indicate that China-based companies are engaging in what’s known as “knockdown”—that is, “knocking down” a product into its component parts and reassembling them outside China. For electronics and associated parts, this would be especially easy to do in Taiwan and Vietnam, says Yao, since those countries are already exporting such goods to the US and therefore have the capacity to ramp up assembly on the fly.
This sort of thing might look like a shift in production, but could simply represent a temporary workaround—a diversion of trade that will return to China once trade tensions ease. The prevalence of these practices could also help explain why US consumers have so far seen prices change little.
That said, signs of a more permanent supply chain rejiggering abound. Foreign investment in Vietnam and Thailand has surged since the beginning of this year, notes SocGen. Foxconn, which supplies Apple, is now gearing up iPhone X production in India. More recently, the company made moves to start producing in Vietnam (paywall), joining a slew of other smartphone accessory makers and suppliers (paywall). In early May, the CEO of Brooks Running—a shoe company partially owned by Warren Buffett—announced that it was shuttering operations in China to set up shop in Vietnam. The company said the threat of shoe tariffs forced the decision.
The backstory, however, is important here. In many cases, the trade war isn’t so much triggering a China manufacturing exodus as it is accelerating a shift in supply chains that was already well underway. China’s working-age population began shrinking back in 2012. Wages are now nearing levels in advanced economies. And low-wage workers are getting harder to find—let alone retain.
Last week, Quartz met with executives of Cambridge Industries Group, a telecom equipment manufacturer, in an industrial park outside Shanghai (part of a trip sponsored by the China-US Exchange Foundation, a Hong Kong-based nonprofit). The sharp rise in labor costs in the last decade has pushed the company to install a fleet of robots in its factory, allowing it to shrink its assembly line from 63 people a few years ago to just 13 today. Still, cost pressures mean the company only pays low-skilled assembly line workers about 5,000 yuan ($720) a month—too little to prevent high turnover as staff leave to take less tedious jobs as restaurant waiters, which pay about the same.
These cost pressures have been pushing companies to move factories to poorer Asian nations like Vietnam, where factory workers earn half the pay commanded by Chinese counterparts. Samsung is perhaps the most prominent example and by 2017, its subsidiary had already seized the top berth as the biggest company in Vietnam, by revenue. A number of sports apparel companies have also decamped for Vietnam.
The suddenness of the factory flight out of China might make it sound like ditching the country is a no-brainer. But for smaller companies that lack Samsung’s clout with suppliers, it’s not. Having spent years nestling their businesses around China’s rich supply chain, these firms can find themselves facing painful tradeoffs.
For instance, CIG told Quartz that it recently buckled to fears of trade war fallout a few months back and invested in a new factory in Malaysia. The transition was astonishingly smooth: it got things up and running in less than six months. And Malaysian workers require much lower pay than those in China. But the companies executives nonetheless bemoan the move. As it turns out, production is still more expensive because China’s supply chain is much bigger, denser and, therefore, more efficient than Malaysia’s. The diverse ecosystem of suppliers within two hours of its Shanghai factory lets it source parts smoothly and quickly. It would take Malaysia at least three to five years—and possibly as many as 10—to build such a complex network of suppliers, said its executive.
Regardless of these logistical challenges, it’s reasonable to expect supply chains in many industries to continue to regroup beyond China’s borders.
Despite the heated trade war rhetoric, so far, the tariff rates have been relatively light and have spared many major categories of Chinese exports. But the US government’s threats to impose 25% tariffs on all Chinese imports looms—as do its restrictions on major Chinese tech companies like Huawei and ZTE, noted Nomura economists in a recent analysis.
And tensions are, if anything, tightening. Earlier this week, US president Donald Trump declared that if Xi Jinping, chairman of China’s Communist Party, declined to meet with him at the G-20 meeting in Osaka in late June, he would impose duties on an additional $300 billion worth of Chinese goods.
That won’t sit well among China’s leaders, who are obsessively on guard against anything that the Chinese public might see as a sign of their government’s weakness or its inability to command America’s respect. The more both sides harden their resolve to tough it out, the greater the pressure on companies to hedge their bets on China and move elsewhere.
But at this point, even a breakthrough US-China trade deal might not be enough to deter the supply chain changes afoot. The last year or so has been brutal for firms whose bottom lines hinge on continuous, reliable, uninterrupted trade among each other. That’s as much from uncertainty—the chance of even more trade barriers—than the actual duties imposed.
Trump can remove the current barriers. But what about the risk of more to come? His trade war has made tariffs a viable policy tool for future administrations confronting China’s growing economic and geopolitical clout. As one of the executives at CIG saw it, that threat can’t be put back in the bag. “Even if Trump is not [in office],” she said, “customers have already started thinking, ‘What if you get another crazy president—one who does 50% tariffs?'”