Post Covid-19, can emerging markets capitalise on a shift in manufacturing away from China?

The coronavirus pandemic has sparked questions about whether China can sustain its position at the centre of global manufacturing and supply chains. 

The fact that the virus originated in China, the world’s major manufacturing hub, led to disruptions in global supply chains of basic goods, and gave rise to speculation that some companies would seek alternative production bases.

Indeed, international reaction was swift, with representatives of three of the world’s four largest economies publicly encouraging companies to shift their manufacturing operations out of China as part of plans to diversify global industry.

In April Phil Hogan, the EU trade commissioner, told international media that the bloc would seek to reduce its trade dependencies. These comments followed Japan’s decision to unveil a $2.2bn package to support countries looking to relocate from China.

In the US, meanwhile, Larry Kudlow, the director of the National Economic Council who is also considered to be President Donald Trump’s top economic advisor, told media that the government should cover 100% of the costs associated with bringing the country's manufacturing firms back home from China.

While Covid-19 has accelerated the debate around such relocation, it is not a new phenomenon in itself. In recent years rising production costs, coupled with increased tariffs implemented as part of the US-China trade war, have seen businesses steadily move their factories and plants out of China in favour of more competitive markets.

Other firms employ a “China +1” strategy, whereby companies seek to diversify production capacity by setting up factory lines in other countries, while maintaining significant operations in China.

As some companies look to move out of China, a number of emerging markets with developed industrial sectors and low labour costs have emerged as natural contenders.

ASEAN looks to capitalise

Many firms looking to maintain their operations in Asia have turned towards ASEAN countries.

In particular, Vietnam has absorbed much of the manufacturing capacity that China has lost. The country has signed a raft of international trade deals and invested significantly in industrial infrastructure over the past decade, and has experienced an increase in textiles and apparel manufacturing, among other industries. An additional consideration is that labour costs are around 50% less than China.

More recently, the effective response to the virus in the country, which has had fewer than 300 cases and has yet to register a Covid-19-related death, has further bolstered investor confidence.

In early May regional media reported that US tech giant Apple would produce around 30% of its AirPods – some 3m-4m units – for the second quarter in Vietnam rather than China.

Vietnam has also expanded its production of personal protective equipment (PPE), and in doing so has rivalled China’s so-called “coronavirus diplomacy” by donating medical supplies to Europe and fellow Asian countries.

With 40 firms producing 7m fabric masks a day – and capacity for an additional 5.7m surgical masks – by mid-April the country had donated 550,000 masks to France, Germany, Italy, Spain and the UK, along with a further 390,000 to its neighbour Cambodia and 340,000 to Laos. Furthermore, US company DuPont recently sold 450,000 Vietnam-made hazmat suits to the US government.

But Vietnam is not the only emerging Asian economy courting China-based manufacturers.

In an attempt to react to the specific needs of the post-pandemic landscape, lawmakers in the Philippines are considering changes to the long-pending Corporate Income Tax and Incentives Rationalisation Act. Currently before the Senate, the bill is intended to streamline and "rationalise" incentives offered to firms located in special economic zones while progressively lowering the rate of corporate income tax across the board.  

However, opponents of the bill have warned that now is not the time to limit incentives for export-oriented firms as countries across the region look to attract international manufacturers seeking an alternative base to China. In mid-May, the Department of Finance proposed changes to the bill that would grant the president more flexibility in allowing incentives to be tailored to the needs of specific investors. 

“The Philippines provides an ideal location as a hub in the Pacific, so we must do all we can to attract manufacturers here as they reassess their global operations,” Charito Plaza, director-general of the Philippine Economic Zone Authority, told OBG. “This will come not only from preserving our tried-and-tested incentives, but also from concerted efforts to reduce power costs, and enhance digital and physical infrastructure around the country. More seaports and airports are needed in every region.”

Elsewhere, international media reported this month that the Indian government is developing a land pool of 462,000 ha – twice the size of Luxembourg – to attract manufacturing businesses relocating from China in 10 sectors, including electrical, pharmaceuticals, medical devices, food processing and textiles.

Meanwhile, the 20-year Thailand 4.0 economic strategy, launched in 2016, has sought to move the country towards high-tech, innovative and digital industrial production by offering incentives for companies and updating infrastructure.

In October last year the Indonesian government also outlined plans to develop more special economic zones to position the country as a leading destination for manufacturing firms looking to move out of China.

Moving closer to home

While ASEAN countries are attractive alternatives for some companies, others have signalled their intention to move manufacturing capacity closer to their home and/or target markets.

For US or US-focused firms, Mexico – already the largest trade partner of the US –  stands out as a logical option.

With significant industrial and manufacturing industries, particularly in the automotive and aviation segments, and trade benefits under the United States-Mexico-Canada Agreement (USMCA), the country is well positioned to integrate itself further into global supply chains after the pandemic. 

“International companies already active in Mexico who are looking to relocate some or all of their manufacturing bases away from China could benefit Mexico substantially, given that it offers a sustainable local supply but at only a marginally higher cost initially,” Martin Toscano, managing director of Evonik México, told OBG. “As the USMCA comes into effect on July 1, this has reinforced the notion that competitors for North America-based firms lie in Europe or Asia, rather than in Canada or Mexico.” 

Perhaps in a sign of further Covid-19-related changes to come, in March an auto parts manufacturer supplying Japanese car company Mazda shifted some of its production from China to Mexico’s Guanajuato State.

On a similar note, existing manufacturing hubs in Morocco, Tunisia and Egypt could be viewed as competitive destinations for European industrial firms seeking an overseas production base.

With well-established trade links to European markets, Morocco in particular is an attractive proposition. The country has been lauded internationally for its response to the novel coronavirus, which has seen it leverage its industrial capacity to produce in-demand medical supplies and PPE.

“Thanks to a robust industrial base and its strategic location, Morocco has been able to maintain exports to neighbouring countries during the lockdown, as well as keep operations up-and-running in key sectors such as agri-business, textiles and the automotive industry,” Hicham Boudraa, acting managing director at the Moroccan Investment and Export Development Agency, told OBG.

Parallel to such efforts, with the virus and subsequent disruption of supply chains leaving many countries with a shortfall of essential goods, governments around the world are also likely to attempt to boost their own domestic capacity and self-sufficiency.

At the heart of this is a shift away from the just-in-time manufacturing model – a low-cost strategy that sees inputs arrive just as they are needed in the production process – and towards the so-called “just-in-case model”, which involves adding to the domestic production capacity of essential goods to hedge against times of crisis.

Difficulties of relocation

The decision to relocate to another country comes with a series of challenges, with some analysts suggesting that the exodus will be less extensive than others have anticipated.

In a joint poll carried out by PwC and the US chambers of commerce in both Beijing and Shanghai in mid-April, 70% of US companies surveyed said they had no plans to relocate production or supply chain links away from China due to Covid-19.

Many respondents cited China’s position ahead of the global curve when it comes to restarting the economy, with 68% forecasting a return to normal activities within three months and 96% within six months.

Another factor complicating any potential relocation is related to parts and raw materials, with many countries still reliant on China for the components – from electronic parts, to textiles, to raw pharmaceutical materials – needed for production.

“Almost 50% of raw materials used by manufacturers in our economic zones come from China. When suppliers in China closed earlier this year, many manufacturers had to stop operations, although some still had sufficient inventory to allow them to continue operations for a while,” Plaza told OBG.

On a more positive note, Plaza pointed out that once export-oriented manufacturers set up a base in the country, they serve to stimulate local enterprise as SMEs integrate into their supply chains, which can enhance manufacturing self-sufficiency over time.  

Taking such factors into consideration, many businesses looking at relocation will have to assess any costs associated with establishing new supply chains for components, or delays in production brought on by disruptions in China.

While many anticipate that foreign companies will continue with a China +1 strategy moving forward, China is expected to remain the main manufacturing centre in the near term, with trends towards diversifying global industrial capacity set to continue over a longer period.