A half-trillion dollar shift away from China

There is an opportunity for countries to grab exports worth $450 billion that India cannot afford to miss

These days rarely a day passes without trade wars making the headlines. And yet, despite more than a year of duties on US merchandise imports from China, and a synchronised global slowdown nearly universally blamed on the trade wars, the headline trade numbers do not seem to have changed much. To investigate this, Credit Suisse surveyed a hundred global companies (with a combined $1 trillion in annual sales), and pored over trade statistics as well as longer-term economic trends.

Beyond the obvious policy uncertainty (negotiations are still ongoing), we found two main reasons why there has not yet been a more aggressive shift of manufacturing away from China. First, capacity in China is not merely for exporting to the US, but also for the growing domestic demand, as well as for other non-tariff affected export markets. Over the past year or so, a decline in China's exports to the US has been offset by rising exports to the European Union (EU), Vietnam and other nations. While some of this could just be products being re-routed to avoid the duties, a significant part, in our view, was Chinese manufacturers redirecting their surplus capacities to other markets.

And this brings us to the second reason. More than three-fourths of the Chinese exports to the US — that are finished goods sold directly to consumers, such as apparel, toys or handsets — are coming under duties only in the final list. The first three lists mainly had intermediate goods or those sold to corporations, where the duties did not cause a large and visible price impact on end-consumers. The finished goods sold in the retail market that were part of these earlier lists, such as washing machines, saw significant price increases post tariffs, and that drove down demand. Given that manufacturers use Chinese capacity for global demand, their first response to tariffs in only one country would be to raise prices in that geography. It is only when demand volumes get affected that the pressure to shift capacity would rise, and that should pick up now.

But this only seems to be accelerating a medium-term trend already in play: Nearly two-thirds of firms we surveyed were either already moving some of the production out of China, or were planning to. More than 90 per cent of these would do so even if the tariffs imposed by the US government were reversed.

The main reason is the shrinking Chinese workforce, which is estimated to fall by a further 50 million by 2030. One would assume that this decline would come mainly from the 200 million Chinese workers still in agriculture, but interestingly, the manufacturing workforce has dropped by almost 20 million in the last four years, making both labour cost and availability a challenge for manufacturers. We estimate that number could fall by a further 9 to 15 million in the next five years in the labour-intensive sectors of electronics and appliance assembly, apparel and textiles, footwear, toys and furniture.

The impact on Chinese exports would be exacerbated by growing domestic demand in China. China’s rising dependency ratio (that is, the number of individuals dependent on a worker: Children or retired people) bottomed out a decade ago, and has been rising ever since, a natural consequence of the one-child policy implemented four decades ago. As the number of consumers and their ability to consume grows, but the number of producers falls, its surplus production available for exports is likely to fall faster. While mechanisation may help grow production at the margin, robots today are nowhere close to providing the range of actions that humans have, particularly at current costs.

We estimate that $350-550 billion of exports could switch out of China in these industries in the next five years: The number could be much higher if the other countries are able to absorb it. Vietnam, for example, which topped the list of countries that companies in our survey said they were moving manufacturing to (India was second), is too small given the scale of the opportunity: It grows manufacturing GDP by just $5 billion every year and firms feared it “would fill up in five years”. Bangladesh gets almost 90 per cent of its exports in apparel, and languishes on nearly all metrics of “ease of doing business”. Other East Asian nations are either not large enough or lack the labour cost advantage: They may benefit from manufacturing shifts in high-technology goods.

A large part of the increase in the global workforce till 2030 is likely to happen in sub-Saharan Africa, India, Pakistan, Indonesia, North Africa, and West Asia. With the exception of India and Indonesia, most of these have struggled to grow labour productivity meaningfully and sustainably, implying they are not natural options for firms exiting China.

Unfortunately, India too is punching well below its weight. Several large technology firms are indeed investing in India as an export base, and 25 per cent annual growth in electronics manufacturing in India over the last four years has managed to stall the increase in net imports of electronics. Self-sufficiency has improved not just in handsets but in consumer appliances too (like air-conditioners). Much of this is merely assembly so far, but the component supply chain is also starting to move to India.

But India is not even on the radar for high-technology manufacturing shifts, and the most disappointing and perplexing trends are in apparel, where wage costs make a big difference. This despite there being a local ecosystem and most large buyers already having sourcing offices in the country. Cotton apparel exports shifting out of China have moved to Bangladesh, and synthetic apparel to Vietnam. There is at least a reasonable explanation for cotton, given that wages in Bangladesh are half that of India, in addition to more flexible labour laws. In synthetic apparel, however, despite workers in China being nearly three times more expensive than in India, and even Vietnam now 30 per cent more expensive, India has barely any export share. Business owners say that high import duties on chemicals that are used to make synthetic yarn have stunted the whole value-chain in India.

Foreign direct investment was rising even before the recent cut in corporate tax rates: One of the few bright spots in the Indian economy in the past six months. It should continue to be strong, but the opportunity is much larger, and one that is only India’s to lose.

The writer is co-head of Asia Pacific Strategy for Credit Suisse