economics & strategy understanding china understanding china: post-pandemic state of the supply...
TRANSCRIPT
Refer to important disclosures at the end of this report.
Ma Tieying Economist [email protected]
Please direct distribution queries to Violet Lee +65 68785281 [email protected]
The outbreak of the COVID-19 pandemic this year has exposed the
vulnerability of global supply chain, which heavily relies on China for
sourcing and production. This, juxtaposed with the Sino-US trade
tensions and China’s labor cost increases, will likely prompt more China-
based MNCs to diversify their supply chains in the coming years.
Group Research
30 May 20, 2020
Economics & Strategy
Understanding China Post-pandemic state of the supply chain
• The COVID-19 crisis, juxtaposed with the Sino-US trade tensions
and China’s labour cost increases, will likely prompt more China-
based MNCs to diversify supply chains.
• The existing trend of production relocation in the low value-
added sector from China to other emerging markets will likely
be reinforced.
• Production of the “strategic” goods may be shifted from China
towards the end markets.
• Supply chain diversification in the technology sector is also
possible, but a complete relocation should be unlikely.
• Foreign companies targeting China’s domestic market are least
likely to move out, given the country’s large market scale and
post COVID-19 growth opportunities.
• Overall, we expect more MNCs to adopt a ‘China+1’ strategy in
the coming years, maintaining China as a primary production
base while increasingly looking for alternative suppliers.
• India, Indonesia, Thailand and Vietnam may benefit from this
long-term process of diversification.
• China, on the other hand, will likely remain as an important
global manufacturing powerhouse, with FDI geared towards its
large domestic market and high value-added sectors.
Understanding China: Post-pandemic state of the supply chain May 20, 2020
Page 2
Problems exposed by COVID-19
Thanks to globalisation and the opening-up of the Chinese economy in
the past decades, China has grown into the world’s largest
manufacturing powerhouse. It currently ranks as the world’s No.1
source of textiles, plastics & rubber, metals, machinery & electrical
equipment imports, No.3 of chemicals imports, and No.6 of food and
transport equipment imports. Because of China’s dominant position in
global manufacturing, when Chinese factories closed during the
country’s COVID-19 outbreak in January-February this year, businesses
and consumers in other parts of the world suddenly faced difficulties in
procuring materials and products. For instance, South Korean
automakers including Hyundai and Kia shut down their local plants
temporarily in February, due to the lack of crucial components imported
from China. Japanese video game producer Nintendo suffered a
shortage of Switch consoles in its Vietnamese factories, also due to the
lack of components from Chinese suppliers.
Problems have been particularly acute in the segments of PPE (personal
protective equipment) and medical goods. According to a study by
Peterson Institute for International Economics, China is the source of
more than 50% of world imports of respirator masks/surgical masks,
medical goggles, and protective garments. Due to the shortage of supply
from China, and at the same time, surge in global demand during the
spreading pandemic, PPE prices surged sharply. PIIE estimates that
China's export prices for respirators and surgical masks increased by 182%
US • Food #1
• Chemicals #2
• Mach & Elec #2
• Transportation #2
• Fuels #3
• Plastics & Rubber #3
• Metals #3
Germany • Chemicals #1
• Transportation #1
• Food #2
• Plastics & Rubber #2
• Metals #2
• Mach & Elec #3
France • Food #3
China • Textiles #1
• Plastics & Rubber #1
• Metals #1
• Mach & Elec #1
• Chemicals #3
• Saudi Arabia • Fuels #2
Russia • Fuels #1 Japan
• Transportation #3
Vietnam • Textiles #3
Bangladesh • Textiles #2
The world’s top 3 sources of imports, 2018
Sources: WITS database, DBS
Understanding China: Post-pandemic state of the supply chain May 20, 2020
Page 3
in March versus January-February, and prices for medical goggles and
protective garments were also up by 15% and 11% respectively.
Thanks to the full-scale lockdown and strict quarantees, China has
successfully brought COVID-19 under control since March. Chinese
workers have gradually returned to work and Chinese factories have
resumed production. China has also significnatly ramped up the capacity
of PPE in more recent months, with the large companies like car maker
BYD and oil and gas producer Sinopec diverting their production lines to
make masks. Despite the resilient recovery, the severe disruption at the
early phase of the pandemic has left a lesson, prompting the China-
based MNCs to reassess supply chain risks and review business plans.
The low value-added sector
Indeed, COVID-19 will likely reinforce the existing trend for MNCs to
relocate the low value-added production from China to other emerging
markets. This trend has emerged ever since a decade ago, in the context
of rapid population aging, wage cost increase, and structural transition
in the Chinese economy. The US tariff hikes after the outbreak of the
China-US trade war in 2018 have further squeezed the profit margin of
low value-added producers, therefore accelerating the process of
relocation.
Reflected in the trade data, China’s share in the world’s imports of
textile products declined notably by 4ppt between 2010 and 2018. Its
share in the world’s total imports also fell from the peak of 13% in 2015
0 50 100
Protective garments
Respirators & surgical masks
Medical goggles
Medical shoe covers
Hospital gloves
China Others
Sources of world imports of PPE
%
Sources: PIIE, DBS
Understanding China: Post-pandemic state of the supply chain May 20, 2020
Page 4
to 12% in 2018. Industry news suggests that Vietnam has already
overtaken China to become the largest footwear production base for
Nike and Adidas. Japan’s Fast Retailing Co. which operates the Uniqlo
clothing chain, has also shifted production from China to Southeast Asia
in recent years. The company reportedly increased the number of
Vietnamese suppliers by 40% YoY in 2018.
The “strategic” sector
Meanwhile, COVID-19 may trigger the production relocation of some
“strategic” goods, such as PPE, medical equipment and pharmaceuticals,
from China towards the end markets. For these sectors deemed
strategic, many countries would find it necessary to increase self-
sufficiency and reduce the over-reliance on foreign suppliers after
COVID-19.
The US is already calling for the reshoring of medical equipment and
pharmaceuticals. Lawmakers proposed two bills in March, including the
Securing America’s Medicine Cabinet Act, which offers incentives for
companies to increase the US-based production of
active pharmaceutical ingredients; and the Medical Supply Chain
Security Act, which provides authority for the Food and Drug
Administration to require companies to disclose information like the
source of origin and use of raw materials. It will not be surprising to see
other governments follow suit, using a carrot and stick approach to
encourage companies to move back the production of strategic goods.
0
5
10
15
20
25
30
35
40
1990 1995 2000 2005 2010 2015
China Bangladesh
Vietnam India
Italy
Top 5 sources of world imports: Textiles
%
Sources: WITS database, DBS
0
2
4
6
8
10
12
14
2000 2005 2010 2015
China's share in world imports: All products
%
Sources: WITS database, DBS
Understanding China: Post-pandemic state of the supply chain May 20, 2020
Page 5
Technology sector
In the technology sector, supply chain diversification from China to other
emerging markets or some developed markets is also possible after
COVID-19, but a complete relocation should be unlikely. Owing to wage
cost increase and trade war, the tech companies based in China have
also been facing the pressure of relocation prior to the COVID-19
outbreak. These include the relatively labor intensive segments like the
assembly of computers and smartphones, and the cybersecurity
sensitive segments like network equipment and servers. The COVID-19
crisis is likely to provide another catalyst for the China-base tech
companies to diversify supply chains. This, however, does not mean they
will move the whole supply chain out of China any time soon.
According to the Global Competitiveness Index, China remains an
outperformer among emerging markets in terms of infrastructure
conditions, labor skills, ICT adoption and innovation capability. These are
the important elements required by technology goods production.
Compared to the developed markets, labor costs in China remain more
affordable today. Average wages in China, albeit rising, are equivalent
to only about 20% of that in the US, Germany and Japan. Although
automation technology is becoming cheaper, it would still take time for
industrial robots to be widely installed in the developed markets and to
substantially replace Chinese workers. For now, robot density in the US,
Germany and Japan remains low at less than 10%.
0
20
40
60
80
100
Infrastructure ICT adoption Skills Innovationcapability
Malaysia China Czech PolandThailand Mexico Indonesia TurkeyPhilippines Vietnam India Brazil
Global competitiveness index - subindicesScore, 2019
Sources: World Economic Forum, DBS
Understanding China: Post-pandemic state of the supply chain May 20, 2020
Page 6
In addition, the technology sector has a relatively high degree of product
complexity and requires the support of a long supply chain. There are
more than 100,000 electronics manufacturing firms operating in China
today, contributing as much as 30% of global ICT goods exports. The
establishment of a large-scale electronics cluster and ICT ecosystem
would also make it difficult for foreign tech companies to completely
move out of China.
When looking at the trade and investment statistics, we find that China’s
share in the world’s imports of machinery and electrical equipment has
peaked in 2017 but remained basically stable at 28%. FDI utilized in
China’s electronics sector has stayed around the level of USD6-8bn per
South Korea
Singapore
GermanyJapan
USTaiwan
NetherlandsUK
China
ThailandMalaysia
Indonesia
Philippines
India
0
100
200
300
400
500
600
700
0 10,000 20,000 30,000 40,000 50,000 60,000 70,000
Robot density vs Per capita income
Per capita GDP in USD, 2019
Sources: International Federation of Robotics, IMF, DBS
Number of installed industrial robots per 10,000 workers, 2016
Major electronics manufacturers in China
Total:
Xi'an Micron
Samsung Chengdu
Dell Foxconn Intel
Chongqing Quanta SK Hynix
Wistron
Shenzhen Foxconn Huawei Lenovo SMIC ZTE Dongguan Huawei Samsung Zhuhai Flex Xiaomi Zhongshan Wistron
Zhengzhou Foxconn
Nanjing Compal TSMC Suzhou AsusTek Samsung UMC Kunshan Compal Dell Pegatron Wistron Wuxi SK Hynix Changshu Quanta Hefei Lenovo Shanghai Intel Quanta Pegatron SMIC TSMC
Sources: NBS, MOFCOM, DBS
Total: 134,000 in 2018
Dalian Intel
Xiamen UMC
Beijing SMIC Xiaomi Tianjin Foxconn Samsung SMIC Taiyuan Foxconn Yantai Foxconn
Wuhan Lenovo
Understanding China: Post-pandemic state of the supply chain May 20, 2020
Page 7
annum in the past decade. South Korea’s Samsung has moved
smartphone production to Vietnam and closed all its smartphone
factories in China as of last year. On the other hand, Samsung has
continued to increase investment in the Chinese cities including Xi’an
and Suzhou to expand the semiconductor and LCD production lines.
Meanwhile, the company has continued to rely on China to supply
components for its smartphone plants located in Vietnam.
China’s large domestic market and post COVID-19 opportunities
MNCs targeting China’s domestic market should be least likely to exit
the country. China is currently the second largest consumer market
globally, just after the US. It also ranks as the world’s second largest
healthcare market, and largest e-commerce market, mobile payment
market and industrial robot market. In particular, demand for healthcare
and technology will likely grow at a faster pace after COVID-19, creating
more opportunities for foreign producers in these areas.
Health expenditures currently account for about 5% of China’s GDP, a
moderate level among emerging economies. A faster expansion in
China’s healthcare market has been a widely expected long-term trend
prior to the COVID-19 outbreak, due to the rapidly aging population and
rising life standards. The COVID-19 crisis may prompt greater changes in
Chinese consumers’ spending patterns and meanwhile, inspire upgrades
in China’s healthcare system.
0
5
10
15
20
25
30
35
40
1990 1995 2000 2005 2010 2015
China US
Germany Japan
South Korea
Top 5 sources of world imports: Machinery & Electrical equipment%
Sources: WITS database, DBS
0
2
4
6
8
10
12
2000 2005 2010 2015
China: FDI utilized, by sector
Textile
Medical & Pharmaceutical
Universal Equipment
Special Purpose Equipment
Electronics
USD bn
Sources: CEIC, DBS
Understanding China: Post-pandemic state of the supply chain May 20, 2020
Page 8
Digital economy (broad definition including ICT and the traditional
sectors integrated with digital technology) is equivalent to about 30% of
China’s GDP today, more than doubling from ten years ago. An IMF
report projects that this ratio will rise further to reach 50% by 2025.
Apparently, demand for digital services including online shopping,
online entertainment, remote work and distance learning has surged in
China during COVID-19. The Chinese online services providers like
JD.com and Meituan Dianping have used robots and autonomous
vehicles to deliver food and medical supplies. The country’s digital
transformation process is expected to gain further momentum after
COVID-19, bringing more opportunities for ICT goods producers.
‘China+1’ strategy
Putting things together, we think the COVID-19 crisis will reinforce the
importance of geographic diversification of global supply chain. But this
does not mean all companies in all industries will move the whole supply
chain out of China any time soon. The most likely outcome is for more
MNCs to adopt a ‘China+1’ strategy, maintaining China as a primary
production base while increasingly looking for alternative suppliers.
The emerging markets with similar supply-side conditions as China
should be the ideal candidates of alternative suppliers. Considering the
three crucial factors – the ease of doing business, level of wage costs and
scale of labor force, India, Indonesia, Thailand and Vietnam appear to be
the Asian economies best positioned to receive the manufacturing work
transferred from China. Vietnam has seen a strong surge in FDI inflows
0
2
4
6
8
10
12
Bra
zil
Pola
nd
Vie
tna
m
Mex
ico
Chi
na
Phili
ppin
es
Turk
ey
Mal
aysi
a
Thai
lan
d
Ind
ia
Indo
nesi
a
Health expenditures in EMs
Sources: World Bank, DBS
% of GDP, latest year available
0
5
10
15
20
25
30
35
40
2008 2011 2014 2015 2016 2017 2018
Digital economy in China
Sources: China Academy of Information and Communication Technology, DBS
% of GDP
Understanding China: Post-pandemic state of the supply chain May 20, 2020
Page 9
in recent years. India now also has the ambition to attract more FDI, with
its government reportedly in the process of making land more easily
available, relaxing labor rules and offering tax incentives. Apple’s
Taiwanese contract manufacturers including Foxconn and Wistron
already have plans to expand production facilities in India.
Notwithstanding some degree of geographic supply chain
diversification, China will likely remain as an important global
manufacturing powerhouse. As revealed by a March survey jointly
conducted by AmCham and PwC, the majority 70-80% of American
companies operating in China have no plans to move production and
sourcing out of the country due to COVID-19. Another survey by Japan
External Trade Organization also shows that China has remained as the
top destination of overseas expansion for Japanese firms as of end-
FY2019, despite the narrowing gap with Vietnam. With the Chinese
government committed to strengthen IP protection, step up the
financial sector reform and promote free trade, the long-term prospect
for China to continue improving business environment and raising per
capita incomes remains intact. This is expected to continue to attract
foreign investment into the country, with the focus increasingly placed
on its domestic market and high value-added sectors in the years ahead.
Brazil
China Czech
Germany
Hong Kong
IndiaIndonesia
Japan
Malaysia
Mexico
Netherlands
Philippines
Poland
South KoreaSingapore
TaiwanThailand
Turkey
UK
US
Vietnam
60
65
70
75
80
85
90
95
100
0 10,000 20,000 30,000 40,000 50,000 60,000 70,000
Ease of doing business vs Per capita income
Ease of doing business 2020, score 1-100
Per capita GDP 2019, USD
Note: Bubble size represents population
Sources: World Bank, IMF, United Nations, DBS
Understanding China: Post-pandemic state of the supply chain May 20, 2020
Page 10
Appendix
0
2
4
6
8
10
12
14
2000 2005 2010 2015
China's share in world imports: All products
%
Sources: WITS database, DBS
0
5
10
15
20
1990 1995 2000 2005 2010 2015
US Germany
France Netherlands
Italy
Top 5 sources of world imports: Food products%
Sources: WITS database, DBS
0
5
10
15
20
25
30
35
40
1990 1995 2000 2005 2010 2015
China Bangladesh
Vietnam India
Italy
Top 5 sources of world imports: Textiles
%
Sources: WITS database, DBS
0
5
10
15
20
25
1990 1995 2000 2005 2010 2015
Germany US
China Ireland
France
Top 5 sources of world imports: Chemicals
%
Sources: WITS database, DBS
Understanding China: Post-pandemic state of the supply chain May 20, 2020
Page 11
0
5
10
15
20
1990 1995 2000 2005 2010 2015
China Germany
US Japan
South Korea
Top 5 sources of world imports: Plastics & Rubber%
Sources: WITS database, DBS
0
5
10
15
20
1990 1995 2000 2005 2010 2015
China GermanyUS JapanItaly
Top 5 sources of world imports: Metals
%
Sources: WITS database, DBS
0
5
10
15
20
25
30
35
40
1990 1995 2000 2005 2010 2015
China US
Germany Japan
South Korea
Top 5 sources of world imports: Machinery & Electrical equipment%
Sources: WITS database, DBS
0
5
10
15
20
25
30
1990 1995 2000 2005 2010 2015
Germany US
Japan Mexico
France
Top 5 sources of world imports: Transport equipment%
Sources: WITS database, DBS
Understanding China: Post-pandemic state of the supply chain May 20, 2020
Page 12
0.0
0.5
1.0
1.5
2.0
2.5
1990 1995 2000 2005 2010 2015
Global FDI inflowsUSDtn
Sources: UNCTAD, DBS
0
50
100
150
1990 1995 2000 2005 2010 2015
China
India
ASEAN5
FDI inflows into AsiaUSDbn
Sources: UNCTAD, DBS
Note: ASEAN5 refers to Indonesia,
Malaysia, Philippines, Thailand, Vietnam
0
10
20
30
40
50
60
70
80
90
100
2000 2005 2010 2015
China: FDI utilized, by industry
ManufacturingServices
USD bn
Sources: CEIC, DBS
0
2
4
6
8
10
12
2000 2005 2010 2015
China: FDI utilized, by sector
Textile
Medical & Pharmaceutical
Universal Equipment
Special Purpose Equipment
Electronics
USD bn
Sources: CEIC, DBS
Understanding China: Post-pandemic state of the supply chain May 20, 2020
Page 13
0
10
20
30
40
50
2000 2005 2010 2015
China: FDI utilized, by sector
Wholesale & Retail Trade
Banking & Insurance
Real Estate
Information & Communication
Leasing & Commercial Service
USD bn
Sources: CEIC, DBS
0
2
4
6
8
10
2000 2005 2010 2015
Germany Japan
Singapore South Korea
Taiwan US
USD bn
Sources: CEIC, DBS
China: FDI utilized, by source
0
1
2
3
4
5
6
2005 2010 2015
Japan: Outward FDI, by market
China India ASEAN
Sources: CEIC, DBS
JPY tn
0
50
100
150
200
250
300
2000 2005 2010 2015
Singapore: Outward FDI, by market
China India ASEAN5
Sources: CEIC, DBS
USD bn
Note: ASEAN5 refers to Indonesia, Malaysia,
Philippines, Thailand, Vietnam
Understanding China: Post-pandemic state of the supply chain May 20, 2020
Page 14
0
2
4
6
8
10
12
2000 2005 2010 2015
South Korea: Outward FDI, by market
China ASEAN4
Sources: CEIC, DBS
USD bn
Note: ASEAN4 refers to Indonesia, Malaysia, Thailand, Vietnam
-10
0
10
20
30
2000 2005 2010 2015
Tho
usa
nd
s
US: Outward FDI, by market
China India ASEAN4
Sources: CEIC, DBS
Note: ASEAN4 refers to Indonesia, Malaysia, Philippines, Thailand
USD bn
0
1
2
3
4
0
10
20
30
40
50
2005 2010 2015
Total
Automobiles (RHS)
Electronics (RHS)
Textiles (RHS)
India: FDI inflows
Sources: CEIC, DBS
USD bn USD bn
0
10
20
30
40
2013 2014 2015 2016 2017 2018 2019
Vietnam: FDI registered
Total
Manufacturing
USD bn
Sources: CEIC, DBS
Understanding China: Post-pandemic state of the supply chain May 20, 2020
Page 15
Related reports: Understanding China: The COVID-19 is a stress test on globalisation
China Chartbook: Understanding the impact of COVID-19 in 10 charts
Coronavirus and supply chain: Electronics sector in focus
Impact of coronavirus on the region – a supply chain perspective
Understanding China: From trade war to tech war
Understanding Vietnam: A rising star
Understanding China: Post-pandemic state of the supply chain May 20, 2020
Page 16
Sources: Data for all charts and tables are from CEIC, Bloomberg and DBS Group Research (forecasts and transformations).
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Nathan Chow Irvin Seah
Strategist - China & Hong Kong Economist - Singapore, Malaysia, & Vietnam
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Chris Leung Duncan Tan
Economist - China & Hong Kong FX and Rates Strategist - Asean
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Ma Tieying, CFA Philip Wee
Economist - Japan, South Korea, & Taiwan FX Strategist - G3 & Asia
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Group ResearchEconomics & Macro Strategy
Taimur Baig, Ph.D.
Chief Economist - G3 & Asia
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