Despite uncertainties, a large-scale shift of production from China to other countries might not be possible, at least in the short to medium term
As the world tries to re-globalize, reduce their supply-chain dependencies on any single country, create resilience from geopolitical shocks, and de-risk their markets, a new trade war is breaking out between China and the United States, which together account for over one-third of the global economy. China has started to carry out raids onUS companies based in its country, detain their local staff, and conduct cybersecurity review of products sold by some of these companies.
The US on the other hand, besides increasing its military activities in South China Sea, had drawn first blood on October 7, 2022, when it enacted a series of new export control regulations targeting China’s artificial intelligence (AI) and semiconductor industries. The purpose of the October 7 export controls was to exploit US control of strategic semiconductor technologies in order to choke off China’s access to future progress in AI, including its national security applications. This fresh round of conflict between the two giants of global trade will no doubt send shockwaves around the world impacting every country.
China hits at US companies
US corporate due diligence firm Mintz Group said in late March that Chinese authorities had raided its Beijing office and detained five local staff. China’s foreign ministry said at the time Mintz was suspected of engaging in unlawful business operations. Police visited Bain & Co’s office in Shanghai and questioned staff, the US management consultancy said last week. China has also said it will conduct a cybersecurity review of products sold in the country by US memory chip manufacturer Micron Technology Inc, amid US moves to bar Chinese access to cutting-edge chip technology. The other side of the story is that these companies, which were the target of the raids, were involved in identifying Chinese shell companies that were being used to bypass US trade restrictions.
India could be used to bypass US sanctions
The US is worried about Chinese tactic for avoiding the controls is accessing computing capacity through the Cloud. Since the regulations target geographic destination and not corporate ownership, it remains entirely legal for Chinese AI companies to import the chips to their subsidiaries in, say, India and then allow Chinese programmers in China to access the computing capacity via the Cloud.
The Indian government has reportedly given preliminary clearance to several Chinese suppliers of Apple, allowing them to form joint ventures with Indian companies to set up facilities in the country. The move is aimed at expanding the local value chain in iPhone and electronics manufacturing. Fourteen out of the 17 Chinese suppliers that approached the government have received the initial clearance. These companies include Luxshare, Sunny Optical, Han’s Laser Technology, YUTO Packaging Technology, Strong, Salcomp and Boson. These firms supply components to other smartphone and electronics brands as well.
Apple’s move to shift iPhone production to India could well have been triggered by the US trade sanctions. In mid-2022, Apple was on track to purchase advanced NAND memory chips from China’s YMTC for use in iPhones. Apple cancelled the order in the wake of the export controls.
Chinese exports to US decline sharply
Meanwhile, the increase of geopolitical tensions between Washington and Beijing spurred speculation about a sectoral decoupling between the world’s largest economies. While the value of US imports of Chinese goods and services reached the highest on record in 2022, there are signs that US tariffs are shifting bilateral trade flows. Last year, US goods imports from China that are subject to tariffs fell by about 14% versus 2017 pre-trade war levels, according to analysis from Chad Bown, a senior fellow at the Peterson Institute for International Economics.
Over the past five years, US tariffs, export restrictions and subsidies have persuaded American companies to diversify their imports away from China. The total share of Chinese imports to the US has slipped about 3 percentage points since 2018, when former President Donald Trump imposed tariffs on thousands of Chinese goods. During this time, China ceded a portion of its share of total US imports to other Asian export nations like Vietnam, India, Taiwan, Malaysia and Thailand. However, a part of this shift could be Chinese companies setting up operations in these countries to bypass US restrictions.
Sidestepping US tariffs
Chinese manufacturers looking to sidestep US tariffs and shorten supply chains are opening operations in nations such as Vietnam, Thailand and Mexico. Mexico is becoming a key US sourcing alternative to China. Highly integrated US-Mexico supply lines and preferential trade treatment under the USMCA (United States Mexico Canada) are helping to create investment opportunities across the border. Importers – and even some Chinese exporters – looking to diversify their supply chains are racing to snap up Mexican industrial space, which reached a 97.5% occupancy rate in 2022. Demand for warehouses and other industrial properties is particularly high along the US border near Tijuana where industrial vacancy rates are near zero. Some 47 new industrial parks are either planned or under construction, according to the Mexican Association of Private Industrial Parks.
Rare earth vulnerability
Chinas is also like to weaponize its dominance of rare-earth metal mining and especially refining capacity, controlling more than 60% and 80% respectively of global capacity. There’s an important difference, however, between China’s dominance of rare earths and the US dominance of semiconductors. China is vulnerable in semiconductors because it lacks technology and a credible path to acquire it. The United States and its allies are vulnerable in rare earth metals only because they have not shown adequate political will to address the problem.
The United States’ position in rare earths is analogous to the crisis of Europe’s dependence of Russian natural gas. Europe had all the technology to build additional liquid natural gas shipping terminals and the wealth to acquire foreign sources. It simply had a different strategy of “peace through trade” that ensured no substantive attempt to build out the capacity.
Shifting from China not that easy
However, once Russia invaded Ukraine, the crisis created the necessary political will. Any Chinese move to cut off rare earth metals would spark a rush to develop new mines and new refining capacity–as occurred when China restricted rare earth exports to Japan in 2010. Developing alternative sources is far from instantaneous, but slow normal timelines in mine permitting and refining installation construction and can be vastly accelerated during a crisis.
Still, there is also a view that a large-scale shift of production from China to other countries is not possible, at least in the short to medium term. The ecosystem that developed in the last 40 years around Chinese manufacturing is too deep and vast to be quickly disrupted. China is so much bigger than such countries as Vietnam and other Southeast Asian nations that it is not possible to move the lion’s share of Chinese capacity to these countries. Thus, even as global companies effectively purchase insurance against political risk in China by moving assets to other countries, they are likely to be left with considerable exposure to China in the coming years.
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