Trade War Truce No Panacea For China Manufacturer Drift

The decision by China and the U.S. to pull back from another escalation of their mutually destructive tariff war is unlikely to stop the continued migration of multinational corporations (MNC) from China as they seek to avoid tariffs and diversify risk.

As reported in FreightWaves earlier this month, a shipper survey by Resilience360 found that 36.1% of those companies looking to relocate operations from China to another country were doing so because of prohibitive U.S. tariffs. Issues with market access and regulatory restrictions (21.1%) and rising labor costs (19.7%) were also prominent push factors.

With no guarantees that the tariff war will end any time soon and with the benefits of diversification becoming clearer to original equipment manufacturers (OEMs) by the day, supply chain insiders expect further migration of production out of China to other parts of Asia.

"Anywhere But China"

"Companies will continue to diversify their supply chain despite the truce," said Vivien Cheong, regional sales manager APAC at Ticontract & Tim Consult.

"The trade war has been a valuable lesson for companies on what their supply chain strategy should be moving forward. Tariff risk aside, there are other risks worth the diversification."

Dr. Raymon Krishnan, President of Singapore-headquartered The Logistics & Supply Chain Management Society, said the "ABC or ‘Anywhere But China' movement" started as far back as 2011 and had been given fresh impetus by the trade war.

"Regardless as to whether a trade deal will be reached between the two countries, this need for diversification will continue into 2020," he added.

China Plus One

Phil Levy, Flexport Chief Economist, said the evolving production landscape in China had prompted companies to look at alternatives to China, "or at least a ‘China plus one' strategy," even before the onset of the trade war.

"The trade conflict certainly accelerated that," he added. "It's worth remembering that for about $250 billion of trade, almost half of U.S. imports from China, there was no tariff relief [in the Dec. 13 phase one agreement]."

While some tariffs were postponed (List 4b) and others are the subject of reduction promises (List 4a), Levy believes it is still far too soon to sound the all-clear.

"There is a reasonable chance that this truce could hold for the coming year, in which case the goods originally slated for Dec. 15 tariffs would be trading freely," he added.

Will The Truce Hold?

"But that's not a certainty. There were lots of ambiguities in the agreement – there were measurable criteria that will not be met, agricultural purchases, for example. And there are other irritants to the relationship that could provoke backsliding."

Levy thinks it highly unlikely that a comprehensive deal that addresses the bulk of U.S. concerns about China is close and expects diversification by OEMs to continue.

"On the policy front, relief for companies will come when we return to a more orderly and less capricious approach to trade policy," he added.

"That would mean, for example, that a Section 301 investigation that found $50 billion in damages could not be used as the legal basis for $500 billion in tariffs."

Ex-China: An Irreversible Trend

Jens H. Lund, chief financial officer at DSV Panalpina, believes the manufacturing drift from China due to the trade war is unlikely to be reversed even if a comprehensive deal is agreed by the world's two largest economies.

"When you have a more diverse supply chain and there's some disruption or some problem you can increase output quickly in some of the areas and compensate," he added.

According to Lund, where prices outside China are lower per hour or per product, "let's say it's clothing or shoes or whatever, If that is the price per hour, I would not think it's possible to move it back [to China]."

The U.S. As A Manufacturing Base?

As U.S.-China trade tensions escalated earlier this year, President Trump demanded U.S. companies "immediately start looking for an alternative to China, including bringing your companies HOME and making your products in the USA." However, it is increasingly clear that only half of his order is being heeded.

"Multinational corporations are driven by the profit motive," said analyst firm Nomura. "To escape the brunt of the trade war, MNCs with operations in China will more likely locate to other low-cost production centers instead of to the U.S."

Lund added, "The problem is, if you have an industrial worker in the U.S. who earns $25 an hour and you have a guy in Bangladesh that gets $2 or $1 per hour, you can put 10% or 20% tariff on it and it doesn't really matter.

"And you know what the worst thing is, the people in Bangladesh they need this money to get out of poverty."

Trans-Pacific Shipping Downturn

The drift of OEMs away from China is already having a major impact on the trans-Pacific trade. Rolf Habben Jansen, chief executive officer of container shipping giant Hapag-Lloyd, told FreightWaves that as a result of the U.S.-China trade war, volumes from China to the U.S. had "definitely come down" this year. However, the carrier has seen "markets like Vietnam, Indonesia and especially India to the U.S. develop very well."

Source: SONAR

Yet volume gains elsewhere in Asia have not saved the trans-Pacific trade this year. China's exports to the U.S. were down 23% year-over-year in November with the trade war "sucking the life" out of the trans-Pacific trade, container volumes exported out of Asia in retreat and volumes shipped from Asia to North America expected to decline for the first time in a decade.

This has weighed heavily on liner spot freight rates through most of 2019, with China-U.S. West Coast prices currently 20% lower than a year ago, according to Freightos (see SONAR below).

As  reported in FreightWaves, the Dec. 13 trade truce struck by the U.S. and China is unlikely to boost volumes. "The new agreement, with details still sketchy at the moment, will do little to boost eastbound trans-Pacific container volumes in the short run," noted Alphaliner.

Source: SONAR Freightos Baltic Daily Index (China North America West)

More FreightWaves and American Shipper articles by Mike

Image by Gino Crescoli from Pixabay