By Gary Evans and Jon Custer
Custer Consulting Group
The global pandemic is putting ever more pressure on global supply chains.
Reuters reports the Trump administration is now “turbocharging” its efforts to punish China in an attempt to remove global supply chains from the Middle Kingdom through, among other things, the implementation of new tariffs.
“We’ve been working on [reducing the reliance of our supply chains in China] over the last few years but we are now turbo-charging that initiative,” — Keith Krach, undersecretary for Economic Growth
The U.S. government is pushing hard to move U.S. production and its supply chain dependency away from China. The administration also appears to be more realistic and resigned to the fact it is not feasible for many U.S. suppliers currently located in China, can, or will come back to the States.
Bringing Manufacturing Back To The U.S. Is Not Easy
The challenge lies in how modern supply networks are structured.
The U.S. and other advanced industrial economies have evolved into highly efficient and productive product manufacturing-and-delivery supply chains that provide a plethora of relatively low cost products. That system, however, has created dependencies and expectations that the current pandemic has severely tested.
The days of a single vertically-integrated manufacturer like the old General Motors, for example, who could design and manufacture all or most of the components are all long gone. Modern technology is much too complex, rendering it nearly impossible to possess the capacity to build out a fully vertical supply chain for sosphisticated high-tech products.
In general, the manufacturing sector relies on specialists and subcontractors with a narrow focus in a few areas, and even those specialists have to rely on many other subcontractors.
Much like the location of natural resources are determined by the endowment nature has gifted to different regions of the world, such as iron ore or rare earth elements, manufacturers are similarly reliant on specialists who reside in different continents, regions, and countries.
Moreover, many of the components in, say, consumer electronic products require narrow skill sets, and in the case of memory chips multi-billion-dollar fabrication plants.
Political Pressure On China
Nevertheless, the economic destruction and the massive U.S. coronavirus death toll are driving the Trump administration to move U.S. production and supply chain dependency out of China, even if it moves to other countries.
“This moment is a perfect storm; the pandemic has crystallized all the worries that people have had about doing business with China,” — Senior U.S. official
The State and Commerce Departments, and other agencies are exploring and seriously considering tax incentives and potential re-shoring subsidies, among other measures, to entice companies to move both sourcing and manufacturing out of China.
Trump has also repeatedly threatened new tariffs on top of the up to 25% tax on $370 billion in Chinese goods currently in place. Sanctions on officials or companies, and closer relations with Taiwan, are just a few of the alternative measures the administration may be considering to punish China.
Economic Prosperity Network
Given the difficulties of re-shoring American supply chains, which we briefly touched on above, the Trump administration is even considering a rare multi-lateral approach in its attempt to move supply chains from China. This is quite unusual for the “America First” administration.
The U.S. government is now pushing the creation of an alliance of “trusted partners,” or the “Economic Prosperity Network.” Under its umbrella, companies would operate under a uniform standard, including industries in digital business, energy and infrastructure to research, trade, education and commerce.
The administration is now working with several countries, including Australia, India, Japan, New Zealand, South Korea and Vietnam according to Secretary of State Mike Pompeo. Top level discussion are being held to “how we restructure … supply chains to prevent something like this from ever happening again,” Pompeo said
Though we welcome new approaches to improving the supply chain and making it easier for electronic manufacturers to do business, we remain a bit skeptical as to the efficacy of removing all suppliers from China due to sheer scale.
We have put together the following table, which includes World GDP ($ PPP) and population to illustrate our doubts.
Note the combined 2020 GDP of the EPN countries is 22 percent smaller than China and the population x/ India is only 22 percent of China’s. India appears to be the only country with the scale to absorb much of the supply chain domiciled in China.
Human Capital
Moreover, China’s huge pool of human capital, which emphasizes engineering specialities, makes it tough for other countries to compete, at least in the short-term.
Apple’s Tim Cook puts it more succinctly,
“The number one reason why we like to be in China is the people. China has extraordinary skills. And the part that’s the most unknown is there’s almost 2 million application developers in China that write apps for the iOS App Store. These are some of the most innovative mobile apps in the world, and the entrepreneurs that run them are some of the most inspiring and entrepreneurial in the world. Those are sold not only here but exported around the world.” – Tim Cook
Upshot
Many U.S. companies have invested heavily in Chinese manufacturing and rely on China’s 1.4 billion people for a big chunk of their revenues, such as Apple, which earns 25 percent of its total revenues from the greater China region. Diversification of supply chains out of China, which has already been underway for some time now, does make sense, especially as companies have experienced the risk of having too many suppliers concentrated in one region during the pandemic.
Nevertheless,
But we don’t see a wholesale rush for the exits by companies doing business in China. – Doug Barry, U.S.-China Business Council
Companies will also most likely now be forced to carry more strategic backup inventories, which can be expensive.
Inventory, [Tim] Cook has said, is “fundamentally evil,” and he has been known to observe that it declines in value by 1% to 2% a week in normal times, faster in tough times like the present.
“You kind of want to manage it like you’re in the dairy business,” he has said. “If it gets past its freshness date, you have a problem.” — CNN Money
Politics Of A Presidential Election
Finally, we are in the season of politics with the November presidential election fast approaching.
Predident Trump’s rhetoric to punish China and re-shore supply chains have not always been followed by action. The threat to block global exports of chips to the Chinese telecom giant, Huawei, for example, favored by hawks and under consideration since November, has yet to materialize.
Building new facilities in the U.S. could take five to eight years and this assumes a well trained labor force.
Though it is good business for manufacturers to use this crisis to engage in a comprehensive review of their supply chain vulnerabilities through a rigorous mapping of supply networks, making decisions based on election year rhetoric and fears of a coming U.S.-Sino Cold War is not always optimal. At least not yet.
Everything may change on November 3rd.
Appendix
China Manufacturing Distribution Breakdown
Electronic Industry: Mainly in Guangdong (33%), the rest in Yangtze River delta, Sichuan, Shaanxi Provinces.
Textile Industry: Mainly in Zhejiang (18%) and Jiangsu (20%), the rest in Fujian, Guangdong, Shandong Provinces.
Leather & Feather: South-East Coastal areas, Hebei, Henan, Chongqing and Ningxia provinces.
Metal Product: Zhejiang, Guangdong, Jiangsu, Shandong, Hebei, Henan provinces.
Glass: More in Hebei, Jiangsu, some in Shandong and Guangdong provinces.
Ceramics: Jingdezhen in Jiangxi provinces
Furniture: Mainly in Guangdong and Hebei province, the rest in Jiangsu, Zhejiang, Shanghai, Chengdu and Beijing.
Construction: More in Shandong province, the rest in Hubei, Henan, Guangdong, Jiangsu, Beijing, Zhejiang.
Household Appliance: Guangdong, Zhejiang, Shandong provinces.
Artware & Stationary & Sporting: Zhejiang, Fujian, Guangdong, Hubei
Papermaking & Printing: Guangdong, Zhejiang, Jiangsu, Shandong, Fujian
Machinery Manufacturing: Dongbei Area, Hunan and Hubei provinces.
Petrochemical Industry: Shandong (32%), Liaoning (21%), Guangdong (15%)
Pharmaceutical Industry: Tianjin city, Xian city in Shanxi province
Food & Beverage: Liaoning, Shandong, Jiangsu, Guangdong, Fujian, Hebei, Henan, Hunan, Hubei, Inner Mongolia
Transportation Equipment:
- Motor & Bicycle: Taizhou city in Zhejiang province (40%)
- Shipping/Vessel: Yangtze River delta, Pearl River Delta, Bohai Bay Areas
- Automobile: Mainly in Jilin, Hubei, Shanghai and Yangtze River delta, the rest in Pearl River Delta, Beijing
Sources: Berkeley Sourcing Group, Reuters, HBR