For professional clients only 2 September 2020 Research & Strategy Insights Preserving “Made in China” in deglobalisation Locking in supply chains requires continued reforms and opening up Aidan Yao, Shirley Shen, Senior Economist Economist (Non-China Asia) Macro Research & Core Investments Macro Research – Core Investments Key points China riding high on globalisation • After decades of rapid growth, the progress of The powerful rise of globalisation has been one of the globalisation has slowed since the global financial crisis, defining economic developments of our time. By spreading with its fate further complicated by rising protectionism, production across multiple countries connected via trade and political interference and the COVID-19 outbreak. integrated supply chains, the global economy has achieved momentous efficiency gains and created tremendous values • As the biggest beneficiary, China stands to lose the most in for those involved in the process. As the tissue that connects the event of deglobalisation. So far, however, evidence of “economic organs”, international trade has experienced a disruptions has been scant, with some indicators showing boom since the 1980s. Combined export and import values that China’s market share in trade and manufacturing has surged from 35% of the world’s GDP to over 60% just before in fact risen despite the trade war and pandemic. the onset of the global financial crisis (GFC). Exhibit 1 shows that such stellar growth would not have been possible • This is not to say that China is immune from any supply without the propagation of the multi-country production chain shifts. Some low-margin businesses have already systems that significantly lifted foreign contributions in exited the country in light of rising costs. In contrast, overall trade value-added. foreign firms seeking to tap China’s vast domestic market and supply chain ecosystem are unlikely to leave easily. Exhibit 1: Spreading global supply chains boosts trade Global trade as % of world GDP vs. foreign value added (FVA) in • We think the deglobalisation trend will continue but have exports as % of domestic value added (DVA) varying impacts on different industries. In addition, the 65 % % 44 reshuffling process could be slow and gradual, hampered 60 Trade % GDP [Lhs] 42 by the current pandemic and China raising the cost of 55 FVA % DVA in trade [Rhs] 40 38 exits through its own reforms. 50 36 45 • 34 The propagation of the “China Plus One” model could 40 allow China to maintain some influence over the supply 32 35 chains spreading to other Asian countries, turning “Made 30 in China” to “Made around China” that ends up 30 28 1986 1990 1994 1998 2002 2006 2010 2014 2018 expediting regionalisation at a time when globalisation is Source: World Bank, UNCTAD, HSBC and AXA IM Research, as of Aug 2020 in retreat. 1 Exhibit 2: China has transformed from a small to prominent player in global supply chains Source: OECD and AXA IM Research, as of Aug 2020 China has been among the biggest beneficiaries and drivers well underway before it became a widely-debated topic of globalisation. Its successful integration into the world’s following the Sino-US trade war and COVID-19 pandemic. economy – by leveraging its abundant supply of cheap labour, natural resources and pro-business policies – has led to a Despite the shrinking pie, China has continued to gain market profound change in China’s role from an insignificant regional share in trade and manufacturing. By deploying some of its trade player to one of three vital connectors of global supply “RMB4 trillion” stimulus after the GFC to upgrading manufacturing chains (Exhibit 2). Today, China is both the world’s largest infrastructures, China has managed to buck the declining manufacturer and trading nation, backed by the second trends seen in other manufacturing powerhouses and risen largest economy with over 800 million workers. Any disruptions to the top of the global league table since 2010 (Exhibit 3). At to its production system, as recently demonstrated by the COVID almost 30% of the global market – doubled since 2008 – outbreak, could send shock waves across global supply chains, China’s manufacturing value added (MVA) is now the size of affecting economies that would not otherwise be impacted the US, Japan and Germany combined. without the integrated web of shared production and trade. While some of these gains were used to meet rising domestic Globalisation already in trouble since GFC demand, significant growth in manufacturing was also a result of increased production collaboration with others. However, the rapid rise of globalisation ran out of steam Exhibit 4 shows that China’s contributions to MVA elsewhere after the global financial crisis. Global trade as a share of GDP have risen strongly, reflecting a strengthening of its flatlined in the early part of the last decade (Exhibit 1). In production ties with others within its supply chain networks. part, this reflected a normalisation after a period of exceptional growth, thanks to shifting consumption patterns Trade war adds insult to injury from easily tradeable goods to services. The decline, however, sharpened more recently as governments around Building on the natural protectionist tendency in the period the world tightened trade regulations and pursued of feeble growth, the Sino-US trade war presented yet protectionist policies that aimed at keeping growth within another setback to globalisation. Four rounds of tit-for-tat their borders.1 The deglobalisation process was, therefore, tariff increases saw the average import duties for both countries Exhibits 3, 4, and 5: China bucks the declining trend in global manufacturing and gains shares in trade and foreign direct investment despite the trade war Share of global manufacturing value added Change in manufacturing value added contributed China trade & FDI % of world by China and the US from 2009 to 2015 % % % China Germany USA Japan 14 30 30 25 Percentage points FDI [Lhs] China US 12 25 25 20 Trade [Rhs] 10 20 20 15 8 15 15 10 6 10 10 5 4 5 0 2 5 0 -5 0 0 2004 2006 2008 2010 2012 2014 2016 2018 VT TH MA MX PH KR ID TW IN US JP AU SG CN 1970 1976 1982 1988 1994 2000 2006 2012 2018 Source: World Bank, UNCTAD, WITS, OECD TiVA and AXA IM Research, as of Aug 2020 1 The Economist, “Globalisation in Retreat?” Economist Corporate Network, 2013 2 Exhibits 6, 7 and 8: China loses market share in the US but gains supply chain connection elsewhere Change in share of inputs from China and the US in Change in US import share between 2017 and 2019 economy's exports from 2017 to 2019 1.0 Percentage point 1.0 Percentage points China US 0.5 0.8 0.0 0.6 -0.5 0.4 -1.0 0.2 -1.5 0.0 -2.0 -0.2 JP ID IN JP ID SR IN VT KR SG TH TH NZ GE FR PH HK CN VT KR SG AU US TH CA GE PH UK CN AU MX MA MX TW MA Source: UN Comtrade, UNCTAD, OECD TiVA, HSBC, AXA IM Research, as of Aug 2020 climb to above 20%, resulting in large declines in bilateral trade However, deglobalisation is unlikely to prove a cyclical flows. With higher tariffs and political frictions creating a hostile phenomenon. After decades of pursuing free trade and lower business environment, many multinational corporations (MNCs) tariffs, the world is experiencing a reversal in all these trends are under pressure to reconsider their operations in China, (Exhibits 9 and 10). As rising populism and inequality fan leading to fears that a large shift in supply chains could scepticism about globalisation, China needs to be prepared undermine China’s economic competitiveness and prosperity. for a world that could retrench further into protectionism. Contrary to those fears however, the actual trade and foreign Our previous research2 offers a framework for thinking about direct investment (FDI) flows since 2017 reveal a very different the potential supply-chain moves in and out of China. It puts picture (Exhibit 5). It is true that China has lost export market MNCs into three groups: 1) companies operating in China for share in the US to the likes of Mexico and Vietnam (Exhibit 6). its low cost of production; 2) those for its large domestic But its exports to the rest of the world have increased over market; and 3) those for the comprehensive supply chain the same period, with global gains more than offsetting US networks. In reality, these categorisations are not mutually losses. As a result, China’s total export share has in fact risen exclusive, with many companies drawn to China by more by about half a percentage point since 2017 (Exhibit 7). than one attribute. Still, corporate leaders tend to think in relative importance of their objectives, which makes the China has achieved this in part due to export diversion. By above classification still a relevant, albeit simplified, starting selling inputs to third countries for assembly before final point to analyse the issue. products are shipped to the US, it has successfully circumvented some of the import duties imposed by We think the companies that are most likely to exit China are Washington. Such a strategy has also pulled China’s those which are cost-sensitive. Factor costs, including labour, production partners closer to its supply chain orbits, making land and utility have risen significantly over the past decade. them more dependent on its provision of inputs (Exhibit 8). Within the manufacturing sector, salaries of front-line workers and engineers have risen 30% since 2013 to levels that are Winner does not take all now only behind Korea and Taiwan in Asia (Exhibit 11).