As manufacturing shifts from China, the rest of Asia sees new opportunity

While the heightened trade tensions have disrupted global supply chains, and changing cost structures are forcing companies to pivot production to other parts of Asia, there is no reason why Sri Lanka too cannot gain from this – Pic by Shehan Gunasekara

By Anushka Wijesinha, Aindrie Kuruppu and Dilki Wijeyesekera

Often dubbed ‘the world’s factory’, China has recently been experiencing a shifting of manufacturing investment out of the country. A combination of the steady rise in wage costs in the industrial hubs of Southern China, and the ongoing trade war with the US are causes of it. 

Major manufacturing corporations have begun restructuring their supply chains to give more prominence to South East Asian countries than before. This article explores the shifts taking place, which countries are gaining from it, and what Sri Lanka must do to latch on. 

Shifts by electronics manufacturers

The electronics industry has been the most prominent among the industries with plans to locate to new destinations, amidst these trends. The world’s number one and number three personal computer makers, HP and Dell, are already in the process of shifting 30% of their notebook production out of Chinai. HP has plans to build an alternate supply chain in Thailand or Taiwan, while Dell has been eyeing Vietnam. Other computer manufacturers evaluating plans to shift include Acer, Lenovo and Asustek Computer. 

Further, the global consumer electronics giant, Apple is considering moving 30% of their iPhone production out of Chinaii. Microsoft, Nintendo, Sony, Quanta Computer and Foxconn are also contemplating shifts in some of its production facilities out of China, according to recent reports. In order to avoid additional tariffs imposed by the US Government, production by these firms have been, or are in the process of being, moved out – even partially – to countries ranging from Taiwan to Mexico and the Czech Republic. 

The effects of the rising costs and the trade war go beyond the electronics industry. In the textile and garments industry too, the shifts are being seen. 

Shifts in the apparel industry

The rising production costs over the past few years, and the tariffs imposed by the Trump administration more recently, has affected textile manufacturers in China. Since 2014, exports of Chinese textiles and clothing have declined from about $ 236 billion to $ 206 billion in 2016iii. The industry restructuring has made it difficult for big clothing brands to secure finance and make profits and has resulted in brands re-evaluating their decision to remain producing in China. 

A decade ago, the main production base for major shoe makers Nike, Adidas and Under Armour was China, but now Vietnam holds that titleiv. Eclat Textile Co., a sportswear supplier to Nike and Lululemon Athletica, has exited China due to conditions not ideal for its manufacturing, and has set up shop in Vietnam instead.

Eclat’s Chairman Hung Cheng-Hai said in an interview, “Judging from the global situation, the most important thing now is diversification. Clients also want us to diversify risks and don’t want production bases to be in one country. Now 50% of our garments are made in Vietnam, so we are still not diversified enough.”v 

Eclat is looking to set up smaller regional manufacturing hubs and plans to invest in South Asian nations like Indonesia and Cambodia with the belief that a dispersed supply chain will lower any potential tariff risks and lower costs in the long term.

Cheng-Hai’s sentiments are echoed by other manufacturers who are seeking a diversified base for their operations. The leading Hong Kong-based furniture manufacturer, Man Wah Holdings, which has more than 18 million square feet of manufacturing space in China has recently relocated to Vietnamvi. A growing number of factory operators from the manufacturing hubs of China are visiting Vietnam, India and Cambodia in search of solutionsvii. Yet, it is not easy to find mature manufacturing bases with sufficient skilled labour and infrastructure like China’s and replacing China’s so-called “complete industrial chain” is challenging. 

Vietnam’s boom, but with challenges

The trade war is having trade diversion effects in favour of Vietnam. According to the latest data by the US Census Bureau, US imports from China in Q1 2019 shrunk by 13.9% year-on-year, while imports from Vietnam grew a staggering 40.2%. Vietnam seems to be absorbing most of the firms shifting out of China. 

“Locate here to counter the trade war” has become the main investment promotion slogan for Vietnam in attracting new tenants to their industrial estates. It is especially attracting small and medium-sized factories that make everything from electronics, to shoes, to furniture, to textiles in China’s Pearl River Delta and Yangtze River Delta regions, which are the main export production hubs in the country.  

Despite popular belief, industrial wage costs in Sri Lanka in some technical categories are still lower than in China today. Sri Lanka must proactively identify sectors, and individual firms, that are being disrupted and attract them to set up in Sri Lanka. No doubt, not all would find the country attractive, and many would choose Vietnam, but among the exodus there is likely to be several who will either prefer Sri Lanka or choose Sri Lanka has an additional destination, as part of a risk mitigation effort. Sri Lanka must be realistic, though. We are competing with countries like India which are proactively incentivising the industries re-locating from China. In order to have a shot at success, we need to push forward our reforms on trade, investment and ease of doing business

The latest data from Vietnam’s Foreign Investment Agency (FIA) shows that FDI to Vietnam in the first five months of 2019 reached a four-year high of $ 16.74 billion. This inflow represents a staggering 69.1% year-on-year increase. Around 1,363 new projects were licensed with a total registered capital of $ 6.46 billion in the January-May 2019 period, up 38.7% against the same period last year. Out of 19 sectors receiving capital, the manufacturing and processing sector came on top with $ 10.5 billion, accounting for 72% of total FDIviii.

However, there have been many problems in manufacturing operations in Vietnam, like labour recruitment and retention, worker management and supply of inputs, which are not readily experienced in China. This also points to the fact that countries looking to absorb ‘China-spill’ investment must focus on these factors in order to attract and retain these investments. 

Apart from Vietnam’s own challenges, it would need to watch out for potential challenges from American policymakers – it could be the next target for Trump’s trade action as the country enjoys a $ 40 billion trade surplus with the US. Already in May the US Treasury added Vietnam to its list of countries being monitored for ‘possible currency manipulation’. The US has also taken firm action on ‘roundtripping’ of steel exports from Vietnam, which originated in South Korea and Taiwanix. 

While there is a real risk of US trade action against Vietnam in the near future, Vietnam seems to have done well to diversify its market risks. The country has signed nearly 20 Free Trade Agreements, most recently an FTA with the European Union and the revamped Trans Pacific Partnership (CP-TPP).

India’s plans to capitalise on the shift

India hopes to compete with economies like Vietnam, Malaysia and Bangladesh, which are set to benefit most from the China shift. India has recently announced that they will offer financial incentives to lure companies leaving China and has made efforts to attract export industries in sectors vacated by US companies due to the growing trade tensionsx. Over 150 items have been identifiedxi. These efforts are expected to reduce the large trade deficit with China, India’s largest trading partner. 

India has identified electronics, consumer appliances, footwear, and toys, as well as hydraulic power engines and synthetic fibers as product sectors which have the highest potential to be attractedxii. India has proposed setting up affordable industrial zones across the country’s coastline and giving preference in government procurement to manufacturers based locally as incentives to attract companies looking for alternate production bases. This plan builds on the current “Made in India” initiative which aims to boost manufacturing to 25% of the economy by 2020xiii. 

Sri Lanka’s opportunity, with the right focus

While the heightened trade tensions have disrupted global supply chains, and changing cost structures are forcing companies to pivot production to other parts of Asia, there is no reason why Sri Lanka too cannot gain from this. 

According to Sri Lanka Apparel Exporters Association President Felix Fernando, Sri Lanka can gain from these trends and Sri Lankan apparel manufacturers have been approached by top US clothing buyers to partially manufacture some of the orders currently being serviced by China. However, as Sri Lanka lack the economies of scale possessed by China, we may have to settle for producing only partial orders while countries like Bangladesh and Vietnam which have cheaper costs produce the restxiv.  Meanwhile, Sri Lanka’s tile and bathware manufacturing group, Royals Ceramics Lanka PLC believes that the escalating tensions provide opportunities for Lankan manufacturers to position themselves as a viable alternative manufacturing destinationxv. 

Despite popular belief, industrial wage costs in Sri Lanka in some technical categories are still lower than in China today. Sri Lanka must proactively identify sectors, and individual firms, that are being disrupted and attract them to set up in Sri Lanka. No doubt, not all would find the country attractive, and many would choose Vietnam, but among the exodus there is likely to be several who will either prefer Sri Lanka or choose Sri Lanka has an additional destination, as part of a risk mitigation effort. Sri Lanka must be realistic, though. We are competing with countries like India which are proactively incentivising the industries re-locating from China. In order to have a shot at success, we need to push forward our reforms on trade, investment and ease of doing business. Sri Lanka missed the last time there was a big shift in supply chains, when Japan was investing in the rest of Asia in the 1980s and 90s, and should take this chance to capitalise on the opportunities provided by this restructuringxvi. Sri Lanka would also need to take a closer look at the current investment incentives regime to see if it is fit for this. It’s a limited-time opportunity. 

9Anushka Wijesinha is Advisor, and Aindrie Kuruppu and Dilki Wijeyesekera are Interns, at the Ministry of Development Strategies and International Trade. The views expressed in this article are the authors’ own and do not necessarily reflect those of any organisation/s they are affiliated with. Authors can be contacted via [email protected].)

Footnotes

i https://asia.nikkei.com/Economy/Trade-war/HP-Dell-and-Microsoft-look-to-join-electronics-exodus-from-China 

ii https://fortune.com/2019/06/19/apple-iphone-production-china/ 

iii https://www.scmp.com/news/china/economy/article/2143938/chinas-once-booming-textile-and-clothing-industry-faces-tough 

iv https://qz.com/1274044/nike-and-adidas-are-steadily-ditching-china-for-vietnam-to-make-their-sneakers/ 

v https://www.thestar.com.my/business/business-news/2019/07/15/nike-supplier-pivots-away-from-vietnam-after-exiting-china/ 

vi https://www.scmp.com/economy/china-economy/article/2175432/twist-trumps-trade-war-manufacturers-are-fleeing-china-just 

vii https://www.scmp.com/economy/china-economy/article/2170699/trade-war-forces-companies-consider-pulling-operations-out 

viii https://www.vietnam-briefing.com/news/fdi-in-vietnam-investment-by-sector.html/ 

ix https://www.bloomberg.com/news/articles/2019-07-11/from-trade-war-winner-to-trump-target-vietnam-braces-for-shocks  

x https://timesofindia.indiatimes.com/business/india-business/india-plans-to-offer-incentives-to-companies-moving-from-china/articleshow/69938671.cms 

xi https://www.livemint.com/politics/policy/india-plans-to-offer-incentives-to-companies-moving-from-china-1561437267139.html 

xii https://www.livemint.com/politics/policy/india-plans-to-offer-incentives-to-companies-moving-from-china-1561437267139.html 

xiii https://www.livemint.com/politics/policy/india-plans-to-offer-incentives-to-companies-moving-from-china-1561437267139.html 

xiv https://www.china-briefing.com/news/the-changing-landscape-of-chinas-manufacturing-sector/ 

xv http://www.dailymirror.lk/business-news/US-China-trade-war-beneficial-for-Lankan-tile-and-bathware-makers%3A-Royal-Ceramics/273-169497 

xvi http://www.ft.lk/columns/Trade-frictions--a-redrawing-of-supply-chains-and-implications-for-Sri-Lanka/4-676197