Deconstructing global supply chains

July 16, 2020: The pandemic will reverse globalization by accelerating a move toward regional supply chains. The outcome will be an Asian supply chain network that is both less China-focused and more diverse.

Businesses are moving out of China, once crowned as the “global factory,” and the reason is not just the COVID-19, of course it has added momentum to the departure, but economists cite to more strong reasons being the Sino-U.S. trade war and rising wages in China have already incentivized some corporations to relocate supply chains to other parts of Asia.

There have been several anecdotal reports over the past few years of Chinese manufacturers outsourcing some aspects of their production, mainly to North Vietnam. Manufacturing in coastal China is significantly more expensive than it was a decade or two ago, and with additional logistics challenges and costs associated with manufacturing in the deeper west of the country, that is not always a good option.

Global trade is reshaping and the pandemic is playing an active role in the process as companies look to reduce their dependence on Chinese manufacturing, economists observe. The Economist Intelligence Unit (EIU) says the pandemic will reverse globalization by accelerating a move toward regional supply chains.

Well its not just EIU, but many others who have noted the trend. Gartner Inc ran a “Weathering the Supply Chain Storm” global survey during February and March 2020, soliciting feedback from 260 participants who are responsible for supply chains and related functions, covering a range of different industries. One of the key findings from this survey was that 33% of respondents said that they had either already relocated manufacturing activities out from China, or planned to do so within the next two to three years. Here it should be noted that those who implied a shift out, might not have meant in totality.

China’s dominance in international trade has grown ever since the country was accepted into the WTO in 2001. This event was credited by the EIU as sparking the latest wave of globalization, as multinationals took advantage of production and demand opportunities in the country. However, as a result of Covid-19, it is likely that this period of globalization will not only come to a halt, it will reverse.

The trade wars resulting in higher trade tariffs have had shippers considering alternatives, or at least partial alternatives. And then came the disruption to Chinese manufacturing as a result of Covid-19, were some critical supplies became harder to come by, causing further sourcing strategy thoughts. Supply chain diversification is now a widely mooted topic. The outcome will be an Asian supply chain network that is both less China-focused and more diverse.

This shift away from China would be indicative of a wider trend, as global firms look for ways to build up their resilience following the supply shock induced by the coronavirus. “By building quasi-independent regional supply chains in the Americas and Europe, a global company will provide a hedge against future shocks to their network,” the EIU said. “For those companies that have this luxury already, they have been able to shift production of key components from one region to another as lockdowns and factory closures resulting from coronavirus have unfolded.”

Because of the difficulties surrounding the establishing or moving of supply chains – particularly in the automotive sector – it is likely that any major shifts would be permanent. “As more firms make this decision, the shift to regionalized supply chains will be an enduring outcome of this crisis,” the report said. But here it should be noted that the pull out from China could only be gradual, as the sheer scale of Chinese manufacturing could simply not be accommodated even by a bunch of other large countries.

Independent analyst Fraser Howie said governments would look to reduce their dependency on China, although “there was no way China’s going to be ignored.” Bruce Pang of China Renaissance Securities agreed that China had a key position in the global supply chain in the near term, as alternative markets did not have the same scale to support major relocations.

Together, the mainland, Hong Kong and Taiwan are an almost unbeatable combination, given the depth they offer in hosting various parts of different supply chains, within a common geography. Much of the prospects of supply chain relocation would depend on whether the synergies between the Chinese mainland, Hong Kong and Taiwan are obtainable elsewhere.

Building the case for regional supply chains

Eoin Murray, head of investment at Hermes Investment Management, told CNBC last year that international trade as we know it was unlikely to exist in the future, and would instead be replaced with a regional trading system. Meanwhile, Hans Redeker, global head of FX strategy at Morgan Stanley, warned last June that geopolitical tensions were reversing globalization.

“I think there’s going to be a diversification where these supply chains get moved into places like Vietnam, Bangladesh, Turkey, even Brazil,” Mark Mobius, founder of Mobius Capital Partners said. Suren Thiru, Head of Economics at the British Chamber of Commerce, said some UK businesses were already shortening their supply chains after coronavirus-related disruptions had affected operations.

Shipping lines opine that a shift from inter-continental to regional supply chains would be a positive from an environmental perspective, so long as the majority of trade continues to move on water. Reducing lead time from order-to-shelf can also be seen to be attractive for a number of commodities, not least fashion or perishables, and this also assists to reduce inventory. Although clearly the costs of manufacture plus inventory remain below the highly economical cost of inter-continental transportation, otherwise the shift would have happened already.

If we take 10% of the current Asia-Europe and transpacific demand and place that into their own regional markets (Eastern Europe and predominantly Mexico respectively), the overall demand for global teu*nautical miles transportation reduces by almost 4%. A 30% shift results in an overall 12% decline.

These are not necessarily huge numbers, but they come at a time when the idle fleet still registers 2m teu (~8%), so it would be another straw on the donkey’s back, and a prolongation of getting back to a better (pre-2008) balance between supply and demand.

Another issue is with the fleet of jumbo’s ocean liners have developed. Shipping lines have been hailing jumbo sized ships and there are several of them sail on the oceans and being built-to-order. These large vessels are particularly effective on longer haul routes, but inefficient on shorter (regional) ones. This is evidenced by the fact that the largest ships on the largest trade lane are generally below 5,000 teu capacity.