China’s Big Troubles: Its Days As Global Go-To Manufacturer May Be Coming To An End

Get Ya Wig Split · May 5, 2023

China’s Big Troubles: Its Days As Global Go-To Manufacturer May Be Coming To An End

China’s days of being the Western world’s go-to manufacturing hub may be coming to an end. This has serious ramifications for China, and the world. Depending on where you focus, this is a good thing, or a bad thing. In fact, it’s probably both.

Factory orders in China fell unexpected in April, though this is likely due to China just gearing up after a disastrous Zero Covid policy that led to civil unrest and thousands of layoffs in the manufactured electronics and tech sectors, plus numerous small business closures across the country.

For those with contacts in China, stories of laid off young people struggling to afford their apartments, taking on two jobs in gig economies, or becoming escorts in karaoke bars is becoming commonplace. This is not the country that the CCP once held together with promise of opportunity and quick climbs up the Chinese social ladder. This is starting to turn into America of the late 1990s-2000s, reeling for China’s take over of American tooling and steel, textiles and furniture manufacturing. Many people here know what that feels like.

China’s GDP is the worst it’s been in a generation, growing just over 4%.

Even though China’s Purchasing Managers Index, a measure of manufacturing demand, fell from 51.9 in March to 49.2, it’s not an unheard of number for China and shouldn’t scare investors too much.

The problem is geopolitics. That should scare China’s nnvestors more. They know the drill already. Companies are slow walking out of China because of those tensions. This includes Chinese companies investing in Southeast Asia to avoid trade tariffs, sanctions, and growing political risk.

To keep its business with the Americans (and to a lesser extent, the Europeans) Chinese companies are moving off the mainland. Their multinationals like Jinko Solar – one of the largest solar manufacturers in the world — are doing to China what American multinationals once did here – offshoring middle class jobs

In a country with roughly 900 million workers, many of whom are blue collar and not about to “learn to code”, these job losses tear at the social contract between the CCP and its people. Roughly 17% of Chinese people have a college degree compared to around 36% in the U.S., according to Chinese and U.S. government stats.

Either China figures out a way to consume what it produces at home rather than relying on the U.S. consumer, or Beijing makes it less attractive for companies to set up shop in Vietnam. If they cannot do those things, the bloodletting will continue. If this trend goes on, it should be seen as a harbinger of worse things to come.

China doesn’t do a good job protecting its people in times of trouble. It has a weak unemployment system. You can get thrown to the dogs in China. If you’re a migrant worker, those metaphorical dogs are even bigger.

Why are Companies Leaving China?

Lots of reasons. It depends on the sector. The solar and home furnishings industry have been leaving mainland China to set up shop in Southeast Asia since at least 2013 when the U.S. government put anti-dumping and countervailing duties on a number of companies in that space.

Fast forward to 2018, President Trump puts tariffs on over $300 billion worth of Chinese imports under Section 301 trade laws. He also puts tariffs on all of Chinese solar companies under Section 201 trade laws.

The U.S. trade deficit with Vietnam today is bigger than our trade deficit with Germany. That’s deceiving for two reasons. One, Vietnam buys almost nothing from us. It is a poor country. Two, most of those exports are from Chinese companies.

Then came President Biden. He put export restrictions on computer hardware going to China. He enacted the Uyghur Forced Labor Prevention Act, making it complicated to import goods from Xinjiang province, the large far Western state where China’s version of the “war on terrorism” has incarcerated millions of Muslims, and forced many of them to work, including in no-pay prison labor schemes, as the United Nations reported last year.

The GapGPS -5.1% Inc., which used to source cotton fabrics from Xinjiang, is at least partially leaving China and replacing that labor and supply with Central America. They’ve invested $150 million there. It’s too complicated to know where every garment comes from, so rather than doing due diligence on hundreds of suppliers and trusting their answers, The Gap is investing elsewhere.

I reached out to TargetTGT -1.8% on this issue, but they said today that they did not have anything to say.

China used to make almost all of our clothes. Not anymore. That’s job losses for China.

Luckily for some stitch and sew factories, they have Shein and Temu to save them. These fast-fashion firms rely on outsource partners, many of them small mom and pops working from home, to sell clothing duty free to the U.S. Sadly for them, most of Shein and Temu’s market is here, not in China, and that puts these people at the whims of Congress.

Rep. Earl Blumenauer (D-OR) wants to end the so-called “de minimis” loophole that allows for duty free shipments into the U.S. if priced under $800. If that ever became law, and depending on how low that value went, it would be a huge blow to both of those companies.

Some of China’s Export Sectors Slipping

U.S. imports of China made apparel decreased from about $25 billion in 2018 to about $17 billion in 2021, according to a March 2023 report by the International Trade Commission (ITC).

Imports of these goods from China declined but imports from the rest of the world grew by 25.2%. The ITC estimated a sizable decline in apparel manufacturing imports from China of 40% between 2020 and 2021, while U.S. production increased by up to 6.3% in 2021 in response.

The ITC study looked at 10 different sectors. In all 10, China exports to the U.S. fell. Computer equipment from China fell around 7%; furniture imports fell 25%; electronics equipment imports fell by 40%. Automotive parts imports fell a whopping 50%, according to the ITC.

The study estimated an overall 13% decline in the value of U.S. imports from China in all sectors affected by Section 301 tariffs.

Chinese companies are investing money everywhere to maintain market share as the U.S. government tries to pull American supply chains from the mainland.

China accounted for 0.2% of foreign direct investment into Mexico, on average, between 1999 and 2022, according to the Mexican government’s Secretary of the Economy. China/Hong Kong/Taiwan combined accounted for 2% in 2022. The threesome averaged 0.7% between 1999 and 2021.

China and Hong Kong’s investment into Mexico rose six-fold from $117.1 million in 2015 to nearly $700 million in 2022, according to the Mexican government.

Chinese manufacturing growth might have peaked.

China’s future growth industries could pick up some of this labor, but very little. Robotics will be good for China blue collar labor, but biotech, pharma, and AI will not as making the shift from seamstress to scientist is quite the stretch. So is going from Chinese solar panel maker to AI coder. It is also unlikely that lower skilled office jobs can pick up the blue collar workforce losing out to outsourcing.

To some, this is a come uppance: a “welcome to our world, China” after at least 23 years of American manufacturing going to China. Americans watch as they got poorer and Chinese middle class got richer. American workers watched their steel industry die, as China’s grew to take over the world in terms of production and output capacity. It was impossible to compete. For this reason, there won’t be much love loss here. But we understand what you’re going through, Chinese worker. We, too, lost jobs and were forced into gig economies or door-to-door sales of Chinese made vacuum cleaners and solar panels.

Try now to imagine a world were China pumps the brakes on its capacity. They are almost hamstrung to keep going. They might have to build more ghost cities and bridges to nowhere just to keep people employed.

Perhaps this is why Temu is spending so much here, and Shein is now heading into emerging markets, like Brazil.

It may also explain the proliferation of promotional ads on social media of cool looking gadgets like steel coiled weed whackers and zipper repair units all undoubtedly made and shipped directly to Americans from China.

The Biggest Risk of them All

The reason why the CCP has done so well in China is because the Chinese have gone from a $2 a day Happy Meal toy and Christmas lights making economy, to home to the most billionaires after the U.S., bullet trains, and designer handbags. Poverty has been greatly reduced. Chinese brand names are on your kids’ phone with TikTok. They are in your office with Lenovo and Lexmark. They are on your breakfast plate with Smithfield FoodsSFD 0.0% bacon. Their Goldwind wind turbines dot the Texas landscape.

China is surely not a dying manufacturing power. Europe would be in worse shape, for sure. China can turn the ship around, but if it comes at America’s expense, that will be totally unsustainable.

But China’s days as manufacturer of nearly everything in your house and garden shed look to be pretty much over. That’s a lot of workers whose future is in question for the first time in a generation.

For Washington, bringing back manufacturing to the U.S., or at least protecting the manufacturing that is here now, is deemed critical. It is also a vote getter. No Democrat or Republican will ever win talking about the wonders of globalization and free trade with the cheap labor (and low income) states of the Asia Pacific.

If China’s manufacturing market share shrinks, and Chinese companies move to Mexico and Southeast Asia, what happens to all of these Chinese people? They can’t vote their leaders out. They’ll protest instead. They’ll shut factories. The CCP should be very worried about any fraying of this social contract. It is arguably what keeps them in power.

All of this is good, depending on where you focus.

Trade diversion is good for Southeast Asian emerging markets soaking up Chinese (and Western) capital to build factories and hire the locals.

Reshoring some production is good for American manufacturing which hires blue collar workers, many of whom have been victims of U.S. trade policies favoring offshoring.

But there is bad news in this, and not just for the Chinese.

There are more everyday Chinese people – Old Hundred Names, as they are called – than there are CCP members. If their lives are in trouble, they will push back. They have the numbers on their side.

If that happens, one has to wonder if Beijing will see such uprisings as something the Americans caused. The Chinese government is not a fan of foreign intervention. What would they do? Would they lash out? Would they take it out on Taiwan, especially if the U.S. is saber rattling? I don’t think they would take it out on Taiwan, but it should not surprise anyone if they did. Such a move would be an obvious disaster. The sanctions alone would likely lead to the disruption of global supply chains that make the Covid disruptions look insignificant.

In other words, the bad news is that the erosion of China’s role as go-to manufacturer will likely become a matter of life and death — for industries, for businesses, for some people. Ray Dalio said warned last week that geopolitical tensions have put the two sides “on the brink of war”. That’s bad for everyone.

Macro investors will need to be mindful of these changes in the years ahead. They will have to gauge how fast, and how successful China is at turning inward, building its own consumer market, and in keeping its friends in the emerging markets as the U.S. walks away.