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Cutting China From Supply Chains--Easy To Say, Hard To Do

Jun 2, 2022 06;00 pm

By Hiral Shah

Trade disputes and pandemic disruptions raised questions on China's position as the world's factory. The country relies on free-flowing trade and open access to offshore markets. Recent COVID lockdowns and ongoing trade tensions work against this. China's record of maintaining and building on its central role in global production underscores the resilience of its export engine and the pull it continues to exert on manufacturing supply chains.

"This resilience is somewhat counterintuitive," said Charles Chang China, S&P Global Ratings' Greater China Country Lead for Corporates. "China's labor is no longer especially cheap, and Beijing's 'dynamic zero' COVID policies expose it to lockdowns that disrupt producers."

"Despite these tensions, the country continues to play a critical role in certain industries--now and in the future," said Mr. Chang.

"Vast markets, entrenched production infrastructure, proximity to suppliers, and large pools of skilled, trained labor make major relocations unattractive." Mr. Chang added. "These factors are long term in nature and are likely to remain at play beyond current lockdowns."

This phenomenon is perhaps most apparent in two global sectors: autos and technology hardware. We examine both to illustrate the gravitational forces pulling entities and production to China. The auto case shows how supply chains are drawn to China, while the tech case shows how difficult it is for firms to leave once they are embedded there.

China's share of exports to the U.S. has been on a declining trend as trade frictions intensified from 2017. COVID has only exacerbated tensions by causing transport disruptions that challenged globally distributed supply chains built to minimize costs.

Yet China retains its hold on global production. Its share of global exports has more than doubled since 2000 to the current 17.4%. It has also recovered some lost ground in the past two years as COVID disrupted production in other countries.

"Compared to before the trade war, imports from China are now much higher in the EU and just moderately lower in the U.S.," said Mr. Chang.

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