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Chinese Manufacturers Adapt to the New Landscape of 2020

Summary

China built its economic engine on the back of its strong manufacturing capabilities. However, 2020 has presented unique challenges for its producers as the nation contends with global trade tensions amid the pandemic fallout. While China’s manufacturing industry still may have a bright future ahead, Beijing and manufacturers will need to navigate the pitfalls on their road to recovery.

As we near the end of 2020, the worldwide pandemic has taken its toll and exposed the weaknesses of numerous systems around the globe. In the beginning, China took center stage as the world watched the first signs of the COVID-19 outbreak appear, forcing workers to be sent home during the Chinese New Year holiday. 

While China successfully managed to contain COVID-19, the repercussions of the ongoing trade war still hung over China’s manufacturers like a dark cloud, causing further financial stress on an already strained industry. Since tariffs were enacted in 2018, China began to lose overseas business, and factories were placed in a tight spot. COVID-19 was merely the icing on the cake. The convergence of these shocks have caused two trends to take shape: first, Chinese manufacturers are increasingly looking inward for profits, and second, quality control issues have become commonplace as manufacturers make up for the lost time due to the pandemic. While China’s manufacturing future remains unforeseen, its resilience and quick rebound paint a positive future for the industry. Nonetheless, manufacturers will need to navigate through a difficult market in the near-term.

The Trade War Sets the Stage

Two years ago, the beginnings of a trade war between the US and China had already created headaches for China’s manufacturers. In the first half of 2019 alone, it caused a US$31 billion drop in Chinese exports. Then in 2020, the trade war reduced Chinese exports by 11.1%. Trade disputes have placed many Chinese manufacturers in a difficult position, causing them to seek sources of revenue elsewhere. Manufacturers were thus forced to turn inward and focus on expanding their domestic position, which ultimately proved beneficial as it provided an extra layer of protection during the pandemic.

The MIT Technology Review interviewed an apparel manufacturing business owner who explained that 30% of his sales were made in America before trade tensions arose. The trade war compelled him to look elsewhere to make sales, and the domestic market seemed like the natural option. However, it was not just this one apparel manufacturer that turned inward, it was many more. Dozens of e-commerce businesses such as Taobao and Alibaba did the same, and also helped connect these manufacturers to the Chinese market using a Consumer to Manufacturer (C2M) business model.

The C2M model uses AI and marketing strategies to help manufacturers predict consumer needs and deliver at low prices. It provides services from marketing to branding to help manufacturers vastly grow their consumer base within China, while providing a safe haven from the US and Chinese trade tensions. While this domestic targeted solution has yet to be seen as an outright fix, it has no doubt proved to be a safeguard against trade war shocks. China’s growing middle-class is the backbone behind the C2M model. In 2018, the C2M spending power was US$2.5 billion and estimated to be US$5.9 billion by 2022.

While Chinese manufacturers are adapting, so are American businesses. US companies often find themselves either opting out of China to avoid a 25% tariff, or asking Chinese manufacturers to move their production line to other Asian countries. From 2018-19, there was a decrease in imports from China by 17%, which caused total imports from Asia to contract by 7%. At the same time, Vietnam, among other Asian countries, has seen an increase in manufacturing as an alternative to China. Even Mexico has proved a reliable alternative to Chinese manufacturing. Sticking it out in China will be the reality for those businesses that are “in China for China,” but others that have just used Chinese manufacturing to meet demand in the American market may continue to reconsider their position.

As Phase 1 of the current trade agreement comes into review, trade tensions are expected to rise as China lags far behind on purchasing commitments of US$200 billion worth of American products. These products range from agriculture to manufacturing goods and energy products. China’s delayed purchasing is due to a drop in demand caused by the pandemic. In many ways, US-China trade tensions have given Chinese manufacturers a heads start on focusing their selling base closer to home, allowing for further development of C2M models and in turn, greater security even in the face of COVID-19.

The Pandemic

As COVID-19 began to warrant serious concern in late 2019, it became apparent that manufacturing and supply chains would be disrupted further as plans to quarantine emerged. The panic of COVID-19 in addition to the timing of Chinese New Year placed Chinese manufacturing in a vulnerable position. 

The Chinese New Year is the largest human migration on Earth as billions of people head home for at least 10 days of vacation. During this time, manufacturing is rushed, and often the quality of production suffers. After the Chinese New Year is when the majority of training for new employees takes place. This critical time period for the Chinese manufacturer’s was further exposed as lockdowns stopped workers from returning and prevented new workers from engaging in training. By the time manufacturers were able to partially and fully open during the end of March and April, the rest of the world went into lockdown alongside the onset of COVID-19. This led to the postponement and cancellation of orders, which in turn caused factories to keep workers at home or operate at a limited capacity right after being able to open. Aside from quality, the limited orders caused numerous delays and added to the mounting distrust that foreign importers had towards the Chinese manufacturing and supply chain. 

Many foreign importers and businesses concluded that working with Chinese suppliers in 2020 has been more challenging than in previous years. In June and July of 2020, 47% of importers reported more delays, 42% claimed longer production times, and 42% said there are more quality control issues. As borders remain closed for safety and political tensions increase, it has become increasingly difficult for foreign importers to enter China and ensure the quality of their own products on the factory floor. It’s also harder to work with Chinese manufacturers as many are not there in person to work through a business contract. All of this has led to a shedding of traditional business practices and foreigners becoming further removed from China.

Staying Afloat?

Given the circumstances, one may suspect that China’s manufacturing has taken a huge hit. Yet, despite the fact that COVID-19 has disrupted supply chains across the world, China’s early quarantine and quick return to factory operations have set it in a favorable position to provide products for the world. While China’s general exports for the first 5 months of 2020 fell 7.7%, exports for medical supplies rose 28.5% in that same time period. 

While the pandemic catches up to other countries, China has been the go-to hub for PPE. Not only has China’s manufacturing had a strong recovery in medical supplies and pharmaceuticals, but it has also done well in personal electronics and work-from-home equipment. As the world moves to telework, demand for related supplies has aided Chinese manufacturers. Finally, Chinese exports continue to recover in industries related to machinery and electronics as those still remain at the core of China’s manufacturing. 

Even then, China still faces the previously mentioned issue of quality control. As economic stress places businesses at risk, many manufacturers are utilizing the demand for medical equipment as a quick solution in the interim of uncertainty. The rush to fulfill PPE orders has led to an environment where counterfeit products thrive and quality control is thrown out the window, despite the government’s warning against such practices.

Without a question, China’s manufacturing sector has fared better than most due to the timing of the pandemic. However, this may not be enough to prop up investors’ demand. Quality, reliability, and wider political tensions all factor into foreign brands’ long-term decisions as they are faced with the re-evaluation of where their supply chains should be located. Beijing has picked up on the hesitance and is now taking some steps to make sure that Chinese manufacturing can go back to maintaining the status quo.

Beijing Steers the Economy

The Chinese Communist Party has been quick to adapt to the outbreak of COVID-19, and part of that has been attempting to bolster supply chain security. Beijing has been pushing policies that focus on placing China first and preventing manufacturing from falling further. China’s efforts to save the economy offer a short-term solution but also highlight future uncertainty. 

In the first quarter of 2020, China’s economy shrunk by 6.8%. Immediately, the government lept into action, announcing approximately US$430 billion in governmental loans to ensure businesses and citizens were financially supported. This financial aid was then distributed to try and stabilize employment, ensure living standards, fight poverty, and minimize the economic impact of COVID-19 so the economy and private businesses could continue operating as close to normal as possible. Beside financial moves, Beijing has made targeted policy adjustments to keep manufacturers’ doors open, such as VAT tax refunds, increased short-term export credit insurance, and lenient trade financing.

While navigating an economic slump, China is also dealing with trade tensions from the US. What started off as a tit-for-tat tariff war on certain goods has spread to a wide variety of industries and lengthy blacklists on both sides. As a result, Beijing has had to change gears and focus on implementing an “internal economic cycle” to make up for lost trade. This policy shift pushes production and consumption within China, further encouraging manufacturers to look inward. 

The Chinese Communist Party has begun to explore a path to a more resilient domestic economy. If trade tensions cannot be resolved and foreign demand continues to fall, it could become a critical economic strategy for the government’s 14th 5-year plan (2021-2025). Whether the trade tensions will subside or continue to grow, one thing is for certain; China has already begun to plan for the worst. Making Chinese manufacturing more self-reliant will be a critical part of its strategy, which will be a feat as China currently accounts for 28% of the world’s manufacturing. 

2020 in a Nutshell

China’s manufacturing is where it is today due to a long chain of events, starting with the initial tariffs of 2018. At that point, the industry had already begun eyeing the domestic market. Fast forward to 2020, and the pandemic placed a pause on factory line production and caused widespread staffing shortages. While manufacturing stayed afloat due to foreign demand in COVID-related supplies, issues of supply chain reliability and quality crept to the forefront of foreign investors’ minds. 

Compounding uncertainty in China’s manufacturing is the ongoing tension between the US and China. Exacerbated by the pandemic and other political events, other countries are also turning their back on doing trade with China. In some ways, it is like an extension of the initial tariffs, but on a much larger scale. The mounting prospect of having less-than-willing trade partners paired with foreign companies seeking manufacturing elsewhere have all led to a turning point in how China approaches manufacturing. In the coming years, we will continue witnessing increased self-reliance as a means to protect its economy from future shocks.

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