January 15, 2019

Long before the first rounds of tit-for-tat tariffs kicked in early last year, the global manufacturing industry had already been relocating from China to other Association of Southeast Asian Nations (ASEAN) nations, including Indonesia, Thailand, Malaysia, Singapore, Philippines, Vietnam, Cambodia, Myanmar, Brunei, and Laos. Collectively, these 10 nations comprise over 650 million people with a nominal GDP of roughly $3 trillion and a per capita annual income of $4,600.

By comparison, China’s per capita GDP ended 2018 at around $7,400 per year and is expected to rise to over $8,300 in 2020. It is no secret that Beijing has a master plan to transform China’s once-dominant manufacturing juggernaut – formerly known as the “world’s factory” – to a more consumer-driven, service-oriented economy. Undertaken on a massive scale, that transition is curbing China’s GDP growth.

At the same time, household debt in China has risen from around 30% of GDP back in 2006 to over 50% of GDP now (chart, below), even while large employers of factory workers move out of China to other neighboring countries, where the cost of labor is substantially less. Though foreign business began leaving China long ago, the U.S./China trade war has now ramped up the pace of these corporate exits.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

During the past 10 years, manufacturing wages in China have more than tripled while taxes and fees have also risen sharply. Back in 2004, production costs in China were roughly 6% lower than those of Mexico, but by 2014 the costs of production for identical products were about 4% lower in Mexico than in China. That’s a dramatic swing. Today, because of advances in factory automation technology, the average manufacturing costs in the U.S. are only 5% higher than in China (source: Boston Consulting Group).

Some multinational companies have relocated labor-intensive industries – like shoes and apparel – to the cheaper inland locations, away from high-cost coastal locations, but the impact of tariffs imposed by the Trump administration has directly affected this strategy, leaving companies with little alternative but to leave China and set up shop elsewhere, which for low-tech companies is an easy move.

Companies to China: “We’re Outta Here!”

The statistics of the volume of companies leaving China are pretty glaring. To date, more than 60% of Japanese companies operating in China have moved operations out of China to other countries, while the remaining companies are pulling out their capital due to the currency risk. Sayonara, China!

According to the American Chamber of Commerce in China, which has more than 900 member-companies operating across China, over one-third of the companies within their ranks have already made the move or have plans to relocate production outside the Middle Kingdom.

The Japanese newspaper Nihon Keizai Shimbun reported on September 16, 2018 that factories in China that manufacture shoes for Adidas, Nike, and Under Armour have moved manufacturing to Southeast Asia and India. Additionally, Asia’s largest shipping and logistics company, Kerry Logistics Network Ltd, based in Hong Kong, is currently moving its production lines from China to neighboring Asian nations.

Since the next layer of tariffs, set to be imposed on March 1, could apply to iPhones and other electronics imported into the U.S. from China, Apple and some of its suppliers are starting to explore other alternative locations within Southeast Asia for production of key components. It is estimated that Apple provides and supports over 4.7 million jobs in China with Foxconn being the largest private employer, at 1.3 million jobs.

While it is not conceivable that Apple could rapidly move its production of over 300 million devices per year to another country, requiring one million new skilled workers and billions of dollars in new capital investment, the fact that the subject is being talked about sends up a caution flag to Chinese trade officials.

Though the “Made in China” initiative is President Xi Jinping’s legacy project, as he seeks to dominate in areas of technology, aerospace, and electric vehicles, massive government spending over recent years has created a debt-to-GDP ratio of 260%. According to Bloomberg Economics analysts Fielding Chen and Tom Orlik, China’s total debt will rise to 327% of GDP by 2022, coupled with annual GDP slowing to 5.8% – and these estimates were made in November 2017, well before the current tariff war began.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Seeing as how the stock market is taking to heart the latest progress report from the U.S. delegation that held talks with high-level Chinese officials last week, we know that Chinese officials pledged to increase “substantially” the purchase of U.S. exports within energy, agriculture, and industrial goods. If they follow through, that promises to be kind of like a one-time “Black Friday” buying event for the U.S. economy.

This strategy is intended to entice the Trump administration, eager to reduce the trade deficit for political purposes, to agree to the sale of a big export package to China in return for the U.S. reducing the pressure on China over long-term structural issues – like forced technology transfer, IP theft, American ownership of Chinese companies, cyber intrusion into U.S. institutions, etc. The main takeaway from the talks from the Chinese Ministry was that “they established a platform for future discussions.”

Both President Trump and President Xi are under mounting pressure to reach a wide-ranging accord, but the U.S. delegation of Trade Representative, Robert Lighthizer, Treasury Secretary Steven Mnuchin, and White House Office of Trade and Manufacturing Policy, Peter Navarro, have all been eerily quiet on the talks since their return. It makes me suspicious that a less-than-ideal deal for the U.S. is in the works.

Basically, President Trump said last Thursday that the U.S. was having “tremendous success” in its trade talks with China. Our trade “tough guy,” Peter Navarro, who has a Ph.D. in economics from Harvard, has been muzzled, but even a senior Democrat, Richard Neal (D- MA), chairman of the House Ways and Means committee, which oversees U.S. trade policy, said that American negotiators have “an obligation to look beyond the political pressures of the moment and the easy, one-off transactions, and secure real and lasting change to China’s anti-competitive behavior” (source: Financial Times, January 12, 2019).

This input from Mr. McNeal is important because if Trump settles for a deal short on long-term structural substance to avert the March 2 deadline for hiking tariffs to 25% on Chinese imports, he will definitely be cheered by Wall Street, but scorned by his voting base for not taking the high road.

Thankfully, earnings season will take center stage starting this week while trade officials work the back channels and come up with a formidable plan heading into the next round of talks scheduled for later this month. The end result may be that China will elect for the first time to join the global neighborhood, where its actions and intentions are accountable to its people and to the rest of the world.

About The Author

Bryan Perry

Bryan Perry
SENIOR DIRECTOR

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license.

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