For lead firms, cost of supply chain relocations from China, to more inefficient locations, would need to be compensated
Covid-19 has highlighted dependencies of several countries on China in strategic industries like semiconductors, medical supplies, automobiles, chemicals, metals, textiles and machineries. The outbreak of the pandemic has disrupted supply chains for all these industries. The disruptions began with disturbances in sourcing from China that was the early epicentre of the pandemic. Over the weeks and months that followed, such disruptions, while gradually reducing, came to be accompanied by frustration and anger over China’s handling of information flow on the pandemic. Several countries, led by the US and including Japan, India, South Korea, Australia and Vietnam, have begun working on reconfiguring supply chains, for relocating large parts of these chains outside China. The countries engaged in such efforts are all part of the Indo-Pacific, more specifically the Free and Open Indo-Pacific (FOIP) strategy of the US, for balancing China’s influence.
Can regional production networks be overhauled to produce Indo-Pacific supply chains? It’s an interesting possibility. The emergence of such chains would depend on how the Indo-Pacific addresses some key determinants behind supply chains.
Business decisions on spatial fragmentation of supply chains are determined by relative cost efficiencies of various locations. China has strong proficiencies in assembling, be it smartphones, cars, electronic products, medical supplies and processed food items. Decision-making lead firms in various supply chains have invested in assembling operations in China due to the mainland’s abilities in mobilising custom-skilled workers for assembling products in large batches in short time. Parts and components that are assembled into final products flow into China from various countries in the region and the rest of the world. Several components are also sourced internally from within China. In this regard, China is distinct in its broad-based manufacturing capacities, a character common to a handful of other economies, such as Germany, South Korea, Japan and Mexico. Taiwan and Hong Kong have been instrumental in broad-basing China’s industrial capabilities. 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. While China’s political ties with both Hong Kong and Taiwan are currently turbulent, cultural affinity, common work practices and business principles, including the celebrated ‘Guanxi’, remain unchanged. Guanxi, or the principle of building informal relationships for conducting business, has been important in shaping regional supply chains, not just within the China-Hong Kong-Taiwan space, but also outside of it, to business ties with Japan, South Korea and several parts of Southeast Asia. Such practices are unlikely in locations where business is conducted in formal structured fashions, and judicial means, as opposed to dialogue and consultation, are accepted norms for settling business disputes. Pushing regional businesses out of such familiar cultural spaces would be a tough challenge for Indo-Pacific.
Pursuit of self-reliance by minimising economic dependencies on China has been accentuated by the mounting strategic unease of almost all major Indo-Pacific countries with China. US-China trade and business hostilities have accelerated along with the growth in the Covid-19 pandemic. In parallel, China’s trade and political ties have become complicated with Australia. India, which has major outstanding issues with China, is now engaged in de-escalating the latest border standoff with its largest neighbour. The political and geostrategic discomfort with China is palpable among the Indo-Pacific and has added impetus to endeavours to shift supply chains.
If security and geopolitics are the drivers of shifts, as opposed to cost efficiencies, businesses need to adjust to the perspective. For lead firms, cost of supply chain relocations from China, to more inefficient locations, would need to be compensated. They would expect incentives from host countries. During the Donald Trump presidency, some American businesses relocated to the US, not on efficiency grounds, but due to incentives. Businesses would expect sizeable incentives, including generous subsidies, for activating shifts. Indo-Pacific countries should be ready to offer good incentives, more so because China has already begun offering them to foreign businesses for retaining investments in the mainland.
Indo-Pacific countries also need to note China’s importance not just as a sourcing and assembling hub, but also as major market for final demand. Post-Covid-19, supply chains would aim to become shorter and locate closer to final demand markets. China’s global significance as a final demand destination would continue to influence business decisions. Not many markets, be in Asia, Europe or elsewhere, would be able to absorb products as much as China, in the months following the recovery from Covid-19.
The task of fruitful reorganisation of supply chains within the Indo-Pacific might become easier if Indo-Pacific countries, particularly those in Asia such as India, Australia, Japan and South Korea, agree on a few essential rules of the game. These include investment-facilitating decisions like a multi-country alternative commercial arbitration framework; common tax rules, particularly on digital tax; and a set of incentives that businesses would be eligible for if they relocate supply chains and reposition them within the common group of countries. An Indo-Pacific trade agreement is too much to expect. But basic ground rules are not impossible to agree on. Otherwise, ‘snatching’ the chains from China might remain an elusive prospect.
The author is a senior research fellow and research lead (Trade & Economics) at the Institute of South Asian Studies in the National University of Singapore. Views are personal