Tuesday, September 25, 2018

Is moving production out of China to avoid US tariffs feasible?

The Trump administration imposed an addition 10% tariff (will jump to 25% by the end of the year) on $200 billion worth of Chinese imports to the US. This is in addition to 25% tariff on $50 billion worth of Chinese imports. The escalating trade war between the US and its usual trading partners is forcing companies to rethink if it is as appropriate, profitable and reliable to continue producing goods in China as it was before. However, relocation to countries such as Bangladesh, Cambodia, Ethiopia, Thailand, and Viet Nam may not be that easy. 

Companies have two choices: (i) to raise productivity sufficiently so that the gains offset the cost escalation due to additional tariffs (think in terms of marginal effect); and (ii) to relocate production somewhere else to take advantage of cheaper labor and business costs but with no change in tariff structure. The first option is almost impossible in the immediate term. The second option is doable, but are there necessary physical and social infrastructures in place to realize it in other countries?

Convenience and reliability of production, transportation and distribution are of paramount importance. Good roads for workers to commute, reliable and unclogged transportation network for ferrying goods in and out of the country, political stability and disciplined trade unions, good governance, and adequate supply of electricity  are some of the supply-side constraints that need to be addressed in addition to business-friendly policies. This, at least, applies to Nepal.

Excerpt from a news story from NYT:

Huffing, snorting and in no hurry to move, the big-horned bovines occasionally meander across the Khmer-American Friendship Highway, the dusty, 140-mile route linking Phnom Penh’s factories with the port in the coastal city of Sihanoukville. They are not the only potential obstacles. At quitting time, factory workers heading home on foot and motorbikes clog the road. For factory owners on deadline, those crowded roads can mean frustrating delays.
[…]But China will be hard to quit. From zippers and rivets on jackets and jeans to the minerals used in iPhones, China makes or processes many of the ingredients that go into today’s consumer goods. It has a dependable source of workers who know how to hold down factory jobs. It has reliable roads and rail lines connecting suppliers to assembly plants to ports. Countries like Vietnam and Cambodia, by contrast, lack China’s vast supplier base and dependable roads. More workers have to be trained. Many companies have to start from scratch.
[…]One day a few years ago Mr. Bobrovizki arrived at his factory to find several unions had locked it. Negotiations took weeks. In Cambodia some unions are backed by the party of Hun Sen, the prime minister, adding to political risks for foreign companies.“I lost half a million dollars in those two weeks that they blocked my gate,” Mr. Bobrovizki said.
[…]One American company recently told a supplier with a factory in Phnom Penh that it wants to take its China production down to zero as soon as possible in order to avoid tariffs, said Bradley Gordon, a lawyer who advises multinational companies in Cambodia. That Phnom Penh factory plans to hire 1,000 more workers in the next month and employ nearly 10,000 workers by next year.
Still, China remains an efficient place to do business. Its logistics network is vast and quick-moving. Over the past three decades, China has built 4.7 million kilometers, or about 2.9 million miles, of highways. It has 13 of the world’s 50 largest ports, and three of the top five. China’s sheer manufacturing capabilities are unrivaled. One measure of its output, called manufacturing value added, shows that China makes roughly as much as the United States and Japan combined.

Meanwhile, companies producing electronic goods are already thinking of moving part of production value chain out of China. Here is a news story from Reuters:

[…]Several companies, including SK Hynix of South Korea and Mitsubishi Electric, Toshiba Machine Co. and Komatsu of Japan, have been plotting production moves since July, when the first tariffs hit, and the shifts are now underway, company representatives and others with knowledge of the plans said. Others, such as Taiwanese computer-maker Compal Electronics and South Korea’s LG Electronics, are making contingency plans in case the trade war continues or worsens.
[…]The quick reactions to the U.S. tariffs are possible because many large manufacturers have facilities in multiple countries and can move at least small amounts of production without building new factories. Some governments, notably in Taiwan and Thailand, are actively encouraging companies to move work from China.
[…]At SK Hynix, which makes computer memory chips, work is underway to move production of certain chip modules back to South Korea from China. Like its U.S. rival, Micron Technology, which is also moving some memory-chip work from China to other Asian locations, SK Hynix does some of its packaging and testing of chips in China, with the chips themselves mostly made elsewhere. Most of SK Hynix’s production will not be affected, the source added, since China’s dominance in computer and smartphone manufacturing makes it by far the largest market for DRAM chips.
[…]Toshiba Machine Co. says it plans to shift production of U.S.-bound plastic molding machines from China to Japan or Thailand in October. The machines are used for making plastic components such as automotive bumpers. “We’ve decided to shift part of our production from China because the impact of the tariffs is significant,” a spokesman said. Mitsubishi Electric, meanwhile, says that it is in the process of shifting production of U.S.-bound machine tools used for metal processing from its manufacturing base in Dalian, in northeastern China, to a plant in Nagoya.