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Trump-inspired supply chain diversification hurting China more than helping US

U.S. tariffs on hundreds of billions of dollars of Chinese imports have contributed to an exodus of business from the world's biggest manufacturing economy. So far, the main beneficiaries have been other Asian countries and not the U.S.

The Trump administration has slapped tariffs on $250 billion of Chinese goods across a wide swath of sectors, including technology, types of consumer goods and industrial products, with another batch of tariffs on $300 billion of imports looming. If Trump's goal is to punish China for its market-distorting practices, the policy can be deemed a success; if he is hoping those levies will encourage companies to bring production back to the U.S., the jury is still out.

Vietnam has gained most thus far, with a 7.9% jump in GDP — based on trade data from Q1 2018 to Q1 2019 and a formula that measures the additional U.S. imports of products from third countries and scaled by each country's GDP — coming from trade diversion over that span as the U.S. and China's trade feud intensified, with much of that driven by electronics and textiles, according to Japanese investment bank Nomura. Taiwan, just a short boat ride from mainland China, has seen a 2.1% increase in GDP over the same period thanks to the rewiring of global supply chains, while Malaysia and Argentina have added 1.3% and 1.2% to their GDP, respectively.

These Southeast Asian markets are largely appealing due to the fact that they are not subject to U.S. tariffs, have lower operating costs, including for labor, and are conducive business environments, Katrina Ell, an Asia-Pacific economist for Moody's, said in an interview.

Vietnam has particularly low costs, a young and large working-age population and has benefited from government-induced price stability after years of high inflation, she said.

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Imports by numbers

Imports from Vietnam eclipsed $5.2 billion in the first three months of 2019, compared with less than $4 billion in the same period a year earlier, while Taiwan set a monthly U.S. export record in January, U.S. Census Bureau data show.

Meanwhile, imports from China have dropped precipitously in the first three months of 2019, dipping to $31.18 billion in March from $33.19 billion in February and $41.60 billion in January.

Chinese exports to the U.S. fell by $1.63 billion year-over-year in May, according to analysis of Chinese government data by Panjiva, a division of S&P Global Inc.

Electronics manufacturers that make telephone parts and automatic data process machines, as well as furniture makers, have taken to Vietnam, according to Nomura. Typewriter parts and office machine makers have gone to Taiwan, while Malaysia has begun shipping more semiconductors and circuits to the U.S., Nomura data shows. Indonesia, meanwhile, has seen an increase in U.S. imports of travel goods, handbags, wallets and fish fillets.

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Mexico has also benefited from the move away from China, but Trump's recent threat of tariffs as a tool of persuasion over immigration policy may give supply chain managers pause before committing too many resources to the U.S.'s southern neighbor.

Longer trend

The shift of manufacturing supply chains away from mainland China toward Southeast Asia began in 2010, long before trade tensions between the U.S. and China emerged, due to rapidly rising manufacturing labor costs in the coastal Chinese provinces.

This has already "significantly" boosted foreign direct investment into countries such as Malaysia, Thailand and Vietnam, especially in the latter's textiles and electronics manufacturing industries, said Rajiv Biswas, Asia-Pacific Chief Economist for IHS Markit.

The U.S.-China trade war has only exacerbated this as multinationals flee tariff exposure, Biswas said, upending long-standing supply chains that run through the world’s second-largest economy.

Vietnam has been one of the longer-term destinations for manufacturers shifting out of China, particularly when it comes to electronics production, Chris Rogers, research director for Panjiva, wrote in a recent report.

Even without the U.S.-China trade war, "many developing economies transition from high labor intensity, low value products such as apparel towards more capital intensive, high value items," Rogers said.

Exodus limits

However, there are restrictions on how much Vietnam and other countries can capitalize on China's woes. Vietnam’s labor costs are rising, although they remain relatively low compared with China, Malaysia and Thailand. Its ability to continue absorbing foreign investment is also being constrained by rising land costs, and it is facing infrastructure bottlenecks.

Some makers of apparel, footwear, travel goods and furniture, not all of which have been hit by tariffs yet, have moved production out of China to other southeast Asian destinations, but there are unique characteristics of China's economy that are not replicable elsewhere, Jonathan Gold, vice president of supply chain for the National Retail Federation, said in an interview.

"There is no new China that can take up all the slack and capacity to take everything," he said. "As companies try to shift, they're running into issues of capacity. And you have to have the right skill set to make sure the product meets requirements, design and everything else."

As such, several retail companies, including Macy's Inc. and Home Depot Inc., have noted on earnings calls that they will likely raise prices for consumers to offset tariffs.

No end in sight

An imminent resolution to the U.S.-China trade war seems unlikely.

Trump further ratcheted up the tension June 10, telling CNBC that if Chinese President Xi Jinping does not attend the G-20 Summit in Osaka, Japan, in late June, Trump will impose a fourth tranche of tariffs on an additional $300 billion of Chinese goods, or all remaining imports from the Asian nation.

"At best, I expect a truce after the June 28-29 meeting between Trump and Xi," Gary Hufbauer, nonresident senior fellow at the Peterson Institute for International Economics, said in an interview. "In other words, no further escalation, but no de-escalation of existing tariffs until China delivers on commitments."

The fact that manufacturing jobs are moving to other Asian countries and not to the U.S. as a result of Trump's tariffs is probably not a concern to the president, according to Daryl Liew, head of portfolio management at REYL Singapore Pte. Ltd. "At the moment, Trump's just happy that companies are leaving China but, of course, he can always change his tune," he said.