Author: Nicholas Lardy, PIIE
In defence of his trade war with China, US President Donald Trump has yet again let his Twitter fingers get ahead of reality. He tweeted in late August 2019 that ‘China wants to make a deal so badly’ and that ‘Thousands of companies are leaving because of the Tariffs’. This supposed exodus of foreign firms is another element informing his view that China is under increasing economic pressure and is anxious to accept US terms for a trade agreement.
The trade war is not dampening foreign direct investment (FDI) into China. Non-financial FDI is currently running at almost US$140 billion annually, meaning that thousands of new foreign firms are established in China every month. Since the tariff war broke out in mid-2018 FDI has expanded at about 3 per cent annually, a similar pace to the previous five years. And the recent data does not include the massive new investments in chemical plants — China recently approved wholly foreign-owned investments by both ExxonMobil and BASF, each at a record US$10 billion.
Continued large inbound FDI flows are consistent with the expectations of member companies of the US–China Business Council. The Council’s recent member survey found that 97 per cent reported that their operations in China are profitable and 87 per cent said they had not relocated and had no plans to relocate any of their activities. In short, there is little support for the view that large numbers of foreign firms are fleeing China — the opposite seems to be the case.
A few foreign firms have recently left China but two points need to be kept in mind.
First, foreign firms have been moving out of China for decades. Some firms enter with business strategies that fail, leading to their exit. The best example is Occidental Petroleum. It entered China in 1983 with a flawed business strategy and was forced to write off its US$250 million investment when it withdrew in 1990. Other foreign firms, especially those exporting the most labour-intensive consumer goods, flourished in China for many years. But as local wages continued to rise, these firms eventually moved production to other countries with much lower wages such as Bangladesh.
Second, China has over a half million foreign-invested firms. Anecdotes of a handful of firms leaving China do not confirm a broad trend.
While some foreign firms report that they are considering alternatives to producing in China, it remains to be seen how many will actually leave and how many of those that leave will relocate to the United States. A large share of foreign firms in China, especially US firms, are there primarily to produce goods to sell on China’s still rapidly growing domestic market. These firms have no incentive to relocate within Asia, much less to the United States.
Caterpillar, for example, has more than 30 plants in China to make construction equipment that is mostly sold on the domestic market. The high costs of shipping relative to value make it infeasible to make heavy machinery in the United States and then export it to China. Caterpillar, like other foreign producers of capital goods in China, is very unlikely to relocate any of its production.
And relocating production out of China is easier said than done. Foreign affiliates operating in China draw on an extensive local supply chain that has been built up over decades and employ about 25 million Chinese workers, a significant share of which are skilled engineers and managers. Vietnam is commonly suggested as an alternative but it could only absorb a tiny fraction of production by foreign enterprises now operating in China. Vietnam’s total non-farm employment is only 44 million and foreign firms operating there already report shortages of skilled engineers and managers.
Relocating a significant number of foreign firms from China to Vietnam would put further upward pressure on Vietnam’s already rising wages, intensify existing skilled labour shortages and stretch its limited logistical capacity to breaking point.
Apple contracted Taiwanese manufacturer Foxconn to produce 220 million iPhones in China in 2018. Foxconn would face a number of difficulties if Apple asked the firm to relocate from China as Foxconn employs hundreds of thousands of factory workers and tens of thousands of skilled engineers and managers in China and draws on a network of more than 1500 local suppliers.
It appears that…