China’s swan song and COVID-19’s big winner

China’s reign as the world’s manufacturing epicenter is coming to a close and the coronavirus is its swan song.

Throughout the last 30 years, China has become a manufacturing superpower whose reach spans the globe. It is the world’s biggest supplier of parts, components and finished goods on an OEM basis. (OEM or original equipment manufacturer, means that goods are manufactured in China but sold under another brand.) Global brands like Volkswagen, Apple, Pfizer and thousands more have manufacturing facilities in the Chinese mainland.

China’s manufacturing competence ranges from automobiles to pharmaceuticals, shipping to textiles, chemicals to electronics. You name it, they make it.  Its manufacturing prowess has made it the second largest global economy whose size is 39 times that of the Philippines.

Since China turned capitalist in 1978, it attracted tens of thousands of foreign investors who built factories lured by cheap labor, lax environmental and labor regulations, low rent, low power costs and good logistics. A domestic market consisting of a billion young consumers sweetened the pot too.

Companies that established manufacturing bases in China enjoyed scandalous profits for more than 40 years.

But the profit party is winding-down…… since 2015, manufacturers have lamented the steep rise in labor cost and rent. Environmental and labor regulations have also tightened to match European standards. The trade war with the US made things worse as China gradually lost its tariff advantage. With this, China’s allure as a manufacturing machine has faded. The coronavirus, with its stinging effect on supply chains worldwide, made it painfully clear that the red republic is no longer the ideal place to manufacture goods.

How bad is COVID-19’s economic effects?

Many liken the coronavirus to the SARS epidemic which disrupted our lives for just a few months. COVID-19 is a completely different beast. SARS started in Guangdong in 2002 and recorded 8,000 cases. During that year, China’s share of global manufacturing output was only nine percent. In contrast, the number of detected cases of COVID-19 has already topped 80,000 and China’s share of global manufacturing output has ballooned to 28 percent. In other words, from just nine percent in 2002, nearly one-third of all good manufactured on the planet originates from China today. The communist nation has become so important that should its manufacturing engine cease, the world will cease along with it.

Realizing this, stock markets across the globe took another nosedive, the majority shedding between six percent to 25 percent of their value so far. According to my favorite economist, Nouriel Roubini (the same economist who predicted the subprime crisis), stock markets will shed 30 to 40 percent of its value this year.

We will feel the full brunt of China’s lockdown this month. The drop in production last February was just the tip of the iceberg as most factories still maintained inventories of China-made parts and components . These inventories are now depleted and cannot be replenished. Without alternatives, companies will have to shut down causing sales and profits to plummet and relegating millions to unemployment. Fiat-Chrysler, Apple and Hyundai have already announced a temporary halt in production in some of their plants.

On the other hand, companies who depend on China’s enormous market like General Motors and Jollibee, will take a hit. (For those unaware, Jollibee owns Yonghe King and Hong Zhuang Yuan with 323 and 45 restaurants in China, respectively).

Not even smaller economies will be spared. The export sector of ASEAN will be badly affected as we are reliant on China-made components; ASEAN’s exports of tropical fruits, agricultural products and commodities like iron ore will plummet too; a blood bath in the tourism and airline sector is already upon us; infrastructure projects using Chinese made suppliers will be delayed; demand for oil will drop by 435,000 barrels a day which will affect oil producing countries; All things told, the effect of COVID-19 will be about $1.38 trillion or 1.5 percent of global GDP.

No surprise, companies across the globe are already thinking of transferring their manufacturing bases elsewhere.

Which countries will benefit from all this?

Economists agree that the biggest benefactor will be Mexico as companies move their manufacturing facilities there. Mexico offers relatively low labor and business costs but boast manufacturing competence in automobiles, electronic products, pharmaceuticals and aerospace. Mexico ranks 8th in the world in term of engineering competence. The icing on Mexico’s cake is that it enjoys a free trade agreement with the US and Canada.

In Asia, the big winner will be Vietnam. Nomura of Japan recently surveyed over 50 companies that relocated their production facilities out of China. It found that 26 companies moved their factories to Vietnam, eight moved to Thailand and two went to Indonesia. None went to the Philippines. The rest went out of Asia.

Vietnam offers manufacturing conditions that the Philippines cannot match. These includes a favorable tax climate, relative ease in doing business, a government that honors contracts and low labor and power costs.

As usual, the Philippines will lose-out on this investment bonanza since government can’t get its act together. The painful reality is that this government is not showing the same urgency on fixing our economic weaknesses as it does politicking and settling old scores. Economic reforms are too few and too slow. Sure, TRAIN and Build3 were steps toward the right direction, but nothing substantial followed after that. The delay in passing CITIRA has caused our already small intake of foreign direct investments to drop even further. Perhaps the next administration will do a better job in making the country more attractive to investors.

Back to China – our neighbor to the north has had a good run as the “factory of the world” and amassed incredible wealth on the back of it. But alas, all good things must come to end. COVID-19 is China’s swan song as the world’s manufacturing superpower.