Global Trade Talk: Reconfiguring US-China Supply Chains for a Post-Coronavirus World
Global Trade Talk is part of an ongoing series highlighting international business, trade, investment, and site location issues and opportunities. This article focuses on the conversation between Jack Perkowski, JFP Holdings Ltd., and Keith Rabin, KWR International, Inc.
Hello Jack, how are you? It has been a long time since we last talked. Before we begin, can you tell us about your background and current activities?
After graduating from Harvard Business School, I went to work on Wall Street, joining Paine Webber, where I served for 20 years and ended up running the Investment Banking Department. I then decided to do something different for a second career and became interested in Asia. That led to a trip to Hong Kong in 1990 and my moving there in late 1991. I quickly decided within Asia, China was the key driver, and in 1992 made my first trip to the Mainland.
At that time, China’s auto market was small and fragmented. They were manufacturing about 500 thousand vehicles a year, but it was clear the country wanted to develop a large auto industry. However, foreign companies were slow to enter because volumes were too small, so to encourage investment, the government allowed foreigners to have majority ownership in automotive components companies. That is now allowed in most industries in China, but at the time, auto components were the only industry where this was permitted.
I decided to do a roll-up buying majority ownership in a dozen leading auto component companies; putting them under one umbrella; introducing new management and quality systems. To test whether this could work, I visited 100 factories in 40 cities, and concluded it was a viable strategy. I then went back to Wall Street and raised $150 million over the Christmas holidays in 1993 to fund the company. In February 1994, I founded ASIMCO Technologies, an automotive components company focused on China’s emerging auto market. A year later, we raised another $150 million. Over several years, we invested $300 million, which is a lot of money even today. In 1995, though, it was a very large sum.
ASIMCO evolved into a company with 12,000 employees, 17 factories and about a billion dollars in sales. In 2009, ASIMCO was sold to Bain Capital, and I started JFP Holdings, which helps foreign companies to determine whether there is a market in China for their product, service or technology. We also help Chinese companies to expand in overseas markets. We are very hands-on, undertaking research, and then helping our clients to effectively develop and implement their strategies and ongoing business operations.
Almost ten years ago we published an interview with you titled “Profiting from China’s Domestic Economy” concerning China’s rise over several decades to become the world’s second-largest economy. Can you talk about China’s emergence and the role it now plays in the world economy?
China’s growth has been very rapid and it became the world’s second-largest economy about the time we spoke in 2010. Its GDP was about $1.3 trillion in 2001 when it joined the World Trade Organization (WTO) – and over the past 20 years, it has grown by more than tenfold to about $14 trillion. In contrast, the US remains the world’s largest economy, at about $22 trillion.
Japan, which had been in second place, is now third, at about $5 trillion – so there is quite a drop from second to third place. Therefore, if you are a company looking for growth, China is very important. It is hard to see how in coming decades a company can maintain or build a global leadership position if it does not have a meaningful presence there. This is reflected in the Fortune 500 list, which now has as many Chinese firms included as from the US.
Per capita income in China has also risen to around $10 thousand a year. That, however, is a bit misleading, because it is an average. It includes an emerging middle and upper class of more than 500 million people, which is about 1.5 times the entire population of the US. These people largely live in major cities and are rapidly increasing their consumption. McKinsey, for example, estimated  last year that China delivered more than half of global growth in luxury spending between 2012 and 2018 and is expected to deliver 65% of additional spending into 2025.
This is important. US companies and policymakers need to think of China – not only in terms of manufacturing and sourcing – but also as an important driver of global growth. Therefore, while we need to address the dangers of being over-reliant on China in our supply chain, we also must remain aware of China’s growing global market share, so we can benefit and participate in a fair, constructive and competitive manner.
It is true that China’s economy is increasingly driven by consumer demand. It has also become an important source of R&D and innovation – trends that have risen dramatically since we last talked. Can you talk about this phenomenon, where China stands, and what it means to the US and companies and investors?
Unlike many who located factories in China as a way to reduce the costs of US production, I did not set up ASIMCO as an export company. Our emphasis was on becoming an important part of the local auto market. At the same time, we worked with foreign companies such as Bosch, Caterpillar, and others that sourced components in China, but viewed that as an extra revenue source and a way to ensure our factories could produce to international standards. Lowering labor costs was certainly a factor, but not the central element of our strategy, as I knew costs would rise as China developed. Toyota, for example, is a company that takes a similar view and doesn’t really embrace cost alone as a strategy. It has always wanted its suppliers to make components locally where possible so they can be close to where they are being used. That has been our approach as well.
Bottom line – to benefit from growth in China you need to be there. That is the only way to truly understand and participate. When we began, potential Chinese customers told us they would not take us seriously unless we had a factory there. That is important. The Chinese understand networks and supporting firms follow production. This leads to investment, infrastructure, and development of auxiliary industries and innovation within the supply chain. Academic institutions also respond and take steps to train engineers and others with the critical skills needed. This leads to advanced research and an ability to apply technologies and launch success stories. These make investors comfortable and provide additional benefits – which have value not only in China – but in other markets around the world.
With respect to innovation, few Americans realize how rapidly China is developing in areas including digital technologies, consumer payments, e-commerce, and services. In some areas, it is becoming more advanced than the US and we can learn from them. It is important to keep this in perspective and to balance the need to address trade issues and strengthen and safeguard our supply chain with the need to remain present and involved in this increasingly important market. This is the way we can sustain and advance growth and our global competitiveness.
At the same time, there is a legitimate concern in the US about Chinese technology. I spoke to a group of tech executives and investors in Jackson Hole last year. All they wanted to talk about was China’s development of 5G. While there are security implications if Chinese 5G equipment is installed in the US, you can’t blame China for taking steps to move up the value chain. The US also needs to upgrade our capacity and competitiveness – and our ability to develop the products, services, and supply chains that are needed moving forward.
China’s growth has heightened its political ambitions and in recent years we have seen growing tension in the South China Sea, the pursuit of the Belt and Road Initiative, control over rare earth metals, rising tariffs and trade disputes, blockage of Huawei and a generally more competitive posture than in the past. This has strained bilateral relations with the US and led to anxiety in Asia and other countries. What does this portend for China and US-China relations moving forward? Considering these developments and backlash over China with coronavirus what changes are we likely to see from China in respect to its trade and bilateral relations with other nations and multilateral institutions?
China joined the WTO in 2001 and there has since been a sharp uptick in every economic measure. Its economy has grown about ten times and the country has clearly benefitted from globalization. Meanwhile, the US and the rest of the world looked the other way as many Chinese policies and business practices during this period have been in violation of international trade practices. We have been like two ships passing in the night. No one, regardless of who was in the White House, wanted to address contentious trade, IPR, technology transfer, and other key issues.
Every year there was a state dinner or two and leaders of each country would shake hands, but important issues were never discussed in a direct, constructive way. President Trump has done this for the first time and the dynamics have changed. Up until the coronavirus, however, most of the world considered the Trade War as “Trump’s Trade War,” but the virus has caused trillions of dollars of damages throughout the world, and now many more countries will be concerned about China’s behavior. This will place more pressure on both Chinese companies and the government – and the country will have to adjust. At the same time, China’s leadership is going back to its more authoritarian roots, and no one likes that —least of all the Chinese people.
While many of China’s relationships with other countries are likely to be more confrontational going forward, I remain optimistic. At the beginning of the year, a phase one US-China trade agreement was signed. When it came out, many said the US did not get what it needed, and others said it was like the “unequal” treaties China entered with western powers in the 19th and early 20th centuries. I knew it could not be both and read through it.
Everyone has focused on the provision that says China will buy significant merchandise from the United States over the next two years, but the agreement also deals with IPR, currency manipulation, and other key issues. Most importantly, it includes an arbitration mechanism that provides for quarterly meetings between the US Trade Representative and China’s Deputy Prime Minister where issues of non-compliance are discussed and resolved. To me, this seems like a better approach than trying to take Chinese companies to court.
The real question is will the phase one deal be implemented? In my view, the economic devastation that has resulted from the coronavirus ensures that it will. The US and the Trump Administration want the purchases to go through and China wants tariffs to be lifted. So both sides are under pressure to comply. In a curious way, while our countries are at odds at the governmental level – there are real incentives to work through these important issues – which many in China also would like to see resolved. As a result, I believe the virus will help to build consensus and facilitate the implementation of the January 15th agreement.
The COVID-19 coronavirus is having a dramatic effect on global health as well as the global economy and China. What is the current situation in China? How has the virus affected its economy, and can we trust the data that is emerging? What lessons can we draw from the Chinese experience and what changes might result in respect to US-China and global economic relations and trade moving forward?
I don’t know the exact number of cases and deaths in China, and you can certainly fault their transparency and failure to alert the rest of the world. But, once China recognized the seriousness of the virus, the government imposed draconian measures within its borders that could not be applied here. For example, in the US you cannot rope off and restrict millions of people or undertake the kind of contact tracing and restrictions seen in China.
In this way, China was able to arrest the spread of the virus but nonetheless took a big hit in the first quarter. The second quarter will also not be great. China is, however, implementing stimulus measures – not the roads, bridges, and the infrastructure spending we saw after the 2008 financial crisis – but measures to increase the development of 5G and other technologies that were outlined as key industries in the country’s “Made in China 2025” plan.
As a result, China is likely to have a strong second half. The IMF predicts 1.3% annual growth in 2020. This is certainly down from the double-digit growth enjoyed over recent decades, but it is still positive. The bottom line is, while China is still practicing social distancing, imposing precautions, and incurring hardships, the country is largely back to work. We know that because we deal with businesses and factories all over China, including Hubei province where the virus originated. From what we see, the factories are close to full production. China was the first to take the hit, and it is now the first to recover. Beginning in the third quarter, we think growth will pick up and China is likely to see a V-shaped recovery.
For decades the US embraced China’s rise, and production moved there so companies could reduce costs, raise profitability, and access a new, large emerging market. That began to change with growing concerns over jobs, income inequality, and supply chain security. This sentiment accelerated as President Trump began to impose tariffs and even more now with the coronavirus. The result is more serious talk about bringing jobs and production back to the US. Is this possible and what would it mean for US companies, policymakers, and our economy?
It is definitely possible. A lot of production in the US moved to China in recent decades and the pendulum went way too far in that direction. Many jobs were lost; there was social dislocation, and the security of supply chains for a number of key products has been endangered. At the same time, while the US still possesses research and development advantages, foreign-based supply chains, industrial infrastructure, technical expertise, and networks place us at a disadvantage when it comes to implementation and development.
Much of the offshoring was motivated by the search for lower labor costs – but I think tax and regulatory issues in the US also played a role. So, while we need to address environmental concerns and keep to high standards, we must make the country more attractive if we are to bring companies back. This is particularly true in industries where there needs to be a US presence. That is something that has become even more apparent as trade and political disputes further aggravate this imbalance, and now with the coronavirus, logistics and transportation disruptions have caused inventories to run low.
We are also seeing and helping clients and companies to shift production out of China to Southeast Asia and other emerging markets. This is being done to optimize and diversify supply chains, maintain cost competitiveness, minimize tariff exposure, and to allow access to these growing markets. This is true not only for the US but also for Chinese, Japanese, Korean, European, and other firms. What considerations should companies consider as they reconfigure supply chains and their approach to international markets?
Every company needs to use this time to reexamine its supply chains to determine where they are vulnerable. If they don’t do that – they are simply not doing their job. Governments need to do that as well. If you don’t want the pharmaceutical and other critical industries and materials dependent on China or other nations, it is not enough to criticize foreign practices. You also have to provide real alternatives and incentives to bring production back here. This is true both from an inventory as well as an investor and national security standpoint.
Industries will not, however, come back to where they were in the 1970s and 1980s. The world has changed and we are now far more integrated than we were in the past, both in terms of supply and demand. While the need to address this issue has been clear for some time, US-China trade tensions and the coronavirus have accentuated the need to readjust. Until recently, companies were content to leave production in China as investments and this capacity was already in place – even though many factories were set up at an earlier time when labor costs in China were lower and conditions less developed. Now, however, as it has become clear how dependent we are on foreign supply, there is more incentive to reevaluate. In many cases, customers, stakeholders, and investors will demand it.
Some of that production will come back to the US, but where cost remains a key determinant, much of it will go to other countries, such as those in Southeast Asia. A concern I have, however, is these countries are so much smaller than China there is a limit to how much production can be shifted there. There is also less opportunity to sell into the local market. Depending on the industry and location, infrastructure and services may also be lacking.
For example, in China, about 25 million vehicles are now manufactured annually, and there has been substantial investment into forging, casting, and other needed functions. These are expensive operations that are hard to replicate. At the same time, Southeast Asia is relatively close, and we are seeing interest from both foreign and Chinese companies to move at least part of their operations there. Because they offer an opportunity to diversify, countries like Vietnam are benefitting from the shift. Other Southeast Asian countries also provide benefits and need to be examined.
A major obstacle in moving jobs and production back to the US is the need to rebuild and upgrade infrastructure as well as our educational, immigration, and healthcare systems to provide the skills and environment needed to allow the transformation that must unfold. What steps need be taken by the US, state, and local governments if we are to rebuild our manufacturing capacity and to both repatriate production that moved offshore and new trade and investment back to the US?
We definitely have the ability to compete. We need to rebuild parts of our economy, but the cost and scope of a large national infrastructure program will be huge and complex, as is education, immigration, and healthcare reform. I believe, however, these goals will be achieved over time.
We also possess many advantages. For example, we are now an energy exporter and able to supply ourselves at low relative costs. Our universities and capital markets also provide strength. The largest obstacle I see is the need to reduce regulation and institute favorable tax policies. Addressing the devastating impact of the coronavirus on small businesses, which employ the vast majority of our population, is also now a major, if not our most important, priority. We need to get these people back to work ASAP.
Over the years, we have worked for many economic development agencies as well as private developers to facilitate their efforts to attract trade, investment, and business activity within a range of sectors. Drawing from your experience, what advice can you give to US companies and economic development agencies seeking to attract foreign trade and investment and business partners to enhance their businesses, local economies, and international competitiveness.
There are certain things economic development agencies can do tax-wise to provide incentives and create a welcoming business environment. At the same time, it is especially important to clearly and effectively position themselves to demonstrate competitive advantage and why their cities or states are attractive destinations, while also demonstrating their support for companies who relocate there.
When you travel around China, as we did when we arrived, local authorities roll out the red carpet. They make you feel wanted and have an interest in supporting your development. In contrast, I recently accompanied a Chinese manufacturer to a US Midwestern State as they contemplated setting up a facility there. One of their requests was to meet with local officials. The company we were working with was at first unsure who to meet with but eventually set up a meeting.
The officials were very nice, but it was clear this was unusual and they were not accustomed to meeting foreign companies. They were unsure of what they could contribute and did not seem to understand why they were there. In China, local governments are much more determined and willing to play an active role in wooing investment. In a sense, they try to be partners with businesses that base within their jurisdictions. That seems almost a foreign concept here.
As a result, US companies and economic development agencies should be more active and aggressive – to reduce barriers, provide incentives, and demonstrate an interest in attracting businesses that want to base in their city or state. They also need to demonstrate clear reasons as to the benefits of the location – so decisions are based more on value than on cost alone.
Thank you Jack for your time and attention. Look forward to following up soon.
Keith Rabin serves as President at KWR International, Inc., a consulting firm specializing in international market entry, site location and trade, business, investment and economic development; as well as research and public relations/ public affairs services for a wide range of corporate and government clients.
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