How will supply chains shift away from China?

By Robert Xiao, Beijing director

I would like to discuss this week another global topic that has been receiving growing attention: How should companies think about supply-chain shifts? More specifically, how will supply chains shift away from China? I believe these thoughts will offer a valuable global perspective that will help to inform your business decisions in the current volatile economic and political environment. Perhaps they will also serve as a refreshing diversion for your thoughts during the hot summer days.

First and foremost, I should make clear that we anticipate supply chain shifts away from China to continue to be a prominent topic of discussion in corporate boardrooms throughout the 2020s. We retain our long-held view that a corporate exodus from China remains unlikely, given the attractiveness of the Chinese consumer market as well as the competitive advantages offered by its sophisticated industrial clusters, such as Suzhou industrial park (semiconductors, bio- and nano-technology) and Jiangsu industrial cluster (pharmaceuticals, renewable energy), as well as its labour resources and production and logistics networks. Although global supply-chain stress has eased in Europe, Asia, and North America, tensions between China and the US as well as persistent anxieties over Taiwan nevertheless speak to an urgency for firms to diversify their operations and supply-chain footprint in Asia. Further driving these discussions are the lacklustre momentum of China’s post-pandemic reopening coupled with expectations of a sustained slowdown in economic growth later in this decade. As China’s fading attractiveness highlights new commercial opportunities in India and South-east Asia, we expect foreign direct investment (FDI) flows in Asia to be largely concentrated outside China in 2023‑27, to the benefit of the country’s regional neighbours.

Second, it should be noted that supply-chain shifts will likely be gradual and differ significantly by industry. For some sectors, such as finished electronics or automotive parts, Asia is already home to a number of alternative former China production sites, particularly in South-east Asia. This should allow for a relatively quick rerouting of manufacturing and logistics activity. Some of these dynamics were already on display in 2020 and 2022, when lockdowns in China forced the activation of alternative supply networks built out of markets like Vietnam. Malaysia and Thailand also saw larger inflows in 2021‑22 compared to 2018‑19. For many other sectors, supply-chain diversification will entail a much longer process. In the past few decades, China’s integration with the global economy has allowed it to onshore critical production processes spanning a wide range of sectors. For many industries—including automotive, electronics, chemicals, and pharmaceuticals—China is the sole source, or among the few sources, of certain upstream or intermediate goods, as exemplified by its dominance in rare earths and active pharmaceutical ingredients. Replicating these supply chains outside China will, in some cases, require massive capital investment probably spread across multiple years. Companies will need to weigh the cost of supply-chain diversification against profit considerations. If supply-chain replication ultimately ends up duplicating these processes in more expensive or less efficient ways, it will not make commercial sense to effect the changes.

Third, considering the question of “which markets are Asia’s biggest winners?”, we believe certain markets in South-east Asia have already emerged as “winners” in attracting FDI, particularly in the context of worsening US-China ties. Moreover, our long‑held view has been that countries like Vietnam, Malaysia, and Thailand will reap the biggest benefits of these trends. Nevertheless, companies need to assess a wide range of considerations to assess which markets make the most sense for their operations.

Lastly, in terms of the future supply-chain trends, it is worth noting that although diversification and supply-chain shifts are not a new concept, the underlying driving factors have undergone fundamental changes. In the 2010s, these discussions were driven primarily by rising labour and other input costs in China, particularly amid fast-growing wage growth in the country’s coastal provinces. Beginning in 2018, however, these discussions received greater urgency as a result of the US-China trade war, reflecting strategies around tariff avoidance. In the 2020s, we expect geopolitics to be the biggest driver of these discussions, as concerns around asset and staff safety complement (or even eclipse) commercial or profit-driven decision-making. That said, supply-chain restructuring—including in the context of buzzwords like “near-shoring” or “friend-shoring”—will be difficult to implement in practice. Efforts by the US and EU to re-shore investment into domestic semiconductor manufacturing will lead to a return in capital flows to those markets, given strong state-supported policies. For many companies, however, the lower costs in Asia—together with the commercial rationale of staying close to Asian markets, including China—will discourage many firms from withdrawing their operations from the region. Having said that, moves by the US, EU, and other governments to “de-risk” supply chains suggest that government pressure on companies to diversify their supply chains—particularly away from China—will intensify over this decade. Our forecast that Asia will be the world’s fastest-growing region throughout the 2020s will complicate corporate decision-making, as business leaders seek to mitigate risk while positioning to ride the wave of potential opportunities.