October 18, 2022

The Problem with Pulling Out of China

Many U.S. and other nations’ companies are thinking about transferring elsewhere. Easier said than done. Investors could be collateral damage.

Reported by Larry Light

Art by Janik Sollner

Should I stay or should I go? That anxious question, voiced by the Clash in their classic rock tune, today confronts U.S. and other companies with extensive Chinese operations. Big potential downsides exist for either choice, with investors at risk. And making the decision even more fraught is that “decoupling” from China—the in-vogue phrase in corporate circles for leaving—is tough to pull off.

For years, the fast-growing Asian giant has been a magnetic destination for U.S. and other foreign companies to set up operations, particularly in manufacturing. China has become the workplace of the world, with 29% of global factory output, versus 17% for the U.S., the No. 2 goods producer.

But vexing complications have intruded. Talk about decamping from this economic powerhouse is rife among U.S. and other nations’ business leaders, who earlier were attracted by China’s highly skilled labor force, low wages and vast consumer market—and lately are dismayed about Chinese policies, such as crackdowns on its own its private corporations and harsh pandemic restrictions.

Plus, the poor condition of Chinese legal protections has worn thin for many outsiders used to the rule of law. “If you do business in China, you need to support the Chinese narrative,” says David Jacobson, professor of practice at SMU Cox School of Business and a noted China expert. Aiding the negative sentiment are political tensions between Beijing and Washington that started under Donald Trump and continued with Joe Biden, over Taiwan, human rights and tariffs.

Trouble is, for foreign companies, ripping out operations and transplanting them elsewhere is very difficult to do, according to a batch of experts. China’s vaunted network of supply chains, infrastructure and skilled workers is not easy to replicate elsewhere. That means if Chinese business conditions deteriorate, these companies are trapped. Worst case: China invades Taiwan, touching off an international crisis. Less dire, although still damaging: COVID-19 lockdowns persist and perhaps intensify, wrecking productivity at China-based foreign work sites.

On the other side of this equation, shifting production away from a rapidly growing colossus, which someday may overtake the U.S. as the largest economy, could prove to be folly. While China’s gross domestic product has dipped of late, it still is expected to handily outpace U.S. GDP expansion over the next five years, averaging over 4% versus America’s sub-2%. To Ray Dalio, founder of Bridgewater Associates and a long-time China booster, that disparity spells superior opportunity in China.

Eyeing the Exit?

For investors, the problematical state of capitalist nations’ dealings with China could harm stock prices of multinationals, as well as those of Chinese companies listed on U.S. and other foreign bourses. A study in the Harvard Business Review warns that Apple, which has a big China presence and sells a lot of products there, could find itself pushed out of the lucrative Chinese market to the benefit of local competitors—Lenovo, for instance.

Among institutional investors, China investing appears to shine a little less brightly nowadays. While a number are quietly trimming their holdings in Chinese stocks, no one is saying it’s because they fear those shares are headed for trouble. The investment committee of the Teacher Retirement System of Texas, for instance, last week voted to halve its allocation to Chinese stocks, to 1.5%. The only reason TRS gave was that China, which is still technically an emerging market country, had too heavy a weight in the EM index.

U.S. and other non-Chinese companies in the Middle Kingdom are hardly rushing for the door, but they are rethinking how much exposure they want to China going forward. A UBS survey of American C-suite executives in January found that 90% were thinking of moving some production out of China. Favored destinations are Vietnam, India, Malaysia, Mexico—and, yes, the United States. Foreign direct investment in China showed a net negative this year, according to CEIC data.

At the same time, few are talking about a wholesale retreat. AT&T, General Electric, Nike, Colgate-Palmolive and other huge U.S. corporations have had plants in China for more than 20 years, and show no signs of abandoning them. At the same time, American retail chains seem firmly entrenched, including Starbucks and KFC (which reports it sells more chicken to Chinese consumers than to Americans). U.S. financial services firms Citigroup and BlackRock are deepening their engagement among Chinese investors.

The U.S.-China Business Council, a trade group for American companies that do business in China, admits that some U.S. businesses have left China, but adds that they aren’t numerous. Myriad American companies “are in China for China, and understand that China will be the world’s fastest-growing market through and likely beyond 2035, despite some bumps in the road,” remarks Douglas Barry, a spokesperson for the organization.

This isn’t to say that American corporations with China operations aren’t worried, he adds. “Many executives of U.S. firms are losing sleep over the growing list of uncertainties exacerbated by continued souring of the bilateral relationship,” he says. “The mood is one of wait and see, pausing additional or new investment until there is something to see that looks more promising than what happens in the next news cycle.”

Breaking Up Is Hard to Do

Foreign companies in China have begun to open new facilities elsewhere, usually in Asia, with Vietnam a top pick. And some have taken operations out of China in favor of these other destinations. Two years ago, South Korean electronics conglomerate Samsung transferred its Chinese manufacturing to Vietnam. U.S. toy and game maker Hasbro has transplanted its production to Vietnam and India. German footwear and apparel company Adidas also has moved operations to Vietnam. Joining them in Vietnam is Apple, which has an enormous footprint in China; the assembly of AirPods is shifting there.

The rub here is that these substitute locales lack the breadth and depth of manufacturing capacity that China possesses. “Finding alternatives to China is not easy,” says Cameron Brandt, EPFR’s research director. Aside from its small size, Vietnam is still a communist state, with an iffy approach to the rule of law. India’s infrastructure is notoriously lousy. Mexico, which has the virtue of proximity to the American market and a lot of practice running factories just across the border, nonetheless has a “government that is hostile to the U.S. and lots of endemic violence,” Brandt observes.

China’s persistent advantages are what keeps Apple bound there, except for the occasional outlier, such as the AirPods, an analysis from Bloomberg Intelligence concludes. Apple’s premier product, the iPhone, is made almost entirely in China. The study finds that it would take Apple eight years to move just 10% of its production out of China. The company did not respond to requests for comment.

“With China accounting for 70% of global smartphone manufacturing and leading Chinese vendors accounting for nearly half of global shipments, the region has a well-developed supply chain, which will be tough to replicate—and one Apple could lose access to if it moves,” the report declares.

Still, an impetus exists to depart from China, and the future should see more farewells. Many foreign executives “are strategizing how to get out” of China, says SMU’s Jacobson. “What they can’t tell is how long that would take.”