Weekend Long Read: Are Chinese Industries at Risk of Hollowing Out?

12 Sep 2024

While the relocation of some Chinese industries overseas since 2010 has led to declines in the country’s global share of certain exports, a new wave of overseas expansion in recent years has raised concerns about its impact on unemployment in some sectors.

In my view, there is no need to be overly worried about the risks of industrial relocation in the short term, as overall the impact is manageable. China is undergoing an industrial upgrade and transformation as its cost advantage declines.

However, from a medium- to long-term perspective, attention should be paid to three risks.

First, the risk of rapid deceleration in manufacturing growth, leading to a hollowing-out of industries — a process where key industrial elements, such as highly skilled jobs, core competencies, or production capacity, are lost or significantly diminished over time.

There is also the risk of macroeconomic volatility stemming from rapid industrial relocation.

Finally, the risk of rising unemployment in related industries.

Industry migration

Prior to the pandemic, China’s share of global exports peaked in 2015, according to data from the International Trade Centre. After that, the figure declined for three straight years.

A breakdown shows that from 2015 to 2023, China’s share of about a quarter of all 1,265 subcategories of exported goods decreased by more than 1 percentage point. The goods with declining shares were mainly concentrated in resource- and labor-intensive industries.

Many industries that rely heavily on natural resources relocated to countries with abundant supplies, such as Australia. For example, from 2015 to 2023, Australia’s share of mineral exports increased by 18.45 percentage points, with the country replacing China as the world’s largest exporter of the category in 2022.

During the same period, 19 subcategories in China’s mineral sector saw their export shares drop by more than 1 percentage point.

Labor-intensive industries, especially those in the mid- to low-end manufacturing sector and the processing and assembly stages of high-end manufacturing, mainly shifted to emerging economies such as Vietnam, India and Malaysia.

New overseas wave

Chinese companies have experienced two waves of overseas expansion over the past two decades: one was around 2010 and the other started around 2021.

The first saw labor-intensive companies follow their foreign-invested counterparts in building factories in low-cost economies such as Vietnam and Indonesia.

From 2010 to 2016, China’s outward direct investment in nonfinancial sectors surged, leading to a significant decline in China’s share of labor-intensive exports since 2015.

In the second wave, most companies are still in the planning stage, selecting sites for new factories. As a result, a large-scale production shift has yet to occur and the impact on exports remains to be seen.

It is worth noting that China’s nonfinancial outbound direct investment surged to $130 billion last year, second only to the figure in 2016.

Why go overseas?

One rationale behind the industrial relocation is China’s rising labor and raw material costs. While the country’s cost advantage in low-end manufacturing diminishes, and emerging economies are gaining that competitive edge, it still retains strength in terms of its full industrial chain capacity and large pool of high-quality labor, making the overall trend of industrial relocation manageable.

The relocation also creates room for a domestic industrial upgrade and transformation. China’s industrial chain is moving toward the higher end of the value chain. Some of its low-value-added industries have relocated from eastern regions to central and western China, while others have shifted to countries with lower labor, land, and environmental protection costs.

The relocation also allows Chinese companies to leverage preferential tariff policies introduced by developed economies for goods produced in emerging markets. Meanwhile, these developing countries are increasing policy support for foreign enterprises, further narrowing the gap between their business environments and that of China.

Trade disputes and geopolitical risks are also contributing factors. Amid the ongoing China-U.S. trade row, Washington has imposed additional tariffs on Chinese goods, accelerating the shift of global industrial chains to low-tariff economies. Meanwhile, for the security of supply, companies have been inclined to adopt shorter and more localized supply chains as well as those located in regions that are politically friendly.

New characteristics

Unlike the previous wave of global expansion by Chinese enterprises that were dominated by labor-intensive industries, such as textiles and electronics processing, the second wave is being led by the automotive, machinery, and electrical equipment sectors. These are very competitive globally.

The motivation for overseas expansion among this wave of companies is also different from their predecessors. In the face of trade restrictions from the U.S. and Europe, coupled with fierce competition at home, Chinese companies are going global to explore new markets and improve their profitability.

Thus, destinations for overseas expansion are also changing. In addition to Southeast Asian economies with demographic advantages, such as Vietnam and Indonesia, Chinese companies are also looking at developed economies and their neighboring countries like the U.S., Mexico, Germany and Hungary.

Meanwhile, companies are keeping key links of the industrial chain within China and still relying on the domestic supply system.

One of the major advantages enjoyed by Chinese enterprises seeking to go global is policy support. China has simplified the management and approval system for overseas investment, facilitating companies’ offshore investments.

China’s robust industrial and supply chain system also provides companies with an edge in their global operations.

However, there are also external challenges. Rising protectionism and unilateralism, along with potential trade disputes, will increase the uncertainties faced by companies going overseas. Additionally, companies will have to possess stronger management capabilities.

Impacts

In the short term, the impact of industrial relocation on China’s overall exports is limited, with the country’s competitiveness shifting to the mid- and high-value stages of production.

This is typified by the textile industry’s relocation to Vietnam. Foreign value added (FVA) accounts for a large proportion of Vietnam’s textile exports, with China being the largest source of the FVA. From 2015 to 2021, China saw its share of FVA in Vietnam’s textile industry nearly double to 42.8%.

Overall, China’s global share of exports is not expected to see much change amid the industrial shift. Last year, the number was 14.2%, up slightly from 13.7% in 2015.

In the medium- to long-term outlook, however, we should be alert to risks of industries being hollowed out, macroeconomic fluctuation, and higher unemployment caused by industrial relocation.

Although industrial chain relocation does not necessarily hollow out industries, it could be a consequence if key links cannot be retained, or if the pace of the industrial outflow is too rapid, which would be hard to reverse in the short term.

The risk of macroeconomic volatility also deserves attention. Real estate and exports have long been key economic drivers, and the property sector is mired in a slump. Export growth might slow if the industrial relocation is carried out too quickly, adding pressure to the work of maintaining stable economic growth.

We also need to acknowledge rising unemployment in the affected industries. As of the end of last year, the number of major companies in the textile, apparel, and accessory industries — those with annual revenue of at least 20 million yuan from their core business — had decreased by 2,200 from a peak in 2017.

Meanwhile, the number of people employed by major companies in the textile, footwear, and hat manufacturing sectors roughly halved from the 2015 level to about 2.3 million in 2022.

Possible solutions

Against this backdrop, China needs to continue to push for a higher level of opening-up, opposing all forms of unilateralism and trade protectionism, and supporting the multilateral trade system.

It would also be beneficial for China to provide fiscal and tax support for homegrown companies seeking to expand overseas, while simplifying procedures required to go global.

China also needs to establish new advantages to attract high-quality foreign investment. Creating a world-class business environment is one thing, and fully leveraging its sizable market demand is also important.

The world’s second-largest economy would also benefit from leveraging intrinsic motivation to upgrade its industrial chain. Increasing investment in scientific research to make breakthroughs in key technologies would ultimately enhance the resilience and security of its industrial and supply chains.