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Structural Shift Makes China Sourcing Risky Business

Harry Moser

The perception that investing in and sourcing from China is risky business has suppressed capital flows into China’s already struggling economy. China entered into a structural economic slowdown even before the pandemic. Its seemingly invincible growth model proved less sustainable than once thought. China’s 4Ds––demographics, debt, drought and decoupling––are weakening its economy. 

An economic quadruple-threat precipitates China’s slowdown 

1) Demographics: China’s labor shortages and rising wages are making manufacturing or sourcing in China less profitable and exports less competitive. China’s population is shrinking with many provinces already experiencing negative growth. In 2022, birthrates dropped to 9.56 million, the fewest since 1790. By 2035, 30% of China’s population will be 60 years old or older. 

2) Debt: China’s dodgy investment activity has led to inflated real estate, land bubbles, and unsustainable debt. In 2023, China’s annual exports fell for the first time in seven years. As exports decrease, Beijing bolsters the economy by pumping money into the system with investments from state banks and local governments. But funding is typically prioritized to conform to the authoritarian government’s ambitions rather than based on risk-return calculations. 

3) Drought: Eighty percent of China’s water is concentrated in the South, even though the bulk of its industrial base and economic development is in the North. Water scarcity threatens China’s industrial base, and climate change is expected to exacerbate the problem. Retreating glaciers, disappearing ice cover, increasing temperatures, and China’s unequal water distribution all contribute to China’s water shortage crisis. 

4) Decoupling: The aforementioned “trifecta” plus geopolitical risk are driving the fourth shift. Multinational companies are worried about elevated business risks amidst a wave of raids, detentions, investigations, and an amended anti-espionage act. China’s FDI tumbled to $20 billion in the first quarter of 2023 as compared to $100 billion in 2022’s first quarter. FDI fell by the most on record in the final two months of 2022, down 33% in November and 29% in December. FDI turned negative in the third quarter of 2023 for the first time on record. 

Pandemic Impact 

Initially, in the first COVID pandemic wave, China shut down the economy quickly and oppressively. Many Western companies stopped importing Chinese goods. But by Q3 2020, China was the first world economy to grow again, and the seemingly resilient Chinese economy was back in the black by year’s end. 

The second wave of the COVID pandemic was a totally different scenario. China again employed strict lockdown measures and restrictive policies. But the pandemic exacerbated China’s structural weaknesses. By 2021, problems with China’s real estate and banking sector surfaced. At the same time, strict lockdowns decreased consumer spending, factory production, and foreign direct investment. Countries worldwide lifted COVID restrictions by Q4 2022 but China persisted and the Chinese economy began to lose ground. 

Multinational companies reconfigured supply chain strategies choosing localization, China +1, or an “anywhere but China” policy to reduce risk and an over-reliance on uncertain Chinese policy. 

The No. 1 Factor Driving Reshoring 

Reshoring Initiative data shows that “geopolitical risk exposure” is the most highly ranked of the “main drivers for reshoring operations.” Chief Executive magazine’s 2023 study concurs. COVID shutdowns, the war in Ukraine, the Israeli/Hamas war, and increasing tension over Taiwan indicate it is past time for companies to evaluate reshoring and nearshoring as “insurance” against catastrophic disruptions. 

Companies can use the Reshoring Initiative’s free online TCO Estimator and our new Geopolitical Risk measure (Figure 1) to compare alternative sources. Geopolitical risk (GPR) is the probability in one year of a major disruption in trade resulting in the cessation of exports from that country to the U.S. as a result of an adverse geopolitical event. Detailed risk values are at the linked site. 

User data shows that 20% or 30% of what is now imported from China can be sourced domestically at equal or greater profitability. A revised TCO version, expected to be online in 2024, will include the Geopolitical Risk factor and should drive that percentage to well over 50%. 

The revised Estimator will use geopolitical risk to calculate the expected value of lost margin on revenue lost due to stocking out of a component or product. By including that cost in Total Cost, the user can determine whether it makes sense to “insure” its supply chain by reshoring. 

For help, contact the author at 847-867-1144 or send an email to: harry.moser@reshorenow.org. The main mission of the Reshoring Initiative is to get companies to do the math correctly using the free online Total Cost of Ownership Estimator (TCO). By using TCO, companies can better evaluate sourcing, identify alternatives, and even make a case when selling against offshore competitors.