India is excited to dress reherse the global shift in Supply Chain. The move is geo-political burdened under existing trade deals, controlling politicians and unmet economic aspirations of nations.
The scale of the disastrous and tragic outreach of the pandemic has led countries to take drastic steps, strict survival measures and holding aggressive political stance. The moves nations are making is confirming that the paradigm shift is here to stay.
The uncertainity, anguish and general fatigue of it all is making mankind desparate for familiarity which is seeing nations trying to foothold on blaming, shaming, alleging, retracting and “wolf warrioring”. After all, the familiar world seems long gone as permissive imaginations struggle to project the new one on unstable grounds.
The Obvious
China, often termed as the “World’s factory” particularly, Wuhan with almost 200 of Fortune 500 firms[1] embedded there, is under socio-economic burn from COVID 19, President Xi along with communist diplomats has had to revise and alternate his political response towards the world. There are multiple theories around outbreak management, transparency, foul play, containment and above all- it’s origin! Optical justifications still point to Wuhan, of the Hubei provisnce, whether, it could have been handled well by any jurisdiction with that size & volume of people- has not been put to test. Despite multiple allegations, Trump Government has not presented any evidence to establish the movement of the novel coronavirus was, from a lab in Wuhan. The longer that evidence takes to come, the more unreliable the theory becomes.
COVID-19’s catastrophic range, form infesting a prawn seller of Wuhan wet market to Boris Johnson, UK’s Prime Minister whose recovery heavily crutched on gallons of oxygen, indicates, COVID-19 stopped discriminating long ago!
The existing complexities of Brexit, US – China Trade Deal Phase 1, upcoming presidential elections in US, Italy’s love for China, Germany’s preference to hedge, US withdrawing and China increasing support to WHO, there aren’t too many linear inferences.
What is set to change in the Supply Chain?
Over the past half century, there has been a shift from inventory based supply system to “just-in-time” approach, wherein most of the companies order goods on need base In a ideal world this reduces inventory based expenses. In a less than ideal world it offers little or no cushion in case a supply-chain disruptions. Welcome! we are in “less than ideal”
- The US – China Trade Deal Pahse 1 had some agreed commitments aimed at balancing tariffs by US cutting off some tariffs on Chinese goods in exchange for China purchasing US farm, energy and manufactured goods and above all adressing some US complaints on intellectual property and restriction free entry into Chinese financial sectors. All of this to be spanned over 2-4 years. Interestingly, China was agreeing to withdraw its pressure on US companies to transfer technology to Chinese companies as a pre-condition to providing market access and thrusting government advantages for such access. On the Currency front, China had pledged to refrain from competitive currency devaluations and not to target its exchange for trade advantages.
- Implementations were to be ironed through bi-lateral consultations from middle to top level between US and China. The current situation eliminates bi-lateral consultations, with countries resorting to imposition of penalties and tariffs in view of the complete failure in dialogue.
- Acting in “Good Faith” and not resoting to “retaliation” were meant to be the foreground of the relationship, which are facing uncertainities now.
China’s vulnerabilities stand exposed. Higher tariffs, made China not so cheap an an importing option, companies were willing to shift in portions of their lines, outside China, conservatively to south-east Asia. The US-China Trade Deal could have resolved two main issues of Tariffs and Intellectual Property. The outbreak, has sweepingly placed questionable thoughts on actions of nations. The EU alone is a large block with UK still transitioning Brexit. Germany has preferred not to pick sides between China and USA as it prefers to dominate the position of having a choice not to pick. It also feels confident to be the ones to set standards in tech for many markets.
The situation makes for muddy water disruption with uncertainity around what is expected to cradle the world.
Supply chain uprooting has legal implications
It will be a legally and politically charged uprooting for companies. With a long ask for patience. No question, the pandemic has ripped open a dangerous line of confrontations between US and China which is dragging along the global economic and political system.
Sudden and Drastic: China exported around $ 2.49 trillion worth of goods, with $ 480 billion worth of goods alone in USA in the year 2018[2]. This figure increases every year. The current tragic state of affairs choked this completely. Around 2.47 lakh companies have declared bankruptcy in China during this virus laden first two months of 2020.[3]
Predictions seem to be meeting reality only when one predicts the bankruptcy figure to increase causing a trough in the demand curve. Recently, the US has begun inquiries to understand better how key components of certain critical products are sourced. Little before this outbreak, 39% of American companies including Apple, Google and Nintendo were mulling over shift in supply chain outside China, with 25% of them considering south-east Asia as target destination.[4]
De-coupling of US and China holds several layers to it. What was a US concern has become a global discussion point with companies contemplating “China plus one” or “China plus two” diversification approach to their product lines. There are many companies in Europe and US, asking, Where should we go, if not to China? China currently accounts for 50% to 60% of global growth. Thus, moving out of China is likely a choice of not being in the forefront of economic development.
Legal Problems of exiting China
- Employee Issues within China: most employees have employment contracts, with the typical duration being 1-2 years. Thus, companies seeking to leave China will have to fully pay these or compensate for these. This will be a chunk of expense for companies, navigating and negotiating the exits will be labourious and time consuming. With a second round of COVID-19 outbreak being anticipated, it will impede the frequency or speed with which companies will be able to close these issues, remotely.
- Conversely, for companies who do decide to stay, will have a huge labour and employment problem. The jolt to the growth in China is likely to face economic and legal factors colliding with each other without quick answers.
- Raw Material ownership: Typically, manufacturers in China are not permitted to simply move their tooling and equipment out of China. Chinese manufacturers consider machinery, tools and molds provided during manufacturing as part of their infrastructure. It will not matter to the Chinese government whether a non-Chinese company purports to have contractual ownership rights to the equipment. The Chinese government may refuse export of the equipment upon closing the factory.
- Intellectual Property Rights: As most are aware, China takes a constrictive view of the intellectual property rights of foreign manufacturers, so once a company moves its supplier production out of China, competition steming from China might be, a day away. Companies will have to compete these.
*In the US-China trade deal, Beijing had offered the comfort on the IP, with that getting turbulent, that bankability is reduced.
- Costs and also Labour cost: Labour cost, for US manufacturing to compete if it is proposing to bring manufacturing back home, its domestic labor rates must either be comparable to China or enough labor must be extracted from production to be cost-competitive. This may require automation. Automation, may require re-engineering to produce more efficiently. The operations is likely to get expensive in the short-run till it settles in for use of robotics, 3D printing, AI/ ML.
- Efficiency and skill: China’s rise as a manufacturing dominant, implies efficiency along with cost effectiveness. For manufacturing to be moved to other countries, it will be time consuming to build the same level of expertise. This will require patience and involvement. Dependency on China for manufacturing and development maintained a linear supply structure with benefits of low development / importing cost from China. Cost effective? Yes, risk laden? Yes. Production lines of finished component requires availability of skilled & cheap labour and ecosystems to build technology, this is deeply entrenched in China.
*Apple intends to fund ($334 mln) a new factory in North Taiwan’s Hsinchu Science Park to produce Mini LED and Micro LED displays for furture devices. Apple’s first LED display device is set to be launched in 2021. This is indication of general Supply Chain moves.
Taiwan is considered a higher quality manufacturing hub than China, Taiwan dominates electronics, is open for foreign talent, simple Visa Process, cost of living is cheaper than Hong Kong or Singapore, No new case of COVID-19 in a month.
- Scouting potential hinderance: With traditional methods of trade fairs to understand suppliers, no longer available, due diligence around stability and reliability of suppliers/ vendors will not be possible. Reliance on sourcing agents and trade representatives who are not well-known may not be ideal. Companies will have to approach expensive and established trade houses with established licenses. This will contribute to increase in cost.
- Chicken or the Egg: Companies have to be considering whether to move the development of product or its mass production? Either way longer supply chains with less agility and higher costs of production will not be sustainable in this fragmented globe. Latent costs in longer supply chain, knowledge transfer, training of employees, cultivating relationship with local partners and consolidation of resources in new location will be challenges with reduced abilities to overcome these.
- Capital crunch!: Fearing the greatest of all depressions, companies will have to weigh setting up assembly lines or development unit, stability jurisdictions offer and training costs against liquidity issue.
*Google and Samsung have been considering Vietnam and Thailand to start production of their phones and other hardware[5] despite the risk of “component choke point”.
- Logistic and shipping bottlenecks: Moving set ups out of China and building them elsewhere have logistic challenges. With the shipping industry facing additional challenges due to the outbreak, raw material transportation with consistent stable cost effective supply.
The non-visible Impact:
Key realization, area of concern and a weakness for the world which the pandemic has revealed-
“is that many supply chains in crucial industries rely on a limited number of suppliers and/or on suppliers in a limited geographic region.”
The world, thus is seeing,
Food crisis
China has suspended some Beef Import License of Australia. This impacts Australia’s $3 billion beef exports. China claims that the suspension is over technical issues about contravention of WTO guidelines. Australia’s 80% pork comes from China. In response to a no dialogue retailiation, Australia is taking a stand of refusing pork from China. China, is currently facing a issue around pork imports from Aftrican countries due to risk of Swine Flu.
Speculation has it, that this ban on Australia may be related to the Farm import commitment China made to USA in Phase 1 of US-China Trade Deal. With retaliations by both the countires set to rock the Trade Deal, will farmland consumption on all sides develop an imbalance with newer markets to be explored?
National security
Since November 2019, the Japanese government has lowered the allowable foreign investment ownership in companies critical to national security. Vaccine, medicine, and advanced medical equipment makers have been made entrants to the critical to national security list.
India, has, as recent as April 2020, reclaimed its rights to scrutinise and grant discretionary approval for foreign investment into India from countries with which India shares land border. In addition to Pakistan and Bangladesh, this move impacts investors of China, which by the way, possess a foothold in Indian economy including in financial sector.
Export dependent countries
Italy is export dependent economy and the US-China decoupling is likely cause the economy to face negative impact. Italy prefers to choses China over Germany. By refusing 39 million pound EU aid from the European Stability Mechanism, Italy has been clear in its position, that it wants friends with China over othr EU countries like France and Germany.
*China’s push for global economic technologial dominance has left Europe to chose between US and China.
Is GoI introspecting?
a. Is that labour really cheap?
Indian labour market has huge demography and is cheap but low on skill required in the high-end supply chain. Schemes like Skill India and Pradhan Mantri Kaushal Vikas Yojana are yet to deliver the required results. With low sensitization at grass root level, poor monitoring and focus on capital intensive sectors rather than labor intensive, it fails to offer what is required for the manufacturing aspirtions.
b. Flaws in vocational training schemes have to be addressed and made relevant to the need of the demographic demand. Tremendous change in digital and technical infrastructure is required for caliming the prominence in the virtual space. Most jobs in financial, manufacturing, transportation, packaging and shipping are facing automation rapid and extensive skill growth is required.
c. Labour Law flexibility is yet another roadblock, any step by the government to modify the law is countered by the trade unions. The flexibility can be introduced through “fixed term contracts”. Regressive labour laws act as impediment, deterring employers from expansion. The contrary perspective that should be focused is that flexible labour laws will create flourishing manufacturing market with abundant and better paying labour jobs.[6] However, sudden sweeping modifications in these laws can be counter productive, labour litigation and break in manpower is a deterrent for most companies and organisations. Labour stability is a huge contributor in manufacturing decisions.
d. Does the infrastrature, support making 100s of million pieces?
Most companies considering the move out of China vocally acknowledge that, China remains way ahead to its South-Eastern counterparts, in terms of infrastructure. India faces a severe limitation in the space of infrastructure. Huge private infusion for long term, could boost this for companies.
*India plans to spend $1.4 trillion on infrastructure by 2025 to become $ 5 trillion economy.[7] Deepening of corporate bond market, creating sector specific investment schemes varying on maturity and risks should be created to facilitate and boost investment.
e. Dispute Resolution of Infrastructure Dispute: Next is to focus on dispute resolution of pending and potential infrastructure disputes by institutionalizing it or adopting FIDIC framework contracts which provides for internal Dispute Adjudication Board thereby promoting effective resolution, is imperative for India.
f. Do we value your IP?
The enforcement of IP protection is central to many manufacturers success aspirations which are evaluated before investing and setting up manufacturing in any nation. China has been facing flak for the same and has been involved in a face-off with USA to improve the IP protection environment. The position is aggressive but liberally favouring China to emerge as world power, US had attempted to reign this over under the Phase 1 Trade Deal.
g. India on the other hand, fares poorly as it is ranked 40th in comparison to China’s 28th position in World Intellectual Property Rights Index[8]. The need is urgent and pressing, to develop an IPR culture as the World is shifting towards automation and digitalization. A comprehensive IP ecosystem focusing on high value creation can be key to India’s success.
h. Political instability: Communist China does not face Political instability and conflict of ideologies. The communist principle is deeply entrenched along the bureaucratic hierarchy, offering it stability to achieve the desired results of policies. Political instability transmutes and takes form of laxity in policy decisions and corruption, conflict of ideologies hurting the investments and investor trust.
i. Andhra Pradesh’s decision to re-negotiate power deals and cancelling of infrastructure project in 2019 has put more than Rs. 21000 crore of debt investment under risk. Such precedents are complete deterrents. The need of the hour is to ring-fence such investments which requires a coordinated efforts of both the center and the state working along the principles of cooperative federalism.
j. COVID 19 preparedness and containment: China has demostrated significant strength and maturity in containing and preparing for subsequent outbreaks. Comparatively, India is wobbling. Collapsed healthcare, paucity of testing, inadequate containment models all seem to be indicating future painful interruptions. China is faced by questions around transparency and handling, faulty PPE and testing kits, but hard to ignore, whatever it be blamed for every alternate must show credibility in overcoming the pandemic, successfully and recurrently.
GoI’s Reality check/ introspection
India definitely offers a respite in terms of wet markets operating along side humans with vectors organism transmission in comparision to other SE countries. But we still have Dengue, Malaria and H1N1.
GoI is doing it’s best by presenting lucrative and enticing options,like offering land banks, arguable labour reforms and other legal benefits.[9] It has also, postponed the impostion of tax on digital transactions whihch was not viewed as a favourable move.
Infusing economic stimulus to keep demand up and revival of the economy, the moves have been made, the success of which is yet to unravel. With the best of India’s talent leading companies like Alphabet, Google and Microsoft, outside India, should India be reminided “Your team is only as strong as the weakest link”! The labourers/ migrant labourers have emerged as the weakest link during this outbreak, they are the ones to stabelise growth favouring Supply Chains.
Maybe, India is still viewed as “supplemental to”. Maybe India is best in tech and deep tech, as much as the Government may want to view it as “atmanirbhar” self sufficient supply chain hub.
Disclaimer: This Note is for general information only and not intended for solicitation. Please do not treat this as a legal advice of any sort. Views contained in this, are personal with interpretive value of the author and teams assisting the author.
Readers are encouraged not to rely solely on these contents before making any decision.
[1] Jim Kil Patrick,Covid-19: Managing Supply chain risk and disruption, ( 2020) https://www2.deloitte.com/global/en/pages/risk/articles/covid-19-managing-supply-chain-risk-and-disruption.html
[2] Is china the world’s top trader?, ( 2019) https://chinapower.csis.org/trade-partner/
[3] Coronavirus crisis: 2.47 lakh Chinese firms go bankrupt, (April 12, 2020) https://auto.economictimes.indiatimes.com/news/industry/coronavirus-crisis-2-47-lakh-chinese-firms-go-bankrupt-in-jan-feb/75108045
[4] Second joint survey on impact of tariff, ( May 22, 2019) https://www.amchamchina.org/about/press-center/amcham-statement/second-joint-survey-on-the-impact-of-tariffs
[5] Cheng Ting Fang, Google, Microsoft shift production out of china faster due to virus, (2020) https://asia.nikkei.com/Spotlight/Coronavirus/Google-Microsoft-shift-production-from-China-faster-due-to-virus
[6] Zia Hak, Saubhadra Chatterji & Smriti Kak Ramchandran, Some state put freeze on the labour laws to get business going, (May 09, 2020), https://www.hindustantimes.com/india-news/some-states-freeze-labour-laws/story-6JMELEPdIugsHt8YjQT5vN.html
[7] India needs to spend $1.4 trillion on Infrastructure if it wants to $5 trillion economy: Economic Survey, (January 31, 2020) https://economictimes.indiatimes.com/news/economy/infrastructure/india-needs-to-spend-usd-1-4-trillion-on-infrastructure-during-fy-2020-2025-survey/articleshow/73799448.cms?from=mdr
[8] GIPC Intellectual Property Rights Index, (2020) https://www.statista.com/statistics/257583/gipc-international-intellectual-property-index/
[9] Covid-19: India looks to lure more than1,000 US companies out of China, (May 07, 2020) https://timesofindia.indiatimes.com/business/india-business/covid-19-india-looks-to-lure-more-than-1000-us-companies-out-of-china/articleshow/75595358.cms
India offers land twice Luxemburg’s size to firms leaving china, (May 05, 2020) https://economictimes.indiatimes.com/news/economy/policy/india-offers-land-twice-luxembourgs-size-to-firms-leaving-china/articleshow/75534412.cms
Disclaimer: This Note is for general information only and not intended for solicitation. Please do not treat this as a legal advice of any sort. Views contained in this, are personal with interpretive value of the author and teams assisting the author. Readers are encouraged not to rely solely on these contents before making any decision