Reindustrialization key to cushioning supply chain shock

As Sino-US trade tensions create a new landscape for global supply chain management, HK-based manufacturers, exporters are urged to diversify supplier bases and export markets, and embrace technology. Oswald Chan reports from Hong Kong.

Tensions over the COVID-19 pandemic and fresh United States restrictions on Chinese companies have strained relations between China and the US, heightening the risk of a collapse in trade talks.

While the Phase One trade deal between the world's two biggest economies is likely to remain in place and new tariffs held back, restrictions on sensitive technology and investments are expected to increase.

Due to the trade frictions and the coronavirus pandemic, supply chains will become shorter and less "just-in-time", leading to a more fragmented global trade system with a greater range of suppliers for similar products, increased regionalization of production, and diversification of supplier sources, says US-based credit rating agency Moody's Investors Service.

Supply chains still retain the attributes of globalization and specialization even when world trade becomes more fragmented. Nevertheless, countries would demand that supply chains have the element of security and reliability besides profitability. These changes facilitate the rise of regional production in global manufacturing, with the consumer products industry poised to adopt this new production model.

"Ensuring supply security by enhancing the strength of supply chains will become the overarching objective of governments and companies, overtaking cost and efficiency considerations," says Michael Taylor, Moody's Asia Pacific managing director and chief credit officer.

Shifting production bases is not something new to Hong Kong-based manufacturers and exporters. Even before the Sino-US trade spat erupted, consumer manufacturing industries producing shoes, clothing and hats, as well as industrial manufacturers for metal, electrical appliances, electronics and toys, had shifted their production bases away from some cities on the Chinese mainland amid soaring labor, land and operating costs.

As China-US ties sour, the shift in the global supply chain intensifies. Some Hong Kong manufacturers are suppliers for mainland telecommunication equipment makers, and some supply chain segments have been disrupted.
Cambodia, Indonesia and Bangladesh were the top picks of Hong Kong manufacturers for relocating their production plants due to their abundant labor supply. Vietnam, however, has seen its labor costs soar as Hong Kong manufacturers rushed to relocate their production plants there in the past few years.

"The global supply chain of three industries - high technology, electronics communication and precision equipment - has been disrupted in the past two to three years since China-US trade frictions emerged. We may see a dearth in supply of parts for the three industries if the Sino-US trade tensions persist," said Dennis Ng Wang-pun, president of the Chinese Manufacturers' Association of Hong Kong.

Diversifying and localizing
Companies should adopt diversification and localization strategies to build up robust supply chains. Diversification aims to reduce reliance on any single supplier, whether it's a single producer or a group of producers from the same country, while localization aims at relocating production closer to home markets. In making the relocation decision, manufacturers have to consider a bundle of factors, including economic fundamentals, infrastructure quality, labor supply, geopolitical considerations and the level of supply security.

Against this backdrop, Hong Kong manufacturers are actively sourcing supply of parts from other countries and regions like Japan, South Korea, Taiwan as well as Europe, besides the Chinese mainland.

Television panel makers, for example, have moved some of the production processes from the Chinese mainland to the Association of Southeast Asian Nations, India and Hong Kong. The production processes being relocated to Hong Kong belong to the high-technology segment (semiconductors, parts and equipment) that do not require large-scale mass production in the city, but the value of each business order is much higher.

"If you decide to move your factories, you've got to study the taxation system, customs clearance and company ownership arrangements, and the labor situation in the country to which you intend to move," Federation of Hong Kong Industries Chairman Daniel Yip Chung-yin told China Daily.

BRI and ASEAN market
Countries involved in the Belt and Road Initiative and ASEAN have been among the popular destinations for relocating production bases. Three factors should be considered in deciding whether to relocate manufacturing bases.
Hong Kong companies should first conduct thoughtful analysis of costs and investment returns of making supply chain changes. They should also study the industrial cluster type if they intend to relocate their production bases to the BRI countries. For example, garment manufacturers can consider Uzbekistan which has a niche in the industry.

Thirdly, enterprises should be aware of the culture and religion in each BRI country in order to facilitate smooth business communication. Good business communication is essential for ensuring that business transactions sealed in those countries can guarantee their commercial interests.

Besides relocating supply chains, developing more overseas export markets is vital for Hong Kong manufacturers as this could lessen any adverse effects on their businesses from being too reliant on the US market.

"We urge Hong Kong companies to diversify their production bases as well as export markets. In the new global trade environment, they should not be just worried about the impact of trade frictions and tariffs on their businesses," reckoned Louis Chan, assistant principal economist at the Hong Kong Trade Development Council.

Hong Kong firms can apply their experiences in the mainland consumer market to tap market potential along the BRI route and in the ASEAN region.
"They should not just copycat their success stories in European and US markets and apply them to the Belt and Road or ASEAN countries. They should study carefully the characteristics of each new market in new business expansion strategies," said Chan.

OCBC Wing Hang Bank said HK-based manufacturers could change their business formats to serve the Chinese mainland's growing demand instead of serving external needs.

Technology and innovation
"If Hong Kong companies can launch their own technology services or products, the Guangdong-Hong Kong-Macao Greater Bay Area and ASEAN would be the markets that want such services or products." Yip said.

Hong Kong companies should also ride on technology adoption to deal with new business challenges. Small business brands and startups can leverage online retail and cross-border e-commerce platforms to promote their products across borders at relatively low costs. Digitalization technologies, such as big data, artificial intelligence, internet of things and 5G applications, can hasten the pace of supply chain diversification and localization.

Looking ahead, the SAR government should push reindustrialization further to allow Hong Kong to cultivate a manufacturing base. This can be achieved by strengthening various assistance funds to help local exporters explore new markets, and using resources to train more local engineering students to find a career in the industrial sector.

Ng agreed, saying Hong Kong should consider adopting the blueprint for the development of the local industrial sector so that manufacturers can be less reliant on other countries for supplying parts that are crucial to high-tech industries.

"The government can raise research and development expenditure and investment in the high-tech industry to support Hong Kong's role in Asia's electronics supply chain. The city's R&D expenditure to the GDP ratio stood at 0.86 percent in 2018, way below the government's target of 1.5 percent and the technology hubs of Seoul, Singapore and Shenzhen," OCBC Wing Hang's research team said.

"Reindustrialization would be important following the COVID-19-induced supply chain shock. It may also make Hong Kong's manufacturing sector more technology-intensive and high value-added," the team said.

The Hong Kong business arm of the Singaporean lender also suggested that Hong Kong could sign bilateral trading agreements with more Asian countries or strengthen existing agreements to pave the way for greater regionalization.
Besides bolstering economic links with the Chinese mainland through the Agreement Concerning Amendment to the Mainland and Hong Kong Closer Economic Partnership Arrangement (CEPA) Agreement on Trade in Services, Hong Kong can also boost trade links with ASEAN after the parts relating to Indonesia under the Free Trade Agreement and the Investment Agreement between Hong Kong and ASEAN took effect in July.

ASEAN has overtaken the European Union as the Chinese mainland's largest trading partner, OCBC Wing Hang Bank said. Trading activities within Asia are likely to grow further on the back of booming regional demand. Even if the mainland were to export less and import more in the longer term due to its economic reforms, Hong Kong could still serve as the key re-export port between the mainland and the rest of Asia.

Contact the writer at
oswald@chinadailyhk.com