The U.S.-China trade war is prompting manufacturers to leave China for lower-tariff climes, not least in southeast Asia. However, in its latest container shipping analysis, Drewry argues that there are limits to how much production can be relocated, and that moving factories is neither easy nor swift.
Moreover, while the switch of some production to southeast Asia has boosted container export volumes from the region, the increase has not compensated for lower volumes out of North Asia which have been hit by the contraction in trade between the U.S. and China this year.
“The U.S.-China trade dispute appears to have sucked the life out of the trade, beyond which even the very evident trade substitution could not hope to cover,” noted the analyst.
The bearish impact of tariffs has been readily apparent in trans-Pacific spot rates for much of 2019. According to Freightos, China-U.S. West Coast rates are currently 45% lower than a year earlier, while China-U.S. East Coast prices are 31% lower year-over-year.
Drewry forecasts that with eastbound trade from Asia to the U.S. flat after 10 months of the year, and given the strength of the market in the final two months of 2018, “an annual deficit seems inevitable.”
As reported in FreightWaves, should the trans-Pacific headhaul trade contract this year, it will be the first annual decline in a decade.
The 2019 shortfall, Drewry argues, is entirely driven by the stagnation of volumes out of North Asia and specifically China.
Volumes from North Asia are down by 5% year-to-date. In contrast, growth out of southeast Asia was up 27% to the end of October.
“Clearly, a sizable number of cargo owners have sought a safe haven from the ongoing tariff uncertainty by relocating some of their production,” said Drewry.
“Customs data heavily implies that the preferred choice thus far has been Vietnam, which saw its total exports to the U.S. rise by approximately 35% after nine months of the year, dwarfing the growth of any other trading partner.”
However, Drewry warns that although export numbers out of Vietnam are impressive, this does not make it a ready-made exporting replacement for China.
“Even after the events of the last two years, China’s share of US total imports (in dollar value) was 18% after nine months of this year, down by around 3 percentage points on the same period in 2018 but still far in excess of the combined 7% share of the supposed pretenders to its export crown – Vietnam, Malaysia, Thailand, Indonesia and the Philippines,” said the analyst.
“The sheer scale of China’s export machine means that it will retain its dominant position for the foreseeable future, although it seems likely that it will gradually diminish.”
Drewry notes that moving production out of China to a low tariff country is no easy task.
“Cargo owners have to weigh a myriad of factors, including local labor costs and skills, infrastructure, proximity to demand as well as political and legal stability that all vary in importance depending on the industry,” said Drewry.
Adding to the complexity, having identified a new location, there are also no guarantees that the new production countries will not become fresh targets of U.S. trade policy and subject to future tariffs. “It is a costly endeavor with no safety assurances,” said the analyst.
Another factor shippers must consider is the availability of logistics and shipping services outside of China. For example, as of October, only 13 weekly trans-Pacific services were calling at Vietnam, one more than the same month last year but well below the 60 loops serving various Chinese ports (see below).
“As demand grows so surely will the number of services,” added Drewry. “But current infrastructure constraints will limit the possible expansion in the short- to medium-term.”
The analyst also notes that countries in southeast Asia rely on imports of raw materials and intermediate goods from neighbors (including China) to support the production of exports. This places a ceiling on how much manufacturing can realistically be diverted from China.
“China’s scale has meant that it has increasingly been able to produce everything domestically and has therefore been able to meet more and more of the world’s demand, until recently at least,” said Drewry.
With China in the process of rebalancing toward a more consumption-based economy, Drewry believes Vietnam is well placed, both geographically and economically, to pick up some of the slack in the making of finished goods.
“Its population is younger than that of China and with a higher proportion of people living in rural areas there is a lot of latent manufacturing labor on tap to suppress wage inflation,” argued the analyst.
“The inflow of cargo owners setting up shop will continue; just don’t expect it to be the cure-all for the trade war slump.”
As a result, while Drewry expects container exports to the U.S. to be more dispersed than previously, it believes the production switch away from China will only be modest over the next few years.
“A lack of viable alternative capacity and infrastructure will force many shippers to decide the cost-benefit of moving versus the additional tariff cost from staying is not compelling enough,” it concluded.
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