Nearshoring and China's Four 'Ds'

April 25, 2024
Demographics, debt, drought and decoupling are rewriting the total-cost equation.


China’s economy began to enter a structural slowdown even before the pandemic. Its seemingly unstoppable growth model proved less sustainable than originally thought. The 4D’s—demographics, debt, drought and decoupling—weigh heavily on China’s economy.

Demographics: China’s population is shrinking. Birthrates in China are falling, and its population is aging. The number of births dropped to 9.56 million in 2022, the fewest since 1790. By 2035, 30% of China’s population will be 60 years old or older. China’s labor shortages and rising wages are driving some U.S. companies to reevaluate the profitability of manufacturing or sourcing in China, as Chinese exports become less competitive.

Debt: 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. Risky investment activity has led to inflated real estate, land bubbles and unsustainable debt. According to the World Bank, “No country in history has amassed so much debt so quickly as China has without succumbing to a financial meltdown.

Drought: Water scarcity is threatening China’s industrial base. Climate change is expected to exacerbate the problem. Retreating glaciers, disappearing ice cover, increasing temperatures and China’s unequal water distribution are contributing to China’s water shortage crisis. Eighty percent of China’s water is concentrated in South China, even though the nucleus of its national development is in the north, including the three heavily industrialized provinces of Beijing, Tianjin and Hebei.

Decoupling: These 3D’s plus geopolitical risk are driving the 4th D. The perception that investing in and sourcing from China was risky business suppressed foreign direct investment (FDI), an important driver of China’s economy. China’s FDI toppled to $20 billion in Q1 2023, compared to $100 billion in Q1 2022. In Q3 2023, China’s FDI turned negative for the first time on record. FDI into China plummeted 82% in 2023 year over year, to $33 billion, the lowest figure since 1993. In sharp contrast, the U.S. was the top FDI recipient globally in 2023 (USD 341 billion).

China’s slowing growth prospects made the local market less attractive. Foreign companies’ worries include a wave of raids, investigations and detentions and an expanded anti-espionage law. Business activities like market research could now be considered spying.

Many companies built factories in China to sell to that huge, growing middle-class market in China that is not cooperating by saving less and consuming more. Instead, China is increasing factory capacity to export more to European and American consumers, whose countries are resisting more vigorously than in the past. Treasury Secretary Janet Yellen said the U.S. wouldn’t take “anything off the table” including the possibility of additional tariffs, while the EU indicated it had tools to protect its market, referring to tariffs.

As foreign companies reduce their investment, growth declines, making China a less attractive market, further reducing investment. China’s 30+year virtuous spiral has turned negative.

Pandemic Impact

The systemic shock from the pandemic and the “-COVID” lockdowns exposed and exacerbated China’s structural weaknesses. China’s economic growth of 6 percent dropped to 2.2% in 2020. The pandemic and prolonged strict policies stunted consumer demand, production, investment and international trade. Overall, the impact of China’s strict pandemic policies was vast.

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 late 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 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.

Are you thinking about reshoring?

For help, contact me at 847-867-1144 or email me at [email protected]. Our main mission is to get companies to do the math correctly using our free online estimator. By using TCO, companies can better evaluate sourcing, identify alternatives and even make a case when selling against offshore competitors.

Harry Moser is founder and president of the Reshoring Initiative.

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