Trade war puts new strains on America Inc’s factories in China

SHENZHEN, China/SHANGHAI/HONG KONG (Reuters) – Larry
Sloven arrived in southern China three decades ago, just as the region
was taking off as the low-cost manufacturing center of the world. Since
then, he has exported millions of dollars of goods, ranging from power
tools to LED lights, to some of America’s biggest retailers.

That era may now be coming to an end.

For years, Sloven has seen profits whittled away by rising costs,
tighter regulations and Chinese government policies aimed at building a
more sustainable and services-oriented economy that have squeezed
lower-end manufacturers.

But the final straw may be the prospect of tariffs stemming from a
trade war between the United States and China, and a world of more
protectionism.

“It’s been step, by step, by step. And it’s been getting more and
more expensive to produce products in China,” said Sloven, president of
Capstone International HK Ltd, a division of Capstone Companies, from
Deerfield Beach, Florida, a maker of consumer electronics goods.

Manufacturers
have been feeling the squeeze as China shifts its priorities from
lower-end manufacturing to high technology industries as part of a
broader bid to upgrade its economy.

But with tariffs looming, “everybody finally woke up to the extent
that ‘maybe I should face reality’,” he said. Manufacturers were
increasingly worried that “the next group of tariffs would be the
killer”.

Sloven is now stepping up efforts to trim his exposure to China, diversifying into growing manufacturing centers like Thailand.

“Thailand, Vietnam, Malaysia and Cambodia are countries that have
potential opportunities,” he said. “However, it’s not going to be as
easy as many may think. And you don’t know what’s coming next in China.”

Interviews with over a dozen manufacturers from medical device makers
to agricultural equipment firms illustrate how companies exporting to
the United States are now rethinking their calculations about making
goods in China.

“Before the tariffs came on board, we were looking to move about 30
percent of our production from China to the United States,” said Charles
M. Hubbs, European director at Premier Guard, a medical products
manufacturer, citing reasons such as rising wages, a shrinking workforce
and soaring costs.

“With the latest tariff development, assuming those tariffs will go
into effect, we’ll probably be moving about 60 percent of our
manufacturing out of China to the United States.”

Other companies are closely reviewing their options.

“In the current tariff environment, it’s only natural for companies
like ours and others to be internally reassessing the impact and taking
steps to mitigate that,” said a senior China-based executive with a
major U.S. manufacturer.

Moves could include “limiting additional sourcing from China,
shifting sourcing to other countries, or bringing work back to the
United States”.

Mid-level officials from the two countries are set to hold trade
talks this week in Washington, although the gap between the two sides
over U.S. demands for greater market access remains wide.

The escalating tit-for-tat trade war between the United States and
China, with President Donald Trump threatening to impose tariffs on
Chinese-made goods, could have huge implications for heavily integrated
and globalized supply chains.

For some, the impact has been obvious and direct.

Georgia-based AGCO Corp (AGCO.N)
told the United States Trade Representative that tariffs would make the
farm equipment it makes in Changzhou, a city in China’s Jiangsu
province, “price uncompetitive” in the United States.

Maroon Group, a chemical maker from North America, said it would be
“priced out of the market”, a concern echoed by Goodman Global, a unit
of Japan’s Daikin Industries (6367.T) that assembles air conditioners in Houston from Chinese-made parts.

Some firms have already made their moves. The furniture makers At Home Group Inc (HOME.N) and RH (RH.N) have said they will cut back production in China.

Others are trying to adjust supply chains. DSM China Ltd, part of the
Dutch nutrition firm Royal DSM, is looking to replace U.S. soybeans
with new ingredients such as pea powder it can source locally to avoid
Beijing’s retaliatory import duties.

Rising risk from the trade tensions “gave us good impetus to check
out how we look at the whole business”, said Bernard Cheung, director of
global strategic marketing at DSM China.

For some, the response has been dictated by where they sit in the supply chain.

U.S.-based GMM Nonstick Coatings has moved some production to India
after a 30-40 percent drop-off in China orders for advanced chemicals
used to coat American household kitchenware brands such as George
Foreman and Baker’s Secret as those clients move some production out of
China.

“This tariff thing is adding extra friction to being in China and
it’s making the decision” to shift production “quite easy for U.S.
sourcing departments,” said Ravin Gandhi, GMM’s chief executive.

There are still plenty of manufacturers staying in China for now,
especially those targeting the huge domestic or regional market, Gandhi
said.

China still has the best infrastructure, supply chain networks and
engineering talent, a major hurdle for potential rivals seeking to lure
firms away with lower costs, according executives interviewed by
Reuters.

In terms of scale, China cannot be easily replaced: it has a
manufacturing output of around $2 trillion, according to a Brookings
Institution report in July, the world’s largest.

Bird, a Santa Monica, California-based scooter start-up, wrote in a
submission to the Office of the U.S. Trade Representative in June that
it was “unaware of any U.S. producer of electric scooters that can
manufacture to Bird’s scale and needs”.

Keith Siilats, the head of Bytelogics, another U.S.-based scooter
start-up that manufactures in China, said it was hard to shift
production from China. Instead, he expects to absorb the higher costs
for the moment and plans to develop European operations less vulnerable
to tariff pressure.

China’s manufacturing sector will not vanish overnight, but a shift
is inevitable, said Dan Krassenstein, Shanghai-based director of Asia
operations at ProconPacific, which makes around 3 million specialized
industrial shipment bags.

He said manufacturing was moving to South Asia and Southeast Asia in
search of cheaper labor costs and as Beijing discourages polluting,
lower-margin sectors.

The tariff escalation “is just going to accelerate it”, he said.

Five years ago his company made all its products in China. Now, a quarter are made in India and 5-10 percent in Vietnam.

In Southern China’s Pearl River Delta, the cost of renting industrial
and commercial space has surged around 80 percent in the past eight
years, while companies have complained of soaring labor costs.

“Production costs are cheaper in the U.S. than in China,” said Yuan
Juyou, deputy head of marketing at Wonderful Group, a ceramics maker.
“Even though labor costs are more expensive, we have automated a lot of
processes. Plus electricity, land, these kinds of costs are cheaper than
China.”

Wonderful, a unit of the Chinese manufacturer Marco Polo, began shipping products from its new factory in Tennessee in June.

Regional rivals are also starting to sense an opportunity to step up
and into China’s competitive space. Thailand is actively promoting
itself as a regional manufacturing hub, offering incentives such as an
exemption of up to eight years on corporate income tax for certain
industries and exemptions on import duties for some raw materials.

The country’s corporate income tax rate of 20 percent also ranks it
as the second-lowest among countries in the Association of Southeast
Asian Nations, according to Thailand’s Board of Investment.

Thailand is already a major center for some electronics and
components, and the government plans a series of industrial zones to
push development of target industries.

A China-ASEAN free trade deal also helps mitigate the trade-war risk
for companies trading with both the United States and China.

“The Thai government is making it very easy now to move down there,” said Sloven.

“The Chinese government embraced manufacturing back in the day. But
now, they’re not looking for growth in the product business. They’re
looking for high-tech,” he said.

“It’s a bit like when a wife comes to a husband and says, ‘I don’t love you anymore’.”