Trying to Replace China’s Supply Chains? Don’t Bother

May 31, 2023

So much for the great Vietnamese supply chains that were going to replace China's and save globalization.

Over the past few years, analysts and consultants have eagerly pondered whether the Southeast Asian nation would edge in on its northern neighbor's manufacturing prowess and export exuberance. Vietnam was seen as one of the biggest beneficiaries of the US-China trade conflict.

Recently, however, Vietnam's allure as version 2.0 of the world's factory floor has receded sharply. News trickling out of the country doesn't bode well for companies looking to expand existing operations, or set up new ones there. Industrial production fell sharply in January, as did the number of those employed in the sector. Manufacturing activity contracted. Meanwhile, Vietnamese are turning to moonlighting and side hustles as blue-collar work slows. Wages continue to remain low and inflation is biting. Adding to the gloom, one of the largest shoemakers for Nike and Adidas, Taiwan's Pou Chen Corp., is planning to cut 6,000 jobs at its Ho Chi Minh City plant.

A pile of niggling domestic issues are making it tougher to do business in Vietnam, too. An anti-graft campaign that led to the sudden resignation of President Nguyen Xuan Phuc spooked investors. Vietnam was supposed to be stable, and this leadership change only served to highlight the emerging market-feel of volatile politics intertwined with business decisions and processes like getting permits, approvals, licenses and subsidies. That's disruptive for foreign firms whose executives can quickly fall out of favor as officials in power come and go, delaying investments. Meanwhile, the country's property sector faces a worsening debt crisis with its developers delaying repayments. For potential manufacturers, setting up with the help of domestic funding — as was the case in China — may prove challenging as it requires a lot more ongoing investment for working capital and trade finance. Much like the rest of the world, labor is becoming a prickly issue. After at least 28 strikes in 2022, in January, 600 workers in Ho Chi Minh City protested their Japanese employer Toyo Precision Co.'s meager year-end bonus at the sewing-machine-part facility, according to local media.

For global companies, these challenges create more supply-chain complications just as they emerge from two years of struggling to smooth existing wrinkles and disruptions. After Covid-induced interruptions to production and profits, firms may have little patience to deal with more.

The appeal of moving factories to Vietnam was, in large part, driven by labor costs. The prospect of cheaper wages — relative to other production centers — has historically underpinned shifts of technology to parts of Asia (think chip manufacturing and electronics). That calculus is no longer so simple: much of the rhetoric around moving supply chains assumes that just because there are millions of working-age people in a country, they are content with low wages. It ignores their inclination toward the services sector or inflationary pressures pinching employees (much as they are hurting companies) that makes it tougher to work these jobs. Meanwhile, India and Indonesia are emerging as alternatives. Increasingly, firms need more skilled employees as digitalization and automation gain traction.

Even with the hype around Vietnam's potential ascendancy as a vital cog in the global supply chain, it has struggled to shed the assembly-line label — as opposed to a production hub. Monthly, the country turns out over 400 million cigarette packs, more than 300 million ready-made garments, 17.2 million mobile phones and millions of square meters of polyester. Industrial-scale equipment and machinery, or parts for them, aren't a mainstay, yet. Meanwhile, manufacturers still depend on China for parts and components, and moving up the value chain hasn't proved easy.

Japanese electronics firm Kyocera Corp., for instance, is expanding production of some components at its new Vietnam plant. However, the company noted last March it would only make more ceramic packages used in electronics for insulation and resistance, at this facility. The "cutting-edge small-sized packages for crystal devices are made in a highly complex way," and it will continue to manufacture these "inside Japan for a while."

To be sure, Vietnam's infrastructure — from ports to highways and power supply — is well-developed around industrial parks and economic zones, where most manufacturing activity is concentrated. Still, only 20% of roads are paved and logistics capacity hasn't kept up with trade activity.

With one of the brightest spots looking like it's out of the race, what's next for globalization? For one, the world's factory floor isn't going to be elbowed aside any time soon. Chinese companies are effectively exporting their supply chains and facilities to Europe and Mexico in a bid to ride the nearshoring trend.

Meanwhile, it isn't clear how much demand there actually is for a brand new supply chain ex-China. While 30% of Japanese manufacturers use imported goods, almost 50% don't bring in components, according to a survey by Teikoku Databank at the end of December. Meanwhile, those that do rely on imports are now shying away given the weak yen makes it expensive to bring in goods. In India, companies import electronics and other bits from China, assemble them and add some economic value by putting in a few parts like a capacitor, a device that stores electric charge. The US has kicked off its own factory-building boom, leaning on friendly trade partners.

The reality is industrial companies will manage to source the parts and components they need — some from China, others from Japan and Southeast Asia, and yet more from Mexico. Commercial ties will prevail and labor problems will abound as skilled manufacturing workers run short. Businesses will be forced to selectively decouple and certain sectors will struggle more than others. The higher the economic value of technology, the harder it’ll be to rely on others for it. There won't be one new factory floor of the world to replace China. Just a new model of globalization to get used to.