Is Vietnam, India, or Mexico replacing China?
As China’s export and import slow, as demonstrated in the latest trade figures, the question of whether China is being replaced by other countries as the world’s top manufacturer is reverberating in various corners of the world.
A week ago, a mainstream Chinese expert penned an essay reacting to this concern. In particular, the piece examined the prospect of Vietnam, India and Mexico catching up to or potentially replacing China.
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Below is a translation of the essay in full. The piece was initially published on Guancha.cn.
Vietnam, India, and Mexico, who is challenging China's status as the world's factory?
Researcher, Institute of World Economics and Politics, Chinese Academy of Social Sciences; Director, Research Department, China Forty People's Forum on Finance.
Over the past decade or so, economic and geopolitical factors have successively impacted China's status as the world's factory. In the decade leading up to 2017, changes in economic factors were dominant, as evidenced by rising labor costs, appreciation of the RMB, rising land and environmental costs, and overcapacity in some industries. All of these factors have played a role in driving industrial out-migration.
Since 2017, the international geopolitical landscape has undergone significant changes, and the industrial chain policy of the United States has been continuously adjusted. After Trump took office in 2017, it reshaped the U.S. domestic tax system and launched investment promotion policies to lure industries back to the United States, but the results were not ideal.
Since then, the United States has tried the " near-shoring " policy to promote the industrial chain back to neighboring countries ( such as Mexico ), but has failed to break up the established global production division of labor system. Therefore, the United States further turned to "friend-shoring".
In April 2022, U.S. Treasury Secretary Janet Yellen said in a speech to the Atlantic Council, "We cannot allow countries to use their market position in key raw materials, technologies, or products to have the power to disrupt our economy or exercise unwanted geopolitical leverage." She further suggested reducing U.S. supply chain risk by concentrating supply chains in "countries we know we can count on."
It can be seen that the U.S. strategy of reshaping the global industrial chain has gone through three stages of industrial repatriation, near-shoring and friend-shoring. These practices may not only impact China's status as the world's factory, but may also gradually isolate China in the global industrial chain system.
In addition, the Biden administration has adopted a "small yard, high fence" technology policy in an attempt to promote "targeted decoupling" from China. Since the global outbreak of the epidemic in early 2020, the Japanese government has proposed the "China+1" and "China+N" strategy, and the EU has begun to link supply chain issues to human rights and environmental issues.
In this context, the pressure of China’s industrial transfer to Southeast Asia, South Asia and Latin America is relatively high, especially Mexico in the U.S. near-shoring strategy, and Vietnam and India in the friend-shoring strategy.
Can these countries pose a real challenge to China's status as the world's factory?
Mexico is still in the middle-income trap and poses the least challenge to China
Mexico is adjacent to the United States and has the second largest economy among Latin American countries after Brazil. Since trade frictions began to emerge between China and the United States in 2018, Mexico's development environment seems to have improved. As the CPTPP and the USMCA entered into force in recent years, Mexico's economic and trade ties with major economies such as Japan and the United States are growing closer. Coupled with trade shifting to Mexico as the result of newly imposed tariffs on Chinese goods, Mexico is enjoying new opportunities for development.
The United States has been Mexico's most important trading partner. Exports to the United States accounted for 80% of all Mexican exports, and is in clear competition with China. Among U.S. imports of transportation equipment, electrical equipment, computers and electronics, Mexico accounted for 31%, 25%, 17%, respectively. Because of the close trade ties between the United States and Mexico, and the ability to substitute China in exporting to the United States, Mexico seems likely to become the beneficiaries of trade and investment transfer.
However, if Mexico wants to replace the international status of Chinese manufacturing, its challenges are still huge. Mexico is still in a middle-income trap, facing many structural challenges. In constant 2015 U.S. dollars, Mexico's gross domestic product (GDP) per capita in 2021 will be $9,255, almost no growth from $9,214 in 2007.
Specifically, Mexico's business system is not friendly enough to foreign investment. Economic development is also hampered by a shortage of electricity and transport capacity in terms of infrastructure and corruption.
In addition, some parts of the USMCA are unfavourable to Mexico's business environment. For example, the United States proposed requirements on "the proportion of the domestic added value of the product" or requires "certain production of cars, trucks and parts thereof in the United States", which makes it difficult for Mexico to attract foreign investment transferred from China through the agreement.
The development of Mexico has not yet emerged from its inherent middle-income trap, so the Mexican economy is unlikely to see a miracle in the context of the U.S.-China trade war. Overall, Mexico has gained relatively small growth from the U.S.-China trade friction.
2021年美国彼得森经济研究所的玛丽·拉夫利（Mary Lovely）和David Xu估算，中美贸易摩擦使得墨西哥对美国的出口额多增长了3.4%。从市场份额来看，在美国对中国加征关税的行业中，墨西哥在美国的市场份额平均上升了1.6个百分点，而在未加征关税的行业，墨西哥的市场份额甚至略有下降。
In 2021, Mary Lovely and David Xu of the Peterson Institute for International Economics estimated that the value of Mexico’s imports to the United States had risen by 3.4 percent due to the China-U.S. trade war. Among goods subject to additional tariffs from Washington, Mexico's market share in the U.S. increased by an average of 1.6 percentage points. In contrast, Mexico's market share slightly fell in industries where tariffs were not added.
在投资方面，墨西哥吸引的外商直接投资（FDI）也缺乏积极变化。根据Mary Lovely和David Xu的观察，除了2020年因疫情导致FDI急剧下降之外，墨西哥的FDI在2018年至2021年也并没有出现显著增长。而且墨西哥的大部分FDI流向了以金融和保险服务为代表的第三产业，制造业投资的增长并不理想。
On the investment side, Mexico also lacks positive changes in the foreign direct investment (FDI). According to Lovely and Xu's observation, in addition to the sharp decline in FDI in 2020 due to the epidemic, Mexico's FDI did not show significant growth from 2018 to 2021. Moreover, most of Mexico's FDI flows to the tertiary sector represented by financial and insurance services, and the growth of manufacturing investment is not ideal.
When observing FDI in Mexico in 2021, FDI in major manufacturing fields, such as computer manufacturing, shows a significant decline, except for machinery and transportation equipment manufacturing, which remained the same as in 2018. In recent years, the investment climate in Mexico has been affected by the epidemic and the unfavourable terms of the USMCA, which is not uncertain.
Mexico's economic growth rate is generally rather weak, with a growth rate of -0.2% in 2019 before the outbreak and poor economic performance after the outbreak. The GDP growth reached 5.7% in 2021, but with a growth rate of -8.3% in 2020, Mexico's economy has not yet recovered to pre-epidemic levels.
Vietnam’s advantages unlikely translate into long term challenge
What contributes the most to Vietnam's competitiveness is the policy environment that has been significantly improved at home and abroad. Let's look at Vietnam's domestic policy environment first. The country has been amid a historic reform that focuses on opening up, deregulation and marketization. Against this backdrop, the government has been simplifying legislation and cleaning up the bureaucracy, which helps to provide a more friendly environment that attracts domestic and foreign investment.
When it comes to the international policy environment, from 2017 to 2022, Vietnam took a giant leap in opening up to the world by joining the CPTPP, the European-Vietnam FTA, the Regional Comprehensive Economic Partnership (RCEP), and the Indo-Pacific Economic Framework (IPEF). Coupled with the Association of Southeast Asian Nations (ASEAN) where Vietnam is a member, these economic and trade agreements benefit Vietnam in a way that they converge Vietnam with almost all major economies, including China, the United States, the EU, Japan, and ASEAN together, providing such a priceless policy environment that Vietnam is deeply involved in the international division of labor.
In addition, Vietnam holds a higher position in the global value chain than India. Above 60% of Vietnam's major exports are electrics, garments, footwear, and machinery, whereas those of India are mineral fuels and gemstones, among other low-tech manufacturing products.
Taking a long-term view, however, there's a remote possibility that Vietnam might challenge China's status considering the size of its population and economy. Vietnam has a population of less than 100 million, a smaller size compared to that of Mexico whose population is estimated at 130 million, let alone that of China and India whose sizes of population reach another level. Vietnam's limited areas of economic hinterland leave a poor prospect for its growth in the global production network. In the same vein, industries in Vietnam is disproportionately distributed, with its light industrial capacity outweighing that of its heavy industry.
Vietnam is lagging on the number of world-class companies it has incubated. As of 2021, there are no Vietnamese business among the Fortune 500. India and China, on the other hand, has 7 and 143 respectively. This suggests that Vietnam lacks to ability to take on spillovers when foreign companies rush in the the country. Tha is to say the influx of foreign capital may actually deter growth of local businesses. At present, around 70% of Vietnam's exports trade is taken up by foreign enterprises and the proportion of processing trade in Vietnam's exports is even higher.
In fact, businesses in Chinese mainland take up a significant proportion of FDI in Vietnam, meaning that supply chains in Vietnam and China is becoming more interdependent.
According to the two-way export competition index between China and Vietnam calculated by yours truly, Vietnam poses only limited pressure on China with its exports. The pressure index China has on Vietnam exports hit 85.5%, while only 9.3% the other way around.
In other words, within the 5,000 categories of products defined by HS 6-digit, for every 100 yuan of goods that Vietnam exports, China exports products worth 85.5 yuan from the same category. However, for every 100 yuan of goods that China exports, Vietnam only exports only 9.3 yuan, some of which are from Chinese-owned enterprises in Vietnam.
Therefore, in the Sino-Vietnamese economic competition, China undeniably takes a dominant position and does not need to be concerned about a Vietnamese overtake.
The complementary nature of China-Vietnam economic and trade relations has made itself clear. Vietnam, an economy with a GDP nearly 20% smaller than that of Guangxi Zhuang Autonomous Region, imported 126 billion U.S. dollars worth of good from China in 2021, compared with 800 million 21 years earlier. Vietnam is now China’s fourth largest export destination, next only to the United States, Japan and South Korea.
China's exports to Vietnam with huge surplus suggest that Vietnam is more of an important buffer zone between China and the U.S. than a substitute for China's role as the world's factory.
India faces challenges but enjoys great potential in the long run
The only country that can match China in terms of population size is India. Its biggest advantage also lies in size - the size of its economy. India's GDP per capita in 2020 is 1,930 dollars. Yet given its large population, its GDP in 2020 hit 2.7 trillion, nearly 2.5 times that of Mexico and 10 times that of Vietnam.
According to the growth forecast by the IMF, India's GDP, in U.S. dollar terms, is going to surpass that of the United Kingdom in 2022, bringing it to the world's fifth largest economy after the United States, China, Japan and Germany.
It's noticeable that India has a low participation rate in education and its adult literacy rate (74%) in India are lower than the world average and even more significantly lower than China, Vietnam and Mexico (which is above 95%). However, India has a large population which offers abundant low cost labor.
In addition, the Indian government is taking advantage of its large economy and is putting into work on administration and taxation's side to create a large, unified market at home. In 2021, despite the tremendous impact of the pandemic, India still achieved a growth rate of 8.1%, with further expansion of GDP to over 3 trillion dollars and per capita GDP to nearly 2,300 dollars. Building on what India has achieved in 2021, its economic growth in 2022 increased to 8.4% in the first half.
India's large population and market size gave sturdy foundation to India’s strong R&D capabilities and world-class companies. According to World University Rankings 2021 by Times Higher Education, there are 56 Indian universities among the top 1200, falling short of China’s 92 but vastly outnumber Vietnam and Mexico, which each has three. India's technology and innovation capabilities should never be underestimated.
In addition, as of 2022, there're nine Fortune 500 companies in India. The country's mature IT industry, worldwide elite population and labor's language proficiency all give rise to a deep integration of local Indian companies, overseas elites, and private businesses in the United States. The United States relies on Indian companies to varying degrees for information technology (IT) services in almost all industries. Moreover, India's self-sufficient economy and its low dependence on Chinese intermediate goods supply make it better positioned to form a supply chain separated from China.
但是印度也有其明显的短板，最大问题在于印度的宗教和文化因素。印度出世的宗教信仰让国民内心比较恬淡、发展经济的欲望不强烈，此外种姓制度带来的阶层固化也对发展经济形成了障碍。相比之下，越南则属于东亚的儒家文化圈, 有着比较强的入世取向, 会有相对较强的发展欲望。同时，印度行政效率低、基础设施发展严重滞后，要改变这些发展条件也并不容易。
But India’s religious and cultural factors also limit its development. India’s transcendental religious beliefs have left the people with a low desire for economic development. In contrast, Vietnamese are more influenced by Confucianism, and are willing to devote themselves to society, so they have a relatively stronger desire for development. In addition, India’s caste system, administrative inefficiency and lagging infrastructure development have also created obstacles to India’s economic development.
In terms of location, the three major production networks in the world today are Europe, North America, and East Asia, and India is far from any of them. Although India is slightly closer to the East Asian production network, India’s transportation costs are also significantly higher compared to the countries in the East Asian region. India’s neighbors, other than China, can hardly offer strong support for India’s production system. I am afraid it is difficult for India to support the world’s fourth-largest production network alone.
Moreover, the Modi government over emphasizes on domestic cycle and lacks the determination and action to open up to the outside world. Modi’s call in 2020 for an Atmanirbhar Bharat (self-reliant India) hopes to make the local market bigger and stronger. But it is actually adopting an import substitution strategy, which means raising import tariffs and subsidizing relatively backward domestic production. Yet import substitution has been proven to be a failure by Latin American countries. The rise of East Asian countries has generally adopted an export-oriented strategy to encourage local enterprises to participate in international competition and continuously improve their international competitiveness.
2020年世界经济论坛World Economic Forum（WEF）发布的全球竞争力报告Global Competitiveness Report 2020对19个主要经济体价值链的全球化发展趋势进行了问卷调查，全球商业领袖对于印度价值链的全球化发展趋势评价负面，印度在19个国家中排位倒数第一。
The Global Competitiveness Report 2020, published by the World Economic Forum (WEF), conducted a questionnaire survey on the globalization trends of value chains in 19 major economies. The survey shows that global business leaders have a negative perception of the globalization trends in India's value chains, with India ranking at the bottom of the list of 19 countries.
In general, India’s true emergence requires a round of reform and opening up. However, India’s current religion and culture enable its society to remain relatively stable. If the original religious and cultural system is broken, it may be more challenging for Indian society to rebuild a self-stabilizing system.
China’s task ahead
First, China’s policy should focus on its own development. The core position of a country in the global supply chain is not achieved by suppressing competitors, but by enhancing its own industrial competitiveness.
As for China, to cope with the pressure of industrial chain migration, it is necessary to continuously achieve industrial upgrading and promote industrial competitiveness.
Therefore, China should remain open and inclusive, strengthen international cooperation, further improve the business environment, and promote a favorable macroeconomic environment for industrial upgrading by expanding domestic demand.
Second, from an international perspective, China should continue to adhere to the basic state policy of opening up.
Third, China should take advantage of the trend, strengthen economic and trade ties with Vietnam and other “buffer zone” countries, and promote Vietnam’s economic integration into China’s production network.
Chinese enterprises can actively invest in Vietnam so that Chinese enterprises and other foreign enterprises both play an important role. At the same time, China should promote the “New Western Land-sea Corridor” project, especially the ports in Guangxi Zhuang Autonomous Region, to develop it into a new regional industrial chain cluster on par with the Pearl River Delta and Vietnam.
Finally, further deepening industrial chain cooperation in East Asia is necessary to consolidate China's position in the global production network. Europe, North America and East Asia are the world’s three major regional production networks. To a certain extent, East Asia's deepening development and interdependence are conducive to China’s position as the world’s factory.
By giving up RCEP membership as a founding member, India is also giving up the opportunity to become deeply involved in East Asia’s regional production network. China should draw lessons from India and promote industrial and supply chain cooperation in East Asia. At the same time, China should keep up with the higher standards of international economic and trade rules and force the domestic financial system to further deepen the reform and opening up through the higher standards.
Lu Jia’nan, Liu Lin and Sun Mengqi contributed to the interpretation.
Views expressed in this essay belong to the author alone and do not necessarily reflect the opinion of this newsletter.
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