- China's economic woes will not disrupt its status as a manufacturing powerhouse.
- Strategists don't see another country dethroning China as the world's top manufacturer.
- The flight of foreign investment poses a risk to China's trade resilience.
The headwinds weighing on China range from the housing crisis and deflation to weak consumer confidence and collapsing stocks. Yet none of this necessarily means that another country will be able to take China's place as the world's leading manufacturing power.
In a note released Monday, Eurizon strategists Stephen Jen and Joana Freire said there was little evidence of deglobalization, even as trade relations between the United States and China have deteriorated due to customs duties and geopolitical tensions.
Other countries like Vietnam and Mexico, the latter of which overtook China as the United States' largest trading partner in 2023, have spearheaded a reorganization of global trade flows.
At this point, China's market share of total US imports has exploded, but Eurizon said countries that have exported more to the US instead of China are themselves importing more than never from China.
“[I]In this trade dispute, the United States may have “won,” but China did not “lose,” Jen and Freire said.
China is changing its commercial focus
The market share of Chinese exports to the United States has fallen from 22% to 14% since 2017, and the Trump administration's policies have indeed had the desired effect of discouraging direct imports from China.
China nevertheless remains the world's largest exporter, with a global market share of around 15%, according to Eurizon.
Excluding distorted pandemic levels, this marks an all-time high.
Beijing has achieved a “surprisingly successful” result, Jen and Freire said, despite tariffs and domestic difficulties, by investing heavily in third countries where the United States prefers to import from, such as Mexico and Vietnam.
China, in turn, decided to export components to these countries for final assembly, allowing them to circumvent U.S. tariffs on products assembled in China.
“Indeed, China has invested and exported more in recent years, precisely to the friendly destinations to which the United States has redirected its imports,” Eurizon strategists said.
China was also able to increase its exports to Europe, helping to offset the loss of direct goods to the United States.
The “next China” is China
Eurizon strategists doubt another country could supplant China as the dominant global manufacturer.
Not only does China's capacity far exceed that of its competitors, but export prices have increased in Mexico and Vietnam by 30% and 31%, respectively, over the past three years.
“We believe that the fact that export prices have increased faster than general inflation, a remarkable fact in a period of dollar strengthening, indicates tensions and pressures on the manufacturing capacity of these countries, including a shortage of suitable workers, infrastructure and transport,” Eurizon said. said the strategists.
One figure illustrates this point: China has a manufacturing workforce of around 212 million, more than the combined economies of the US, EU, Japan, Canada, Korea, India, Mexico and Vietnam.
It may be possible for the world to slowly move away from China, but smaller countries would not be able to handle a rapid change that would require them to become manufacturing hubs on par with China.
“In short, we question whether the ‘next China’ could really be China: no other country has the industrial capacity to supplant China,” Jen and Freire said.
Headwinds at the national level
China may not be in danger of losing its trade status, but its economy continues to move in the wrong direction.
“The post-pandemic recovery has been anemic due to weak sentiment and the country is digesting a prolonged period of real estate overinvestment,” UBS strategists wrote in a note on Monday, adding that China experienced its first-ever property deficit. foreign direct investment. in 3Q23.
According to Eurizon, this loss of foreign direct investment may have been fueled by Beijing's policy mistakes in recent years. Its faltering housing market has lowered household wealth, hurt consumer confidence and dampened demand and spending.
All of this was evident in the latest CPI report, which showed that the country's deflation problem continues to worsen.
At the same time, Chinese stocks have significantly underperformed global stocks, reflecting the bearish view of the world on China.
“Overall investor sentiment toward China today remains depressed,” UBS strategists said. “Allocations of foreign funds into Chinese assets have steadily declined, pushing the valuation of Chinese stocks into very cheap territory.”
Jen and Freire said Beijing can still use supportive and pragmatic policies to attract foreign investors to China and eventually help it become the world's largest economy.
“The world's attitude toward China has changed to the same extent as China's domestic politics,” they said. “Overall, China has so far managed to maintain its dominant position as the world’s preeminent manufacturing base.”
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