As China moves from producer to consumer, as more bilateral trade agreements are signed, and as more environmental disasters show just how vulnerable a country's manufacturing base can be, a new era is emerging that is changing the entire philosophy of the global supply chain.

The global supply chain as we know it is being transformed by several forces, including shifts taking place in China, the reduction of the multilateral trading system, and recent disruptions caused by natural disasters. Whether in isolation or combined, these forces have significant implications for the global economy.

As recently as three years ago, the headline business news was all about China as 'the world’s factory' and about 'the China price' redefining the production and cost of consumer goods. Today we have almost come full circle: 'China, global factory' is morphing into 'China, global consumer'.  What has changed is that China is no longer the lowest-cost producer. Today, if companies want to source the lowest-cost goods, they look to other countries – in particular Vietnam, Cambodia and Bangladesh, the new front-lines of low-cost manufacturing and export processing.

As an illustration, wages in the Pearl River Delta have risen by about 30% in 18 months. More importantly, under China’s 12th five-year plan that runs from 2011 to 2015, the minimum wage is envisaged to increase annually by 13.4% for the next five years. It is clear that this is no longer about the role of manufacturing in the economy; it is about recognition of the need to achieve a fairer distribution of national wealth if social stability and sustainable growth are to be maintained, which means allocating more of the overall economic pie to China’s lower classes – especially the factory workers. This goes beyond the issue of rising wages or even rising commodity prices; it is more about deep changes in China itself that reflect a changing society, a maturing of aspirations and values, as well as the changing role that China is playing in global supply chains and the global economy.

China's changing role

Three decades of economic development in China have been built largely on migrant labour flocking from the interior to export-processing factories in the coastal regions. While this is similar in other export-growth economies, the scale in China has been historic. 

At one point, it was estimated that China had 250 million internal migrant workers. The typical worker in an export factory was a young female from a populous interior province, such as Sichuan and Hunan, who would work two terms of three years each. During that time she would live in basic dormitories in the factory compound, eat most of her meals in the factory canteen, go home once a year at Chinese new year, and save enough for a dowry and the purchase of a future home. Eventually, she would return to her home village and lead a relatively comfortable life.

Chinese factory workers today are quite different. They bear witness to China’s incredible and fast-paced transformation into a consumer economy. They are exposed to material temptations, watch foreign TV soap operas and have access to the internet. Their aspirations are different – they wish to be respected, they demand better working conditions and they are more ambitious. They view their time as an assembly-line worker as a building block to a future career, not as an end in itself. This changing reality is impacting the whole export-factory model as more factories rethink the dormitory model and re-locate inland to access the still-available cheaper labour. It also has major implications for transport, logistics and distribution networks that have been built up around the export-oriented coastal regions.

From producer to consumer

As with other major emerging economies in Asia and elsewhere, China is becoming an important consuming economy. This is forcing a rethink in a world that has grown used to a very simple model: sourcing products in the East and selling them in the US and Europe, known loosely as 'the West'. In the near term, China and other emerging economies are unlikely to overtake consumption in the West, which accounts for some 80% of total personal consumption. But the emerging economies, led by China, are becoming the world’s key sites for consumption growth. Over time, global personal consumption will rebalance and supply chains will have to reflect this shift.

Companies will have to develop business strategies for distribution inside the Chinese market, in addition to exporting from China, and will have to plan their supply chains and distribution channels accordingly. They will also have to take into account that as its own retail industry develops, China, in line with – and perhaps in some cases even ahead of – global markets, is placing more and more emphasis on sustainability and the environment.

Chinafactory

Trade agreements

Quite apart from the major changes taking place in China, the supply chain is also being transformed by changes now under way in the global trading system as more countries sign bilateral and regional trade agreements.

Signatory countries always proclaim that these agreements will increase trade and create jobs. It may well be so, at least initially, but these treaties represent a second-best solution because they weaken the multilateral system and its inherent advantages in terms of transparency, simplicity and a level playing field. The analogy some people use is that every time a bilateral agreement is signed, a brick is removed from the multilateral wall. If a few bricks are removed, it is not a big problem; the wall is still there. But if more and more bricks are taken away, sooner or later the wall will lose its structural integrity and collapse. 

It is to be deeply regretted that progress towards building a strong multilateral trade system has not been very encouraging in the past several years, as evidenced by the languishing Doha Round. Due partly to this lack of progress and partly to the natural desire of countries to seek competitive advantage, there will likely be more bilateral agreements. Cumulatively, they will become a real impediment to global supply chains, with consequential adverse impact on business and growth. 

For example, the definition of country of origin is different from one bilateral agreement to another. Companies have to expend resources to track these differences and, in the end, only large companies will have such administrative capacity. Many small and medium-sized enterprises in particular will simply fall by the wayside. Their demise will be a loss to their own countries and the world.

Mitigating for disaster

As we rethink global supply chains for the new era, we also need to learn from recent major disruptions to the supply chain in Asia. The Japanese earthquake and tsunami in March last year impacted global electronics and automobile supply chains. There were fears that the disruption to components suppliers in that region of Japan would have global repercussions in terms of the supply of high-end electronics goods. That disruption, also known as the Fukushima phenomenon, has now been mitigated. But similar scenes of disruption were replayed at the end of the year when floods in Thailand closed thousands of factories supplying the world’s auto and electronics industries. No doubt, this disruption will also be addressed and resolved.

Out of both episodes has come the recognition that we might have drawn some supply chains too tightly. Business has spent 20 years optimising and taking the slack out of the supply chains system. As a result, the system could not withstand major shocks and, in turn, this affected international trade.  As the incidence of disruptions from natural disasters is rising worldwide, greater robustness must be built into the future design of the system. Indeed, what constitutes an 'optimal' supply chain must now take into account more factors, including that of uncertainty.

The above developments – changes in China as well as in the global system – indicate that we are at an inflection point with the familiar supply chain model on which global business has come to rely in recent decades. The entire philosophy behind the supply chain is changing and what is to come could have dramatic impacts on jobs and prosperity around the world. In short, supply chains might seem a technical issue, but fundamentally they are about the distribution of jobs, growth and prosperity. They affect all aspects of the global economy. That is why the Fung Global Institute, a recently established Hong Kong-based think-tank of which I am founding chairman, has as one of its priorities research into how global value chains are changing, evolving and impacting economic development and the distribution of jobs along supply chains. We expect the insights gleaned to be far-reaching and look forward to sharing our findings.

Victor K Fung is chairman of the Fung Global Institute

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