Long read: China is trying to kneecap Indian manufacturing

Liberation day is here. This time Trump wasn’t bluffing. Tariffs on Chinese imports hit 54%, close to the 60% he promised in his campaigns. Expert implications range from near term inflation to long term growth slowdown or potentially prolonged stagflation in the US. This will inevitably drag global growth down. More alarmingly, the rest of the world faces the risk of Chinese dumping as it finds alternate avenues to redirect its exports meant for the US to elsewhere. But this isn’t new. The Chinese are not only exporting stuff to the world, they are setting up plants around the world.

“Chinese companies are racing to build factories around the world and forge new global supply chains, driven by a desire to circumvent tariffs and secure access to markets. Chinese companies have been building manufacturing plants directly in large target markets, such as the EU and Brazil. And they’ve been building plants in “connector countries” like Mexico and Vietnam that provide access to developed markets through trade agreements. Morocco, for example, has emerged as a surprisingly popular destination…due to its trade agreements with both the US and the EU…Countries across the developed world and the Global South alike are eager for Chinese companies to build factories in their markets, with the promise of new jobs and new technology.”

The blog puts up a fascinating map plotting presence of Chinese factories around the globe:

“Up until the pandemic, China’s foreign investment was focused more on acquiring foreign companies, usually in developed countries — basically, Chinese companies bought American/European/Japanese/Korean companies so that they could A) get their technology, and B) use them as local beachheads to sell stuff to rich consumers. This was the big boom of the mid-2010s.

Since 2022, however, China’s focus has shifted dramatically to “greenfield” investment — Chinese companies are building their own offices and factories overseas”

Noah shares some interesting charts on Chinese outbound FDI:
“Greenfield FDI is in many ways more of a boon to the receiving country than M&A; when you build new factories and offices in a country, it creates new jobs, and often transfers new technologies, instead of just changing the ownership of an existing business. And unlike M&A, greenfield FDA tends to target developing countries, because it’s usually at least partially about reducing costs.

So it makes sense for developing countries around the world to be a lot more excited about the flood of Chinese investment now than back in 2016. And we should also expect this wave to be more durable than the previous one, because it’s driven by Chinese costs and by mature Chinese companies with a long-term stake in overseas markets.

Generally speaking, this is how economic development is supposed to work. As countries get richer, their costs go up, and they want to move production to cheaper locations. China was the cheap place to make stuff 20 years ago; now, it’s places like Vietnam, Indonesia, and Morocco. Like a flock of geese, manufacturing companies tend to fly from one country to another, helping each one industrialize along the way.

Also, it’s easier to sell products in a country if you also produce those things inside that country — transport costs are lower, you can get a better understanding of the local market, and you can more quickly respond to local changes in demand, policy, and so on. And on top of that, there are now a bunch of tariffs to consider — Europe will be much friendlier to Chinese companies’ products if those products are made in Europe.

So we should generally view China’s outbound investment boom as a great thing for the world. It’s helping to industrialize poor countries like Indonesia and Morocco, and to diversify and technologically upgrade the economies of middle-income countries like Brazil, Turkey, Mexico, and Thailand. Chinese-led globalization is looking like a positive alternative to America’s bizarre, ideologically-motivated retreat from the world economy.”

However, the big missing piece in the map is India:

“Beijing is trying to shape the global expansion of Chinese manufacturers, including which countries they invest in and how. Beijing is encouraging Chinese companies to build plants in “friendly” countries while discouraging them from investing in others in a kind of “industrial diplomacy.”…India represents the most striking case of Beijing’s effort to shape the international behavior of Chinese firms…[A]cross a number of industries, Beijing seems to be discouraging Chinese firms making future plans to invest in India while also limiting the flow of workers and equipment…

Beijing appears to be limiting Apple’s manufacturing partner Foxconn from bringing Chinese equipment and Chinese workers to India. Some of Foxconn’s Chinese workers in India were even told to return to China. This informal Chinese ban extends to other electronics firms working in India…Beijing has told Chinese automakers specifically not to invest in India…China has been reportedly blocking the export of Chinese solar equipment to India…[Tunnel boring machines] made in China by Germany’s Herrenknecht for export to India have been reportedly held up by Chinese customs.”

Whilst we would like to believe it is India which is blocking the Chinese coming to India (which isn’t completely untrue), Noah shares links to papers which highlight the Chinese conscious choice of not letting their companies make in India. Why?

“At first, multinational companies will keep their best technology out of India, doing only low-value assembly work in the country. But as Indian manufacturers master those simple tasks, they will start to climb the value chain, learning how to do more complex processes and make higher-value goods. At that point it will make economic sense for multinationals to do more higher-tech stuff in India.

Eventually the Indian companies themselves will get so good that they’ll be able to create their own brands, start doing R&D for themselves, and compete on the global stage, using the advantages off scale that they get from knowing their home market better than anyone else.

This means that multinational companies naturally tend to train their future competitors. Nowhere was this effect more powerful than in China, where European, American, Japanese and Korean companies offshored production to China in the 1990s and 2000s, then found themselves competing with Chinese companies in the 2010s. Many in the U.S. now believe that allowing this was a grave strategic error.

China’s leaders probably concur with that assessment, and are determined not to make a similar error with respect to India. It would be cheaper for BYD, or CATL, or Chinese electronics companies to move their factories to India, to take advantage of its cheaper labor and huge domestic market. But in the long run, that could risk speeding up the technological development of Indian rivals to Chinese manufacturers, as well as making India itself rich enough to challenge China on the world stage.

China’s leaders probably envision a new global economy in which high-value manufacturing activity resides in China, lower-value assembly work lives in other countries, and India remains a service-dependent backwater.”

But he ends on a positive note for India that we have the rest of the world to look for support:

“India, of course, doesn’t want this, and it has some powerful natural allies. Other advanced countries — Germany, Japan, Korea, France, and so on — want to avert a future where Chinese companies dominate the globe. The best way to do that is to invest in India.

The U.S., of course, ought to be India’s most important and valuable ally in this struggle. A rational and reasonable U.S. would be trying to encourage as much investment as possible in India, and to boost India’s technological capabilities and income level as fast as possible. But the days of the U.S. acting rational and reasonable are gone; at least for now, America has retreated from the world, embroiled in its own internal struggles and tearing itself apart with bizarre ideology.

So India needs to focus on partnering with the world’s other developed countries — with Japan, Korea, Taiwan, Canada, and the nations of Europe. It needs to maintain friendly and cordial relations with these countries, sign free trade pacts, reduce or eliminate tariffs on imported components, increase business-friendly policies, encourage more inbound FDI, and generally integrate itself into a worldwide bloc that includes every rich country that doesn’t want to see China rule the global economy.

The withdrawal of the U.S. will create headaches for India, as will China’s determination to keep Indian manufacturing down. But India still has plenty of places it can get technology and investment from. And in the long run, I believe its natural advantages will allow it to industrialize and grow rich, regardless of the forces arrayed against it.”

If you want to read our other published material, please visit https://marcellus.in/blog/

Note: The above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. The information provided is intended for educational purposes only. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India (SEBI) and is also an FME (Non-Retail) with the International Financial Services Centres Authority (IFSCA) as a provider of Portfolio Management Services. Additionally, Marcellus is also registered with US Securities and Exchange Commission (“US SEC”) as an Investment Advisor.