By Cornelius Zeeman & Izaan Buys,
Fairtree Portfolio Manager & Equity Analyst
Over the last two decades, China has been the global economy’s main growth driver as it benefitted from a large and inexpensive labour force in an increasingly globalised economy, which benefited from goods deflation. The Chinese economy we know today looks quite different, and the Western world is trying to reduce their reliance on it.
China’s climb up the manufacturing value-chain.
In the early days of China’s economic reforms, the country focused on exporting low-value items such as textiles, toys, and electronics. This, in part, was because China had a large labour force and could produce these goods at a lower cost relative to other countries – negatively impacting manufacturing industries in Developed Markets but benefiting the global consumer.
However, as China’s economy grew and wages increased, it became less competitive in producing low-value items. In response, the Chinese government began to promote the development of higher-value products. The government provided subsidies and tax breaks to companies in these industries and invested heavily in research and development. Chinese companies now produce a wide range of high-value products, including solar panels, electric vehicles, and telecommunications equipment (see Graph 1 below).
Graph 1: NEV and battery production, and wind/solar power generation capacity showed exponential growth in recent years
Source: NBS, data compiled by Goldman Sachs Global Investment Research, 19 October 2023
Reducing dependence on China
In a tug-of-war between the two global superpowers, the US government is taking several steps to reduce its imports from and dependency on China, including:
- It imposes tariffs on Chinese imports, making them more expensive for US consumers and businesses.
- The US government is investing in domestic manufacturing to reduce the country’s reliance on Chinese imports. For example, the Biden administration has proposed a $52 billion investment in the US semiconductor industry.
- The US government is promoting alliances with other countries to reduce the country’s reliance on China. For example, the US is working with its allies to develop alternative supply chains for critical goods such as semiconductors and batteries.
In recent months, we have seen Mexico overtake China in terms of exports to the US (see Graph 2 below).
Graph 2: China’s share of US imports now < Mexico + Canada (% of US imports of everything from China, Mexico, and Canada)
Source: Panjiva, BofA Securities, 7 September 2023
Reasons for the steps taken by the US to curb Chinese economic development include national security concerns, as well as the threat posed to US local manufacturers who would be required to compete against relatively cheap imports – which impacts job creation by local US companies.
Chinese companies are going direct.
A new trend is the rise of Chinese businesses, such as Shein and Temu, which export goods directly to consumers across borders. This poses the same threat as local businesses having to compete with low-cost imports.
Shein is a beneficiary of the Chinese government’s efforts to promote e-commerce. The government has invested heavily in developing the country’s logistics infrastructure and has made it easier for consumers to import goods from overseas. As a result of these changes, Shein has been able to grow rapidly in recent years – it is estimated that 30% of its sales are to customers in the US. The company now ships to over 200 countries and regions, and its revenue is expected to exceed $20 billion in 2023.
Off the back of the success of Shein, another player has emerged in the form of Temu: a new e-commerce platform that is expanding into the US and other European countries. The company is owned by PDD Holdings, one of China’s largest e-commerce companies.
Temu’s strategy for expanding into the US and other European countries is focused on offering a wide range of products at competitive prices, including clothing, shoes, accessories, and home goods. This is because Temu can leverage its manufacturing capabilities in China to produce goods at a lower cost. Since the launch of TEMU, we have seen an exponential increase in the number of monthly active users (MAU) of the app as seen in Graph 3 below.
Graph 3: TEMU MAU has reached 20mn in February 2023
Source: Sensortower, Goldman Sachs, 14 March 2023
Scrutiny from the US relating to de minimis shipments.
An element that allows companies such as Shein and Temu to sell products at lower prices than traditional retailers is that the value of goods shipped cross-border from China to consumers in the US are not subject to regular taxes as they fall under the de minimis shipment rule.
In 2021, more than 60% of all de minimis shipments to the US came from China. Furthermore, Temu and Shein likely contributed 30%+ of all packages shipped to the US under the de minimis provision (see Graph 4 below).
Graph 4: Temu and Shein – share of shipments to the US under the minimis provision
Source: US House Select Committee on Strategic Competition
Although the US government has not yet acted against Shein or Temu, the companies are under increasing scrutiny due to the impact on local retailers. US tariffs on Chinese goods are used to protect local interests in several ways, including making Chinese goods more expensive and protecting the demand for domestically produced goods to support American jobs and businesses in industries that compete with Chinese imports.
It is important to note that tariffs are not a perfect way to protect local interests. They can also have unintended consequences, such as raising prices for consumers and businesses and leading to job losses in other industries.
Despite some narratives of China’s demise because of the US’s efforts to curb their reliance on China, we have seen that Chinese manufacturers continue to move up the value chain, even becoming leaders in the manufacture of some de-carbonisation technologies and have successfully implemented business models of exporting directly to consumers.
China’s total exports by volume and value continue to be robust, in contrast to the decline in exports to the US (see Graph 5 below), which prompts the question as to whether trade routes have simply changed, so that goods, partly or fully manufactured in China, are now imported from neighbouring Southeast Asian countries. This would be a possible way to avoid costly tariffs.
Graph 5: Chinese nominal exports (annual) USD bn
Source: Fairtree, Bloomberg (as of September 2023)
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