By Eamon Barrett
Updated: June 7, 2019 2:14 PM ET

Tariffs are Washington’s weapon of choice in its trade war against Beijing.

The U.S. has levied 25% fees on up to $250 billion worth of goods imported from China, forcing manufacturers to either swallow the additional costs or pass the difference onto consumers. But reports suggest that some companies are choosing a third option: shifting production outside of China.

In a poll released by the American Chamber of Commerce (AmCham) and its counterpart in Shanghai last month, roughly 40% of 250 surveyed firms said they were “considering or have relocated manufacturing facilities outside of China.” In a similar AmCham survey last September, only 30% said they were considering partial relocation. However, the exit can’t all be chalked up to the trade war.

“Businesses moving supply chains out of China long predates the current trade dispute,” says Hannah Anderson, global market strategist at J.P. Morgan Asset Management. “Higher tariffs might have accelerated some of those plans that were already in place, which is certainly something that I’m seeing and hearing when I talk to CEOs, but very few companies hadn’t thought that far ahead already.”

Rising labor costs have been driving factory emigration from China since long before Washington’s tariffs were a factor. Minimum hourly wages in the major factory hubs of Guangdong province rose from Rmb4.12 in 2008 to Rmb14.4 ($2.00) last year. Manufacturers, particularly low value-added ones like textile factories, have sought even cheaper labor in Southeast Asian countries, like Vietnam and Malaysia.

The exodus of low-end manufacturing, however, could be an advantage for China in the long term, says Li Keaobo, the executive secretary general of the Center for China in World Economics (CCWE) at Tsinghua University’s School of Economics and Management. Li says the loss of low-cost manufacturing will force local factories to make advances in high value-added production, which is a transition Beijing approves of.

Beijing established its desire for China to become a center for high-end manufacturing in 2015 when the State Council released the Made in China 2025 policy. The policy, akin to Germany’s Industry 4.0, deployed billions of dollars in funds to upgrade China’s manufacturing capabilities. However, whether China can achieve that goal without the help of subcontracts from Western companies is the very issue that precipitated the trade war.

“A lot of the ways that China is moving up the production chain is through partnerships with U.S. companies and through making specific components of an end product that a U.S. company retails,” Anderson says, asserting that companies moving out of China is not a boon for Beijing but is not an insurmountable issue either.

Most manufacturers aren’t simply going to abandon China. According to Jon Cowley, a trade law expert at Hong Kong-based Baker McKenzie, many companies are exploring shifting “origin conferring manufacturing” operations outside of China, rather than removing their entire manufacturing operation. That means components would be manufactured in China and then shipped to another country to undergo “substantial transformation,” earning the finished product a new country of origin. It’s a tactic that helps manufacturers skirt tariffs by extending, rather than abandoning, current supply chains.

The technique has the added benefit of allowing companies to maintain a foothold in China, which is the world’s second largest consumer market. Over 35% of AmCham’s survey respondents said they had considered adopting an “In China, for China” manufacturing model, where they would continue producing goods in China to supply the massive domestic base.

“As China’s consumer market continues to grow, it’s going to become increasingly important. That’s something that the U.S.-China trade war is not going to fundamentally change,” says Li Chen, professor of Chinese business studies at Chinese University Hong Kong. “But the trade war is going to accelerate the balkanization of supply chains,” he adds.

That might not be such a bad thing. Costs will go up, but the risk of fallout from another trade war will go down.

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