China’s Covid controls are pushing companies to diversify away from a ‘start-stop economy’

China’s Covid controls are pushing companies to diversify away from a ‘start-stop economy’

China’s decision to maintain Covid controls is pushing companies to look for factories outside the country, according to The Economist Intelligence Unit.

“What we are hearing from companies [is] are moving forward with their supply chain diversification plans because this stop-and-go economy is here to stay,” said Nick Marro, global trade leader at The Economist Intelligence Unit.

“If it’s an intermittent economy, if things can’t be done, that affects decision making,” he said. “We don’t expect companies to leave China. We just hope they diversify their presence, China plus one.”

Beijing’s strict covid controls helped the country resume work while the rest of the world was still struggling with the pandemic in 2020. While other countries have relaxed most restrictions and opted to “live with covid,” Beijing has increased virus testing requirements and extensive checks from Shanghai. it was closed for two months earlier this year.

Authorities have tried to keep production at major factories under what is called a closed-loop system, in which employees live and work on the same site, or at most only commute between work and home.

A Covid outbreak at Apple

Supplier Foxconn’s factory in recent weeks shows the continuing challenges factories face in trying to maintain operations and prevent the spread of infections.

“I don’t think we can really extrapolate from just one case, but this is noteworthy because it shows a kind of break in that closed-loop system,” Marro said.

Over the weekend, some Foxconn workers reportedly forced their way out of Covid checkpoints at the factory. Subsequently, the municipal authorities announced plans to help workers who wanted to leave the factory to return to their places of origin.

Foxconn did not respond to a request for comment from CNBC.

“Obviously, if they don’t change this zero-Covid policy, we’ll see cases like this happen again and again,” said Patrick Chen, head of research for CLSA in Taiwan. He said he expects little change in policy unless vaccination rates increase.

“I don’t see much incremental cost associated with this closed-loop production or management, but there will certainly be a negative impact on employee morale or the overall quality of production performance,” he said, noting that Foxconn has announced monetary incentives for keep employees in the factory.

Typically, Chen said workers at factories like Foxconn’s are paid around $1,000 a month.

Weak demand softens the impact

While Foxconn’s Zhengzhou factory handles major iPhone manufacturing, Chen said weak demand for the smartphone means production disruptions have less of an impact.

The global smartphone market declined 12% in the third quarter from a year earlier, although Apple continued to post slight growth, according to Counterpoint Research.

Nearly twice as many American companies reduced their investment in China this year compared to last year, the American Chamber of Commerce in Shanghai found in a survey this summer.

Just under a third of those surveyed said they were increasing investment in the country, according to the survey. But that figure was down from 38% last year.

CLSA’s Chen said the rising cost of running a major operation in China has prompted tech companies to move manufacturing of less complex products out of the country.

However, he noted that it is difficult for Apple to find another 200,000 to 300,000 workers, as there are at Foxconn’s Zhengzhou factory, to make the iPhone outside of China, except in India.

The American smartphone giant announced in September that it would make its latest model, the iPhone 14, in India for the first time. JPMorgan analysts predicted that only 5% of Apple’s global iPhone 14 production would move to India this year.

In recent weeks, China has announced measures to encourage more foreign investment in manufacturing and in specific industries such as animation and brewing. The level of implementation remains unclear, especially as control of Covid outbreaks remains the priority for now.

“Foreign companies want to be in China, and companies that are still in the market, I think we can take them at face value when they say they are committed to the Chinese market,” said EIU’s Marro. “They are waiting for signs that the operating environment and the macroeconomic environment will improve.”

“The biggest problem is that those signals don’t get through,” he said. “At the end of the day, that uncertainty is the biggest problem for investors.”
Source: CNBC

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