China’s dominant role in global supply chains makes the trajectory of production costs there crucial to understanding inflation dynamics around the world over the last two decades. China’s over-investment in manufacturing infrastructure has driven the cost of some goods so low that it has even spurred demand in emerging economies. Diversifying supply chains out of China almost certainly means higher costs and probably higher inflation where the goods are ultimately consumed. COVID-19 has increased the urgency for multinationals to move from “just in time” inventory control to “just in case,” which will raise costs as well. At the same time, a global backlash against goods made in China could cause deflation within China as exports fall and its enormous production capacity overwhelms the domestic market. This scenario could lead to a debt crisis.
Changing attitudes around the world toward China and Chinese-made goods have led economists to ask whether China can become a more consumption-led economy like the U.S. At first glance, some Westerners may conclude that this transition is well underway, as many Chinese households already possess and regularly upgrade consumer items such as televisions, phones, cars, etc. However, while China has made enormous investments in industrial infrastructure, it has devoted less attention to urban infrastructure and services such as schools, transportation, sanitation, water, gas, etc. The latter type of infrastructure, combined with stable export demand, is typically the formula for consumption claiming a greater share of the economy.
Nonetheless, over the longer term, more new supply-chain investment outside of China is likely as a result of COVID-19 and increasing distrust by the U.S. and its allies. Taiwan, Vietnam and Mexico are often cited as potential beneficiaries of this change. Taiwan may have the advantage here due to its location, technology and supply of skilled labor. Vietnam may also benefit, but increasing costs are working against it: over the last 18 months, land prices in Vietnam have doubled and labor costs have increased notably as well. In the end, however, no single state can truly absorb large supply-chain losses from China — the scale and infrastructure are simply too massive, at least at this point in time.