Keywords

Against the backdrop of the COVID-19 pandemic, geopolitical events, and green transition, we believe GSCs will be reshaped amid the trends of diversification, regionalization, digitalization, and green transition. The impacts of COVID-19 and geopolitical factors have led to more frequent GSC disruptions. Therefore, companies now pay more attention to the resilience and robustness of their supply chains. Meanwhile, the trend of green transition also affects the operating costs of companies along the supply chain. As such, companies have begun to reassess their GSC presence while pursuing diversification, regionalization, digitalization, and green transition.

Chinese companies are important participants in GSCs. Share of foreign-invested enterprises (FIEs) in China’s total import and export merchandise trade value reached 39% in 2020,Footnote 1 and the proportion of foreign and Hong Kong SAR, Macao SAR, and the Taiwan region of China invested enterprises’ revenue was particularly high in the automobile sector (53%) and the computer, communication, and electronics sector (47%).Footnote 2 By participating in the international value chain led by multinational enterprises (MNEs), Chinese companies and MNEs are suppliers and purchasers of each other’s products, and China has become an important node of GSCs.

Amid the reshaping of GSCs, Chinese companies along the GSC face industry chain risks associated with industrial relocation and supply chain disruptions. Given the decentralized layout of GSCs and trends such as reshoring and friend-shoring in GSCs, Chinese companies located in the upstream segments face the risk of industrial relocation of foreign investments (i.e., foreign companies moving their supply chains away from China). Moreover, the current external environment has increased the vulnerability of upstream segments in GSCs, and downstream Chinese companies face higher risks of supply chain disruptions.

A sound supply chain ecosystem can help companies cope with industry chain risks, but China’s supply chain ecosystem has yet to be improved in three aspects, i.e., logistics, capital flow, and information flow. In terms of logistics, China’s domestic business-oriented logistics has low efficiency, and its international logistics system is relatively weak. As for capital flow, due to the high carrying costs of Chinese companies and the low efficiency of fund flows in supply chains, it is difficult for traditional supply chain finance (SCF) to help companies confront external shocks. In terms of information flow, a large number of Chinese companies are in the early stages of digital transformation of their supply chains. They still need to further promote digitalization to keep up with the development trend in the digital economy era.

China can improve its supply chain ecosystem from the three above-mentioned aspects to cope with industry chain risks amid the reshaping of GSCs. In terms of logistics, China needs to break down barriers in domestic logistics, seize core international logistics nodes, and improve its comprehensive capabilities in overseas logistics services. In terms of capital flow, the financial institutions-led SCF model should play its role in achieving policy goals, and SCF led by core enterprises shall be utilized in an appropriate manner. In terms of information flow, the use of 5G, artificial intelligence, and cloud computing technologies in the digital economy era will significantly optimize companies’ operating efficiency and reduce their decision-making costs, thereby increasing supply chain surplus.

9.1 GSCs to Be Reshaped Amid COVID-19, Geopolitical Disruptions, and Green Transition

9.1.1 Supply Chain and GSCs

Supply chain refers to a network of various players such as raw material suppliers, manufacturers, distributors, retailers, and end-market customers involved in the production, circulation, and consumption of products or services. For each organization, a supply chain covers all functions needed to identify and satisfy customer needs, such as R&D, marketing, production, distribution, finance, and customer service. Unlike research on industry chains that focuses on a macro perspective, supply chain management should be viewed from a micro perspective. An industry chain refers to an interrelated system consisting of companies that produce various products or provide various services through specialization and transactions. Research on industry chains mainly adopts a macro perspective and emphasizes the relationships among economic sectors, while research on supply chains focuses more on how companies can maximize total supply chain surplus through their own corporate management. Supply chain surplus represents the value generated by a supply chain, which is the difference between what the value of the final product is to the customer and the costs the supply chain incurs in filling the customer’s request.Footnote 3 From the perspective of supply chain management, studying the formation of supply chain surplus can help evaluate the decision-making process of companies.

In supply chain management, three major decisions made by companies affect their supply chain presence. The production process of products can be divided into four levels: Different tasks constitute different occupations, and different occupations make up different stages of production, which ultimately create products.Footnote 4 Generally speaking, a single stage of production is performed in one location, but different stages of production can be performed in either one location or multiple locations. Under the framework of supply chain management, companies usually need to make three decisions about the planning of production processes (or suppliers): First, whether production should be dispersed or concentrated in terms of geographic location. Companies tend to take advantage of the difference in factor prices in different areas to reduce marginal production costs, which leads to geographical dispersion of production processes; on the other hand, the geographical concentration of production processes can help companies cut communication costs and reduce the risk of supply chain disruptions caused by uncertainties in transportation. Second, whether production processes should be outsourced or integrated. Outsourcing can lower companies’ cost of investment in the supply chain, while integrated production can reduce the cost of coordination and management of each segment in the supply chain. Third, whether internal management is lean or agile. A lean supply chain values just-in-time (JIT) manufacturing, which can lower supply chain costs through JIT inventory management. An agile supply chain focuses on quickly responding to customer demand to enhance customer stickiness and drive up customer value, but this comes with higher supply chain costs.

The key to supply chain management lies in product flow, financial flow, and information flow. Supply chains are dynamic, with continuous flow of products, capital, and information among different segments. For any supply chain, customers are the sole revenue contributor, and only end-market customers can provide companies with positive cash flow. All other cash flows represent the exchange of funds within the supply chain, and all flows of information, logistics, and funds incur costs. Therefore, optimizing the management of product flow, financial flow, and information flow is the key to maximizing the total supply chain surplus.

With the cost of international trade declining since the second half of the nineteenth century, MNEs have optimized the allocation of factors and resources of production, leading to the formation of GSCs. GSCs refer to companies’ supply chain designs on a global scale, including the cross-border purchasing of raw materials and intermediate goods, the global layout of production processes, and the global sales of products and services in the era of economic globalization. Multinational enterprises (MNEs) are typical participants in GSCs. Since 1966, standardized containers have been used in the global shipping industry, greatly improving logistics efficiency and reducing logistics costs. The construction of purpose-designed container terminals increased the productivity of dock labor from 1.7 tonnes per hour to 30 tonnes per hour.Footnote 5 MNEs began to optimize the allocation of factors and resources of production globally as the substantial improvement in international transport efficiency reduced the cost of international trade, leading to the formation of GSCs.

GSCs improve production efficiency, but they also bring uncertainties. Although globalized production has led to a decline in companies’ total production costs, it has also prolonged the cycles and response time of logistics, financial flow, and information flow in supply chains, increasing the complexity of supply chain management. In recent years, unexpected events such as the COVID-19 pandemic and geopolitical disruptions, as well as the transition to a circular economy have led countries to pay more attention to uncertainties brought by GSCs, triggering discussions on the reshaping of GSCs.

9.1.2 Reshaping of GSCs Amid the Backdrop of COVID-19, Geopolitical Disruptions, and Green Transition

International transportation costs rose sharply amid the COVID-19 pandemic; companies have suffered losses due to supply chain delays. Container freight rates have risen to historic highs since 2020, and the overall freight rate has increased by 2–3 times from the pre-pandemic level.Footnote 6 When freight rates were at their peaks, the freight-rate-to-cargo-value ratio increased substantially. Since 2H20, the volume of international maritime transport has soared and has been concentrated at core US ports. This has resulted in port congestion, causing a sharp increase in freight rates, and severe supply shortages due to supply chain delays. For example, shipping goods from China to the west coast of the US by sea, which usually took around 20 days, took as long as 47 days (in January 2022) during the COVID-19 pandemic. According to the World Development Report 2020 released by the World Bank, for many goods traded in GSCs, a day’s delay in supply chain cycle is equal to imposing an additional tariff by one percentage point. Although freight rates dropped notably in 2H22, we believe average freight rates are unlikely to return to the pre-pandemic low level in the future as shipping alliances and environmental concerns may dampen the momentum for shipbuilding and promote the scrapping of old ships. Even if freight rates decline, companies still need to reconsider their risk management measures given their exposure to potential freight rate risks.

Trade frictions continue; weight of geopolitical factors in supply chain decision-making has increased significantly. Since the emergence of US-China trade frictions, the weight of geopolitical factors in supply chain decision-making has gradually increased, including political (policy) risks and tariff costs, among others, driving a shift in companies’ goal of supply chain management from a sole focus on efficiency to a dual focus on efficiency and security.

Companies have begun to pay more attention to the resilience and robustness of their supply chains given the impacts of the COVID-19 pandemic and geopolitical factors, which may change the layout of GSCs. The “resilience” of supply chains refers to the ability of organizations and supply chains to plan for, respond to, and recover from disruptions in a timely and cost-effective manner. In contrast, “robustness” is the ability to maintain operations during a crisis.Footnote 7 Amid the impacts from the COVID-19 pandemic and geopolitical factors, GSCs have suffered from a larger number of disruptive factors, along with rising risks of supply chain fragility and fracturing. Faced with increasing uncertainties in the external environment, companies may change the global layout of their supply chains in order to enhance the resilience and robustness of their supply chains. In addition, green transition has increased companies’ production costs and further promoted the reshaping of GSCs. Green transition and carbon emissions reduction have become international consensus. Many countries have set schedules for reaching peak carbon emissions and achieving carbon neutrality, and raised carbon emission costs and environmental standards for companies. At the international level, the EU may take the lead in implementing carbon tariffs, imposing higher tariffs on carbon-intensive imports to guard against carbon leakage. The promotion of green policies may alter the comparative advantages of developing countries, thereby affecting total supply chain costs and further promoting the reshaping of GSCs. We analyze four trends in the reshaping of GSCs in the next section: Diversification, regionalization, digitalization, and green transition.

9.1.3 Development Trends of GSCs: Diversification, Regionalization, Digitalization, and Green Transition

From the perspective of corporate decision-making, GSCs are undergoing changes in geographic locations, production processes, and internal management. At the geographical level, MNEs may redesign their supply chains by reshoring, nearshoring, and friend-shoring. In terms of production process, core enterprises will likely enhance supplier management, such as requiring suppliers to use clean energy; in addition, some companies may strengthen R&D to pursue integrated production instead of external procurement in the face of high risks of supply shortages for certain products. As for internal management, the applicability of lean management has declined. Factors such as information lag and time lag in logistics tend to have a bullwhip effect on supply chains, i.e., small fluctuations in demand at the retail level can cause progressively larger fluctuations in upstream segments, making it more difficult for upstream companies to anticipate demand and manage inventories. Lean management was widely adopted by companies during the rapid expansion of globalization. In the absence of external impacts, lean management under the low-cost and low-inventory model can ensure stable business operations. However, if external shocks occur, the bullwhip effect would make it difficult for suppliers to predict downstream customer demand, and lean management would limit suppliers’ ability to respond quickly to customer demand, causing upstream suppliers to lose revenue due to lack of inventory.

Overall, we see four trends that are shaping the future of GSCs: Diversification, regionalization, digitalization, and green transition.

  1. 1.

    Diversification means that the goal of supply chain management will shift from a sole focus on efficiency to a dual focus on both efficiency and security. Considering the possibility of supply chain disruptions and uncertainties in delivery, companies may have to strengthen the robustness and resilience of supply chains at the expense of cost and efficiency, with a greater level of redundancy and fragmentation in supply chain management. Amid the COVID-19 pandemic, supply chain disruptions have become more prominent due to the concentration of supply chains. Therefore, we think companies may consider diversifying their supply chains and adding alternate suppliers for important products to avoid risks arising from concentrated supply chains. Due to limited room for supply chain reshoring, companies are more likely to reduce supply chain risks by adjusting safety stock and adding alternate suppliers (usually in regions close to existing supply chains or sales territories).

  2. 2.

    The impact of soaring freight rates during the COVID-19 outbreak may prompt companies to relocate their supply chains to nearby regions and shorten the physical length of supply chains, implying growing regionalization of supply chains. The long physical length of a supply chain tends to bring additional security risks such as the bullwhip effect caused by disruptions to GSCs amid COVID-19. Also, we believe that companies may consider, among other factors, establishing a presence in nearby regions and shortening shipping distance to reduce supply chain costs.

  3. 3.

    Digital technologies are reshaping the form of supply chains. Digital transformation of supply chains has become technologically feasible. Amid the background of Industry 4.0, the application of digital technologies such as Internet of Things (IoT) is reshaping the form of supply chains. Meanwhile, supply chain disruptions caused by external shocks such as the COVID-19 pandemic create urgent needs for digitalization of supply chains. The risk of supply chain disruption underscores the importance of the visibility and controllability of information, prompting more companies to pay more attention to omni-channel management. Therefore, companies are likely to significantly increase investment in supply chain digitalization in the future, and Supply Chain 4.0—the next-generation digital supply chain—will likely be put on the agenda.

  4. 4.

    Russia-Ukraine conflict has accelerated the green transition of supply chains. The Russia-Ukraine conflict that broke out in 2022 has increased uncertainty in the supply of traditional fossil energy, and countries in Europe are accelerating decarbonization of energy systems. European countries such as Germany and Italy rely heavily on energy imports from Russia. Data from British Petroleum shows that imports accounted for 39%, 77%, and 59% of the EU’s coal, crude oil, and natural gas consumption in 2020, and most of the imports were from Russia.Footnote 8 Although it is unlikely for Europe to end its dependence on Russian energy in the near term due to the high cost of switching to alternative energy suppliers, the Russia-Ukraine conflict has raised the strategic importance of developing renewable energy to a new height, which may accelerate the global energy transition and drive the decarbonization of supply chains.

9.2 Chinese Companies Have Been Deeply Involved in GSCs

9.2.1 MNEs Facilitate the Formation of GSCs

MNEs are organizers of and participants in global industry chains and supply chains, and play an important role in international economic and trade. In 2014, MNEs’ headquarters and foreign affiliates contributed 33% of global output, 28% of global GDP, 23% of global employment, 55% of international exports, and 49% of international imports.Footnote 9 Since the 1980s, increases in foreign direct investment (FDI) and foreign outsourcing led by MNEs has made the network of GSCs increasingly complex. At the end of the twentieth century, the information technology revolution reduced the coordination cost across regions, making it feasible to spatially separate production processes.Footnote 10 Meanwhile, given varying labor costs in different countries, companies in developed countries can substantially reduce product costs and increase profit margins by locating production processes in developing countries. Therefore, as organizers and participants in supply chains, MNEs keep high-skill stages of production such as R&D and design in their home countries, and carry out low-skill activities such as manufacturing and assembly in developing countries. This represents a typical model of vertical specialization in which high-skill stages of production are located in developed countries and labor-intensive production stages in developing countries.Footnote 11 From the perspective of globalization, such specialization led by MNEs can boost the exports of manufacturing countries, and enables companies in these countries to directly or indirectly integrate themselves into GSCs by providing input products and outsourced services.

MNEs’ activities in China have accelerated China’s integration into GSCs. Since the 1990s, the deepening of China’s market-oriented reforms and its demographic dividend have prompted MNEs to enter China, and China has thus become deeply involved in GSCs. Through FDIs, MNEs undertake labor-intensive stages of production such as processing and manufacturing in China, then export finished products from China to overseas retail markets, making China the world’s most important manufacturing hub amid rapid increases in export value. FIEs accounted for 59% of the total trade value between the Chinese mainland and its trade partners in 2006, and this proportion remained high at 39% in 2020.Footnote 12

9.2.2 Technological Development of Chinese Companies Has Led to Gradual Withdrawal of Foreign Investment From Low-Tech Industries in China

At present, companies receiving direct investments from foreign countries, Hong Kong SAR, Macao SAR, and the Taiwan region of China are mainly concentrated in the east coast of China; among manufacturing industries, foreign and Hong Kong SAR, Macao SAR, and the Taiwan region of China invested enterprises (hereafter referred to as FIEs for brevity in subsection 8.2.2.) enjoy advantages in the automobile and computer & communications industries. In 2020, they accounted for 11% of the number of manufacturing enterprises above a designated size in China.Footnote 13 They were concentrated in coastal provinces due to their focus on exports in their early stages of development. FIEs accounted for 24% of the total revenue of all manufacturing enterprises above a designated size.Footnote 14 In particular, the proportion was as high as 53% in the automobile sector and 47% in the computer, communication & electronics industry, while the proportion of revenue from the primary product processing industry was low.Footnote 15

For enterprises above a designated size, FIEs have been gradually exiting less-profitable sectors while strengthening their presence in highly profitable sectors. The proportion of FIEs in the number of all enterprises above a designated size in China fell from 18% in 2011 to 11% in 2020, and the proportion of operating revenue at FIEs dropped from 26 to 22%, but the proportion of their operating profit increased from 25 to 27%.Footnote 16 Operating revenue of FIEs in the manufacturing industry in the past decade has increased while their number has decreased, and more foreign investors have exited low-tech industries. Over 2011–2020, the number of FIEs declined in most sectors, with sharp declines in medium- and low-tech segments such as textiles & apparel, wood processing, and leather products, indicating FDI outflows from these fields. In high-tech sectors such as transportation equipment manufacturing and special equipment manufacturing, the number of FIEs has increased or declined by a milder margin in 2011–2020. In terms of operating revenue, the average revenue of industrial FIEs that stayed in China expanded markedly in most manufacturing sectors. Over 2011–2020, the average revenue of industrial FIEs rose from Rmb380mn to Rmb570mn, implying an average annual growth rate of 4.6%. By contrast, during the same period, the average revenue of all industrial enterprises above a designated size in China only grew from Rmb260mn to Rmb270mn, at an annual growth rate of 0.5%.Footnote 17

There are multiple reasons why MNEs are gradually exiting low- and medium-tech industries and becoming larger and stronger in industries in which they have advantages. First, technological diffusion has caused MNEs to lose excess profit in low- and medium-tech sectors. Many domestic companies have developed the technological capabilities to compete with foreign companies in low- and medium-tech fields. Through market competition, profit margins of some foreign companies have been reduced, causing foreign companies with weak technological capabilities to exit the market, while other foreign companies with better technological capabilities can grow larger and stronger. Second, rising labor costs in China have pushed some MNEs to leave China and choose to expand their presence in other low-cost countries. Rising labor costs have a more significant impact on total costs in low-tech and labor-intensive industries, hence the greater number of FIEs exiting from these industries in China. In addition, as external factors such as geopolitics and COVID-19 pose challenges to the resilience and robustness of GSCs, some MNEs are choosing to reduce their reliance on production networks in China and are dispersing their supply chain networks in different regions. We will elaborate on this later in this section.

9.2.3 Chinese Companies and MNEs Are Suppliers and Purchasers of Each Other’s Products

As specialization improves efficiency and as companies have their own production boundaries, final products are generally produced by multiple companies, thus forming a supply chain network with companies at the nodes. We refer to the organizers and leaders of the supply chain network as core enterprises. Moreover, enterprises in a supply chain network play two roles: downstream purchasers and upstream suppliers. From a supply chain perspective, Chinese companies can serve as both upstream suppliers and downstream purchasers to MNEs. First, Chinese companies can integrate themselves into MNEs’ upstream supply chains as direct (tier-1) or indirect (tier-2 or other tiers) suppliers. MNEs have a large presence in the automobile and electronic products sector among manufacturing industries. For example, the Shanghai Gigafactory established by Tesla has enabled some Chinese companies to become its upstream suppliers due to the strong regional patterns of the auto value chain. Second, as China is the world’s largest manufacture hub, Chinese companies need to purchase raw materials and intermediate goods from MNEs in order to complete downstream production. Among the major global MNEs we track,Footnote 18 according to FactSet, four of the top 10 MNEs with the highest revenue contribution from China in 2021 were in the raw materials industry (Fortescue Metals Group, BHP Billiton, Rio Tinto, and VALE) and four were in the information technology industry (LG Display, MPS, Qualcomm, and Texas Instruments), reflecting Chinese companies’ great reliance on upstream resources purchased from overseas companies.

Chinese companies have been deeply involved in GSCs. Above all, China is an important node in GSCs. Given China’s factor endowments and industrial support, MNEs have actively established supply chains in China, and a large number of Chinese companies and foreign MNEs have become suppliers and purchasers of each other’s products. In addition to the two roles of suppliers and purchasers, some Chinese companies have grown into multinationals and play a role in GSCs as organizers. For example, by setting up overseas R&D or production centers, Chinese companies such as Huawei and Xiaomi have been allocating resources globally and building their GSC networks.

9.3 Risks of Industrial Relocation and Supply Chain Disruptions Caused by the Reshaping of GSCs

9.3.1 China’s Industry Chain Risks Brought by Supply Chain Reshaping Amid the COVID-19 Pandemic, Geopolitics, and Green Transition

As the COVID-19 pandemic disrupts GSCs, reshoring, or reducing the presence of supply chains in China may be alternative options. Since 2H20, rising demand for imported consumer goods in Europe and the US, coupled with insufficient shipping dispatch capacity and a shortage of cargo handling personnel at ports, have led to poor container turnover and an insufficient supply of shipping capacity.Footnote 19 This has caused GSC disruptions and delays, pushing up the Global Supply Chain Pressure Index (GSCPI) to a historic high (Fig. 9.1). As China is a global production powerhouse for numerous manufactured products (including medical protective equipment), supply chain disruptions triggered by the COVID-19 pandemic have made it difficult for European and US companies and consumers to obtain Chinese products they need in a timely manner. Therefore, in order to ensure a long-term and stable supply in domestic markets, some companies may adjust their supply chains via reshoring, nearshoring, and supplier diversification.Footnote 20

Fig. 9.1
A fluctuating line graph plots the global supply chain pressure index between January 2010 and July 2022. The curve begins below zero in January 2010 and reaches its highest value above 4 after September 2021.

Source Federal Reserve Bank of New York, CICC Research

Global Supply Chain Pressure Index (GSCPI) has been rising since the COVID-19 outbreak. Note The GSCPI is used to provide a summary of potential supply chain disruptions, and it is based on a variety of international transportation cost indices and Purchasing Managers’ Indices (PMI) of seven major global economies

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Geopolitical factors have triggered technological decoupling, product boycotts, and rising trade costs, weighing on international supply chains’ presence in China. Geopolitical factors affect Chinese companies directly in multiple ways, such as bans on domestic companies from trading with Chinese companies, boycotts of Chinese products, higher import tariffs, and imposing of export controls on China. In response to domestic public opinion and policy requirements, MNEs may need to remove Chinese suppliers or downstream Chinese customers from their supplier or customer networks in a targeted way (e.g., the US Entity List). In addition, in the face of higher import barriers, enterprises may shift some of their stages of production away from China to target market countries for their products. Moreover, as companies in various countries need to carry out procurement globally, risks at other nodes of the GSC network triggered by overseas geopolitical events, such as regional disruptions in logistics and production, may also indirectly affect the supply chains of domestic companies.

Green transition increases companies’ production costs; enterprises raise management requirements on their suppliers. China’s energy consumption is dominated by traditional energy sources, while green transition requires an increase in the use of clean energy, which add to the production costs of Chinese companies. Some enterprises have proposed carbon neutrality requirements for their entire supply chains. For example, Apple plans to achieve carbon neutrality for its entire supply chain by 2030, urging its suppliers to adopt clean energyFootnote 21; Huawei has incorporated carbon emission reduction requirements into its supplier management process.Footnote 22

9.3.2 Upstream Chinese Companies Face Risk of Industrial Relocation

Amid the reshaping of GSCs, MNEs may diversify their supply chains away from China and accelerate industrial relocation (i.e., foreign companies move their supply chains away from China), affecting upstream suppliers in China. (1) Impact of COVID-19 pandemic and green transition: MNEs may relocate part of their production capacity out of China and diversify their production sites in order to guard against supply chain disruptions caused by natural hazards such as the COVID-19 pandemic. Also, given the COVID-19 pandemic and green transition, MNEs have imposed higher requirements on supply chain design and supplier management, and some Chinese suppliers that do not meet environmental standards or have weak responsiveness to market changes may be removed from their supply chains. (2) Impact of geopolitical events: Since the emergence of US-China trade frictions, core companies have resorted to reshoring, friend-shoring, and nearshoring in order to avoid import tariffs on specific Chinese products. Meanwhile, the frequent global geopolitical events and the chain reactions of GSCs may prompt some MNEs to relocate their supply chain networks to their home countries. According to a Kearney survey in 2022,Footnote 23 the value and proportion of manufactured goods in the US imported from China declined over 2018–2021, while the proportion of imports from other low-cost Asian countries like Vietnam (friend-shoring), and from Mexico (nearshoring) increased.

To confront the risk of industrial relocation, China can unleash domestic demand to continue to attract foreign investment. We believe foreign MNEs in China mainly adopt two strategies for business development: (1) The “World’s Factory” strategy (relying on Chinese factories to produce goods that are ultimately sold elsewhere); and (2) the “In China for China” strategy (aiming to provide products or services for the vast, growing China market). Given rising labor costs and MNEs’ tendency of reducing production and procurement in China due to external impacts, China, as the world’s factory, may become less attractive to FDIs, and some stages of production may be relocated away from China. However, China’s large demand can provide a buffer, and the country may continue to attract FDIs aiming to serve the domestic market.

In fact, the majority of MNEs in China have started to shift from the “World’s Factory” strategy to the “In China for China” strategy. The solid financial returns of their businesses in China are the main reason why FDIs are staying in China. Over 1998–2013, micro-level data of China’s industrial enterprisesFootnote 24 showed a downward trend in the proportion of FIEs’ sales to overseas regions, which means more FIE products are being sold to the China market. According to a survey by the American Chamber of Commerce in Shanghai, 53% of the surveyed companies in China adopted the strategy of “In China for China” in 2021, another 12% aimed to export products to China, and only 18% of the companies surveyed in China adopted the “World’s Factory” strategy.Footnote 25 Among S&P 500 companies, the profit margins at the top 50 companies with the largest revenue contribution from businesses in China have continued to outperform those of other companies without overseas business since 2010, and have surpassed those of the top 50 MNEs with the largest proportion of revenue from overseas businesses since 2016.Footnote 26 This implies that MNEs in China have been shifting towards high-end business with increasing operating revenue in the past decade, and they have been gradually exiting low-tech and low-profit-margin sectors; in addition, MNEs with a high proportion of business in China have posted high profit margins, reflecting that the Chinese market is able to generate good financial returns, which is the main reason why FDIs have been entering China and staying there.

9.3.3 Downstream Chinese Companies Face the Risk of Supply Chain Disruptions

Chinese companies in the downstream segments of GSCs are facing greater risks of supply chain disruptions and delays as the external environment has increased the vulnerability of upstream supply chains. First, COVID-19 and climate change may cause global or regional production and logistics disruptions, affecting upstream suppliers of Chinese companies. Second, geopolitics may increase uncertainties in the supply of key raw materials and intermediate goods. Foreign suppliers may directly cut off supply to Chinese companies or delay product delivery; foreign governments may put restrictions on exports to China. In addition, as China is deeply integrated into GSCs, the complex international environment may also have an indirect impact on Chinese companies.

Chinese firms need to pay attention to industry-specific supply chain risk factors that may recur or have long-term impacts, and formulate risk response plans. Some conventional risk management measures can help companies reduce the risk of supply chain disruptions, including increasing inventory, adding standardized modules, improving logistics efficiency, and diversifying suppliers.Footnote 27 When faced with supply chain disruptions, companies have different solutions for the short and the long term. For example, Japan imposed export controls on semiconductor materials bound for South Korea in 2019. As the production of relevant materials is highly concentrated at Japanese companies, and photoresists (labile) and hydrogen fluoride (highly toxic) cannot be stockpiled in large quantities, South Korean companies tend to respond by increasing purchases from alternative suppliers and overseas Japan-invested companies in the short term. However, from a long-term perspective, South Korea may choose to improve its domestic production, including investing in the R&D of domestic companies and introducing foreign companies to set up factories in South Korea (in particular, South Korea has made rapid progress in domestic production of hydrogen fluoride).Footnote 28

9.4 China’s Supply Chain Ecosystem Needs to Address Three Issues in Response to Industry Chain Risks

Amid the reshaping of GSCs, Chinese companies face the risks of industrial relocation and supply chain disruptions, threatening the security of industry chains. It is thus of vital importance to address these issues. Industry chain security mainly refers to the ability of supply chains to maintain resilience and robustness in the face of external shocks. Therefore, China needs to build a sound supply chain ecosystem and give companies in supply chains more flexibility in decision-making so that they can quickly adjust the allocation of factors of production when facing changes in the external environment in order to maintain the relatively sustainable and stable ability to obtain supply chain surplus. A sound supply chain ecosystem can help companies improve their supply chain management capabilities, enhance the resilience and robustness of their supply chains, and also ensure industry chain security. Successful supply chain management requires effective control over logistics, capital flow, and information flow. However, various problems in persist in China’s current supply chain ecosystem, and there is still room for Chinese companies to improve their supply chain management capabilities.

9.4.1 Efficiency of Domestic Business-Oriented Logistics Has Yet to Be Improved; International Logistics System Still Weak

Due to the low efficiency of business-oriented logistics, logistics costs in China are relatively high, implying large room for improvement compared with the US. China’s overall logistics costs in absolute terms and as a percentage of GDP are both higher than those in the US. According to the Ministry of Transport of the People’s Republic of China, logistics costs in China stood at Rmb16.7trn in 2021, accounting for 14.6% of GDP, while logistics costs in the US were Rmb12trn (or US$1.85trn) over the same period, accounting for 8.0% of GDP. At present, the efficiency of China’s consumer-oriented logistics is ahead of other countries. For example, the operational efficiency of JD.com’s “Asia No. 1” Warehouse is similar to that of Amazon’s warehouses in terms of daily delivery volume, sorting efficiency, and accuracy. However, business logistics efficiency remains low in China. Data from Wind shows that inventory turnover days of manufacturing sectors in China and the US averaged 83 and 67 days in the past five years, with that in China 23% higher than the US. Therefore, the crux of the problem of China’s higher logistics costs mainly lies in the low efficiency of business-oriented logistics.

Low efficiency of business-oriented logistics in China is mainly dragged by low automation rate, low transportation efficiency, and low proportion of integrated transportation. First, the automation rate of China’s logistics is low, averaging 20% in 2019 (vs. 80% in developed countries)Footnote 29; in 2019, modern warehousing and logistics facilities accounted for 7% of total facilities area in China (vs. 22% in the US).Footnote 30 Second, China’s logistics has low transportation efficiency, with the percentage of empty miles standing at about 40% in 2019 (vs. only 10–20% in developed countries).Footnote 31 Third, the proportion of integrated transport is low. The proportion of rail-sea intermodal transport at Chinese ports was only 2.6% in 2020 (vs. 20–40% in developed countries).Footnote 32 Improving business logistics efficiency can strengthen the comparative advantages of China’s supply chains. At present, China may maintain advantages in per-unit logistics cost in the near term thanks to the large number of employees in the logistics industry. However, as the demographic dividend weakens, China’s logistics costs may face further upward pressure. If business logistics efficiency can be improved, China’s logistics costs are likely to decline, which could reduce the total costs of companies’ supply chains in China and enhance China’s comparative advantages in supply chains compared with other countries with low wages, thus helping Chinese companies cope with supply chain risks.

In addition, China’s international logistics system is still weak, which is unlikely to support Chinese companies in overseas expansion or global procurement, mainly due to three factors. (1) Insufficient distribution of core logistics nodes and resources: As of January 2021, there were about 185 all-cargo aircraft in China, only about one-tenth that of the US (about 1,125).Footnote 33 China’s transport capacity for international routes has yet to be improved. (2) Weak door-to-door services: International logistics services need to cope with institutional and cultural differences in different regions and countries, while Chinese logistics companies lack capabilities in cross-border shipping, order fulfillment, and delivery in overseas regions. For the international express delivery business, foreign companies still play a dominant role in the global market. (3) Weak pricing power: The pricing power of international logistics is related to that of imported and exported goods, and logistics companies can barely determine the price of logistics services on their own. Moreover, Chinese companies have limited presence in the nodes of the international logistics network, which also makes it difficult for them to gain pricing power in the logistics market.

9.4.2 Inefficient Fund Flow Makes It Difficult for Traditional Supply Chain Finance to Cope With External Shocks

The high carrying cost of Chinese companies weighs on the efficiency of fund flow in supply chains. During the daily operations of companies in supply chains, their working capital is mostly tied up in the forms of prepayments, inventories, and accounts receivable, leading to tight cash flow and putting pressure on their capital turnover. The cost of such working capital is mainly represented by carrying cost. Carrying cost refers to all expenses incurred during the flow of goods from the original resource supply to the end-market customers (excluding transportation expenses and administrative expenses), including explicit costs such as warehousing and packaging fees, and implicit costs such as capital tied up and damaged goods.Footnote 34 Carrying costs are higher in China’s supply chains, and lower in the US’s supply chains. Inventory turnover days of the manufacturing industry in China averaged 83 days in the past five years, 23% higher than in the US (67 days). In 2021, China’s logistics value of industrial goods totaled Rmb299.6trn. Given the inventory turnover days of China’s manufacturing industry (76 days) and the weighted average interest rate of corporate loans (4.6%) in 2021, the cost of capital tied up during the logistics process was about Rmb2.5trn in 2021, accounting for 45% of the carrying costs that year.Footnote 35 Accelerating the capital turnover of companies in supply chains can help reduce their operating costs and improve the stability of their operations, thereby enhancing the resilience of China’s supply chain ecosystem.

An important way to improve the efficiency of fund flow and reduce carrying cost is to utilize SCF instruments. In order to meet the financing needs of enterprises in supply chains, relevant financial products are created. Financial institutions can provide enterprises at different stages of production and operation along the supply chain with different supply chain finance (SCF) products, such as: (1) Confirming warehouse financing, goods pledge financing, and order financing in the order placing and purchasing stage; (2) warehouse receipt pledge financing and inventory pledge financing in the inventory carrying stage; and (3) accounts receivable pledge financing and accounts receivable discounting in the sales and payment collection stage. SCF services emerged earlier in foreign countries. Factoring was already common in Western countries centuries ago; and inventory financing services were prevalent in the US in the nineteenth century; in addition, warehouse receipt pledge rules were also established in the US in the early twentieth century.Footnote 36 These are common traditional SCF services and are also prevalent in China at present.

However, traditional pro-cyclical SCF may amplify external shocks to supply chains and exacerbate supply chain instability. One of the disadvantages of traditional SCFFootnote 37 is its high pro-cyclicality during macroeconomic cycles, which may prevent SCF from coping with external shocks to supply chain security, and may even amplify such shocks to supply chains. The pro-cyclicality is characterized by: (1) The credit expansion of financial institutions that inject a lot of liquidity into the market during economic upturns, which may result in asset bubbles and an overheated economy; and (2) a decline in lending activities by financial institutions during economic downturns or in the face of negative external shocks, which may in turn exacerbate the negative impact on the economy. It is worth noting that companies often tend to have poor cash flow during economic downturns or in the face of negative external shocks. However, for the reason of risk control, financial institutions may reduce lending to companies impacted by economic cycles. For example, the economic fluctuations in 2H19 weighed on the business operations of China’s small and medium-sized enterprises (SMEs), increasing the probability of SMEs defaulting on their loans. As such, financial institutions reduced the size of loans issued to SMEs to varying degrees,Footnote 38 adding to the pressure on SMEs.

9.4.3 Digitalization Penetration Rate Has Yet to Be Improved

Chinese companies are still in the early stages of digital transformation. For example, the global average penetration rate of industrial digitalization was 23.5% in 2019, with Germany having the highest penetration rate at 45.3% vs. only 19.5% in China. Although China’s penetration rate of industrial digitalization increased to 21% in 2020, it is still much lower than that in developed countries.Footnote 39 According to iResearch, a large number of Chinese companies are still in the early stages of supply chain digitalization. Relevant supply chain digitalization products are not widely used by Chinese companies at present as they do not have a full understanding of its advantages. Promotion of supply chain digitalization and relevant education marketing are still underway.Footnote 40 Also, many companies cannot directly purchase digital transformation solutions for their entire supply chains due to limited budgets.

Digital transformation can improve the accuracy of demand forecasts for supply chains and help companies cope with external shocks. In the digital economy era, the key to information flow management of supply chains is to strengthen data accumulation and to analyze data using algorithms such as deep learning. In particular, amid COVID-19 and geopolitical impacts, the use of big data and cloud computing technologies can enhance the accuracy of forecasts regarding changes in demand, thereby mitigating supply chain risks. For example, during the COVID-19 pandemic, Macy’s predicted the decline in consumer demand by mining credit card data, and controlled its inventory level in a timely manner. Compared with its rival Kohl’s, which saw inventory increase 48% YoY in 2Q22, Macy’s inventory increased only 7% YoY in the same period, easing the firm’s pressure of destocking (most US department stores suffered from destocking pressure in 2H22).Footnote 41 Therefore, digital transformation may help Chinese companies improve the resilience and robustness of their supply chains.

9.5 Thoughts and Implications

The COVID-19 pandemic, geopolitical events, and green transition have triggered the reshaping of GSCs. As such, Chinese companies are exposed to the risks of industrial relocation of foreign investments and supply chain disruptions. China’s large market potential has prompted MNEs in China to shift toward an “In China for China” strategy to serve the domestic market, which can mitigate the risk of industrial relocation to a certain extent. In addition, changes in the external environment may imply more frequent natural hazards such as pandemics and extreme weather, as well as geopolitical events in the future, leading to more supply chain disruptions. Therefore, China needs to build a supply chain ecosystem with strengthened capabilities to cope with external shocks. We elaborate on the construction of China’s supply chain ecosystem from three perspectives: Logistics, capital flow, and information flow.

9.5.1 Breaking Down Barriers in Domestic Logistics and Building an International Logistics System

Internally, breaking down barriers in domestic logistics can help establish a unified market across China, thereby optimizing the distribution and coordination of factors of production and reducing China’s industry chain risks. First, China needs to break down barriers in inter-regional logistics coordination. In order to establish a unified large market, China could encourage the development of cross-region professional logistics service providers with a comprehensive logistics network, remove the tangible or intangible barriers among regions, and avoid inefficient use of logistics resources while strengthening economies of scale. Second, China needs to break down logistics barriers and strengthen coordination between different modes of transport. Different means and modes of transport have their respective strengths and applicability. Enhancing cooperation and coordination between different means of transport is an important way to improve overall transport efficiency. China’s transport structure still has large room for improvement due to constraints such as industrial structure and inconsistent transport standards. In the future, strengthening the role of railways in transport and developing multimodal transport will be vital to the transformation of the transport structure.

Externally, China needs to upgrade its international logistics system by seizing core supply chain nodes and resources and improving integrated logistics service capabilities. First, China shall accelerate the obtaining of core supply chain nodes and resources. The acquisition of overseas warehouses and shipping capacity, which represent the core resources that play an important role in boosting efficiency and safety in logistics networks, should be prioritized. Warehousing resources are irreplaceable in certain transport scenarios, and overseas warehouses will likely become key infrastructure as the supply chains of cross-border logistics mature. Meanwhile, some logistics companies with integrated capabilities may accelerate overseas acquisitions, thus driving industry consolidation and a transition from extensive growth in the past two years to high-quality consolidation for overseas warehouses. In addition, we see significant upside potential in China’s international shipping capacity resources (cargo aircraft and ships). For example, the proportion of domestic transportation of imported goods in Japan reached 70–80% in 2006,Footnote 42 while the proportion of oil transported domestically in China was only 30% in 2019.Footnote 43 In addition, China could cultivate international logistics companies which can shoulder the responsibility of helping domestic goods going global. Judging from the history of United Parcel Service (UPS) and Federal Express (FedEx), the rise of US cross-border logistics companies is complementary to the global expansion of US companies. FedEx has gradually established a global logistics service network through acquisition of existing facilities and building new ones, and to a large extent helped US multinationals achieve globalization by leveraging its reliable fulfillment capabilities and cost-effective logistics services. Chinese logistics firms also need to grow into international supply chain companies to support Chinese companies’ global expansion.

9.5.2 Leveraging the Benefits of Supply Chain Finance in a Proper Manner

Improving supply chain security requires greater policy support for SCF. SCF led by financial institutions refers to the traditional and most commonly used SCF model, in which financial institutions provide financing services for companies in the upstream and downstream segments of the supply chain by controlling the fund flow, logistics, and information flow in the supply chain. The traditional SCF model is highly pro-cyclical, and is unlikely to play an effective role in confronting shocks to supply chain security, but may instead become an amplifier of shocks. This means that policy support for SCF needs to be enhanced in order to improve supply chain security.

Leveraging the SCF model led by banks and other financial institutions to achieve policy goals. Banks are the most important source of funding supply for SCF in China, where the major large banks are state-owned. From the perspective of ensuring supply chain security, it is necessary to give full play to the role of SCF led by financial institutions in achieving policy goals. Compared with other funding sources for SCF, the transaction value of direct financing by banks was the largest in China, reaching Rmb44.9trn in 2021 and accounting for about 75% of that of all funding sources in the past five years.Footnote 44 When faced with external shocks, companies in supply chains tend to see a decline in their operating cash flow. However, banks can help companies that are vulnerable in the supply chain ensure normal business operations and maintain supply chain security by increasing their cash flow from financing activities.

A new SCF model dominated by core enterprises has emerged. To ensure supply chain security, in addition to SCF led by financial institutions, attention should be paid to the SCF model led by core enterprises, and this model should be utilized properly. With the development of supply chains and financial markets, some core enterprises in supply chains, including large warehousing and logistics companies or technology platforms,Footnote 45 have started to provide funds and other financial services for upstream and downstream enterprises, creating a new SCF model led by core enterprises.Footnote 46

Based on their respective professional advantages and market positioning, core enterprises can obtain key information such as prices, orders, and goods in the upstream and downstream segments of the supply chain, and leverage their or financial institutions’ advantages in capital to provide SCF financial services. Core enterprises generally conduct the SCF business in two ways: (1) Setting up their own commercial factoring companies, financial leasing companies, micro-loan financing platforms, and investment and financing platforms; or (2) cooperating with commercial banks or other financial institutions. This model has grown along with refined production, convenient logistics, and large-scale operation of conglomerates, and has become prevalent in foreign countries. For example, General Electric (GE) provides its customers with asset-based lending and equipment financing services through GE Capital.Footnote 47 There are also many such financial practices in China. SF Express offers accounts receivable factoring, bill discounting, and other services to its suppliers through a financial service subsidiaryFootnote 48; JD.com provides financial products such as prepayment financing, accounts receivable financing, and bill discounting for small, medium, and micro enterprises, as well as merchants on JD.com’s platform.Footnote 49

Under the new SCF model, core enterprises have a better understanding of the operations of companies in the supply chain and can play an effective role in ensuring supply chain security. The SCF model dominated by core enterprises has neither government guarantees nor funding sources from the public. Instead, it relies on internal financial services to support the financing of companies in the supply chain. In addition, compared with the financial institutions-led SCF model, core enterprises-led SCF can reduce information asymmetry and help mitigate the pro-cyclicality of the financial sector as core enterprises have a better understanding of the operations of companies in the supply chain than financial institutions do. Therefore, to overcome financing constraints, policies could provide some room for SCF practices led by core enterprises to play an appropriate role under the premise of legal compliance, in our view.

9.5.3 Seizing Opportunities From the Digital Economy in Supply Chain 4.0

More available and easy-to-use digital technologies can help address the issues of some industries in China that are labor-intensive, costly, and poorly managed. For example, the traditional logistics industry is labor-intensive (however, China’s demographic dividend is disappearing), and it is a fragmented market with low penetration of digital and information technologies. In the digital economy era, technologies such as 5G, AI, and cloud computing will likely significantly optimize logistics companies’ business processes and operations.

China may reduce the need for industrial relocation through investing in Supply Chain 4.0 and strengthening supply chain management to reduce risks. The increasingly mature cross-border e-commerce model is a typical example of the digital supply chain: Cross-border e-commerce has a short distribution channel and high efficiency, facilitates data sharing along the e-commerce network, and enables brands to sell products directly to international consumers. It has become the top choice for Chinese manufacturers to reach global consumers. Moreover, cross-border e-commerce makes it easier for emerging countries and small- and medium-sized enterprises to become part of the global value chain. Apparel company SHEIN’s sales model is an example of the digital supply chain: The firm’s average delivery lead time is only 11 days (vs. 30–60 days for ZARA) and it launches more than 10,000 new items per month (vs. only 1,000–2,000 for ZARA). Chinese brands play a more important role in the cross-border e-commerce supply chain than they are in the traditional trade. We expect the emergence of leading companies in the supply chain to enhance the controllability of the supply chain.