The China evacuation

Companies finally want to leave. But can they afford to?

For years, people have been predicting a multinational corporate exodus from China. Rising labor costs eroded the country’s advantage as a platform for cheap low-end manufacturing. The Chinese government regularly appropriated foreign companies’ technology and gave it to domestic champions. Trump slapped tariffs on China and Biden kept the tariffs in place. Tensions over Taiwan and the South China Sea kept rising. And so on.

It didn’t really happen. Foreign investment kept pouring into the country. As recently as 2020, most companies declared that they had no plans to leave. There was a little bit of diversification, especially into Vietnam, but overall this was quite a modest shift. For example, here’s how Apple has changed its suppliers since the trade war began:

Source: Macro Polo

But there’s a sense that 2022 is different. A confluence of three factors has made companies seriously question whether being in China is actually worth the risk and cost at all.

First, there’s China’s ongoing Covid lockdown, which is disrupting factory output throughout the country. With low vaccination rates for the elderly and a continued refusal to use effective Western-designed mRNA vaccines — and a hefty dose of Xi Jinping stubbornness — China seems set on a path of harsh lockdowns for an indefinite period of time. Just as one example, Tesla’s Shanghai factory was halted for three weeks and its China sales are plummeting.

Second, there’s China’s crackdown on IT companies, finance, and (especially) real estate. Not only do these crackdowns create uncertainty — no company knows whether it’ll be next — but they threaten to lower the country’s overall growth, which will make the country’s domestic market less attractive.

But perhaps most importantly, there’s the war in Ukraine, and its implications for tensions between China and other countries. China has tried to distance itself from Russia somewhat since it became apparent that the invasion was not going well, but people remember that China had essentially condoned Russia’s action in advance and promoted anti-Ukraine narratives in the early weeks of the war. There’s the uncomfortable possibility that China could be hit with devastating financial sanctions of the type that are currently crushing Russia’s economy; if that happened, multinationals’ operations in China would take a severe blow. With China still threatening an invasion of Taiwan, this possibility is very much in people’s minds. So it’s not surprising that capital began to pull out of China when the Ukraine war began:

Robin Brooks @RobinBrooksIIF

China continues to see capital outflows (orange), which is highly unusual. These outflows began after February 24, when war in Ukraine began. The longer these outflows last, the clearer it becomes that markets are looking at China in a new light since Russia invaded Ukraine...

(Update: Secretary of State Anthony Blinken’s recent speech about China underscores the increase in tensions since the start of the Ukraine war.)

So is this it? Is it finally time for the Great China Evacuation to begin? And what, if anything, can (or should) governments of democratic countries do to accelerate the shift and ease the burden of transition?

To answer those questions, we first have to discuss the reasons companies have been so eager to invest in China in the first place.

The five reasons to be in China (and why these are weakening)