Why American Companies Choose China Over Everyone Else

For all-around emerging market manufacturing know-how, for reliability, for currency stability, for safety and for domestic market growth, China is No. 1. The rest are more like No. 100.

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Why American Companies Choose China Over Everyone Else

For all-around emerging market manufacturing know-how, for reliability, for currency stability, for safety and for domestic market growth, China is No. 1. The rest are more like No. 100.

No one comes close in the developing world to China. And that is why U.S. companies are so headstrong about staying there. The trade war will have to get much worse before they are forced to source elsewhere.

Last week, one of the biggest lobby groups for American multinationals in China, the U.S. China Business Council, put out their annual member survey. China was still as profitable or more so than other emerging markets where they have set up shop or source supply.

Only 3% said they were relocating to the U.S. because of tariffs. Under 7% said they were leaving China.

Why do American companies love China so much? It can’t be just because of its size. India is comparably large and friendlier to the U.S. Brazil is pretty big—and closer. Mexico, even closer.

What’s so great about China?

MEXICO ECONOMY
Why not source out of Mexico? It’s closer to the U.S. and it has a free trade deal. SUSANA GONZALEZ/© 2016 BLOOMBERG FINANCE LP

Forget the politics. Forget that it is a one-party state that censors its population and now has religious minorities in so-called “reeducation camps” in far Western China.

Honestly, does any of that matter to a transnational corporation? Unless they run afoul of the Communist leaders or are doing business with the parties deemed responsible for a human rights violation, then it arguably matters little to them. Where is the company that has stopped doing business with China because of human rights matters?

In fact, many companies that source from China, like Apple, are part of so-called ESG mutual funds that invest in what that acronym stands for: companies good on the environment, good on social responsibilities, and with good corporate governance.

For portfolio investors, many top-rated impact investment funds, like the five-star Morningstar-rated Calvert Emerging Markets Equity (CVMIX) that invests in companies considered good environmental stewards who pay women as much as men, hold top China corporations like Alibaba and Mengniu Dairy.

Beat up on China all you want—the truth is that companies overwhelmingly want to be there. Portfolio managers want to as well.

China US Trade
Unmoved. U.S. Trade Representative Robert Lighthizer, center, speaks to China’s Vice Premier Liu He as Treasury Secretary Steven Mnuchin looks on in July 2019 in Shanghai. (AP Photo/Ng Han Guan, Pool)ASSOCIATED PRESS

From a corporate perspective, here is what makes China better than the rest.

The corporate tax rate in China is 25%.

It’s 35% in India, 34% in Brazil, and 30% in Mexico. Right off the bat, China is at least 5% cheaper.

Five percent won’t be the deciding factor in deciding whether to set up a factory in China. But these issues sure will …

China is a communist country, so one would expect their workers would have collective bargaining and other rights. While labor rights are stricter now in China than they were even five years ago and wages are rising, China wages are still cheaper than Brazil’s and Mexico’s.

In terms of labor rights, China ranks 5 on a scale of 1 to 5 as one of the world’s worst countries for workers, according to the International Trade Union Confederation. India is just as bad, meaning it’s a place where businesses can more easily exploit workers.

Mexico is a 4 and Brazil is a 3.

Brazil has some of the toughest labor laws around. Good luck firing someone in Brazil or beating a union lawsuit in a court.

Strong labor rights that favor unions tend to be unattractive to global capital looking for cheap inputs and little drama. China has comparatively weak labor protections on one hand, and a diverse pool of talent on the other—from stitch-and-sew factory workers to scientists and other high tech, advanced machine tool operators are all at the ready. There are hundreds of thousands of them. No country has this.

General Images Of Shanghai As The People's Bank of China Steps Up Support For Slowing Economy
China workers to the world: “Anything you can do, we can do too. And faster. And cheaper.” TOMOHIRO OHSUMI/© 2015 BLOOMBERG FINANCE LP

Moreover, even though India has a similar workforce situation in terms of rights and size, the government long ago decided to focus on being a software developer and IT service exporter.

As an economy, India is known for its IT firms and maybe a generic drug manufacturer. China is surpassing them on the generic drugs side.

China is known for producing everything. Need a photovoltaic cell panel for a drone? China can make that. Need a float for your swimming pool? China’s got it. It’s a wonder that Alibaba or Tencent haven’t spun off their own IT outsourcing unit to compete with Infosys yet.

India also changes governments every few years and only recently unified its cross-state tax code. China has none of these problems. Continuity makes life easier for businesses. It’s one less headache.

There are hidden costs involved in doing business in any country. Taxes can be written off. But countries like Brazil have hidden taxes hard to avoid. A simple corporate cellphone account is taxed nearly as much as the corporate tax rate.

In addition to the tax cost, there is a logistical cost of moving goods from one state to another, one country to the next.

Brazil is notorious for being a logistical mess. It has maybe three decent ports. China dominates on the port side. Its seaports are world class. There is nothing like them anywhere in Latin America or India.

Mexico’s ports are governed by cartels, as Mexico’s president Andres Manuel Lopez Obrador recently said about corruption at two of the country’s ports and customs stations.

India could be a good solution for its location, but its port infrastructure is nowhere near China’s, so logistical costs could be higher depending on product and destination.

Then there is corruption and crime which makes doing business in these countries more complicated.

BRAZIL VIOLENCE
Military soldiers patrol a street in Rio de Janeiro, Brazil. It’s not any safer. Want to make your widgets in Copacabana? DADO GALDIERI/© 2017 BLOOMBERG FINANCE LP

China is corrupt. But not as corrupt as any other major emerging market.

According to Transparency International’s 2018 Corruption Perception Index, China ranks 87th out of 180 nations. India is better at 78. Brazil ranks 105th and Mexico is terrible at 138, equal to Russia, a country everyone in the market refers to as the Wild East.

The small Southeast Asian nations that have been benefiting from Chinese manufacturers setting up factories there aren’t much better, according to Transparency International. Vietnam is ranked 117 out of 180. More corruption often means companies have to face bribes and other strong-arm tactics by politicians and regulators to do business.

Corruption perception in China is not great. But crime is low.

Crime is not as rampant in China as it is elsewhere in emerging markets. India, Mexico and Brazil are way more dangerous. If quality of life for expat workers comes into play, then building a factory in those countries is less safe than building one in China.

Investing in operations in Rio de Janeiro and bringing down American workers might sound enticing, but Rio is one of the most dangerous cities in the world, which is one factor why few companies even consider it.

INDIA POLLUTION
India’s lackluster environmental regulations make it one of the most polluted places around. Would expats want to live here? RUHANI KAUR/© 2018 BLOOMBERG FINANCE LP

Of the 10 most polluted cities in the world, 9 of them are in India.

China is also polluted and has poor air quality. But China is more active in this regard than anyone else. They have invested in high-speed rail that works. And are the largest electric-vehicle producers. The government is taxing coal producers and utilities, trying to reduce fossil fuels. They have a long way to go, but all of this creates opportunities for U.S. companies that want to serve the China market.

Brazil is a good example of this. Companies from Goldman Sachs to Shell Oil were big investors in Brazilian sugar cane ethanol when the government mandated a 10% mix in gasoline. It was an opportunity unique to Brazil, so companies wanted to be a part of that.

Beyond that, however, Brazil is one of the world’s cleanest producers of fuel thanks to its hydroelectric power grid. Outside of Rio and São Paulo, most cities in Brazil have clean air quality.

But electricity in Brazil, despite its free supply of water, is not cheap.

If you’re a company concerned about electricity prices (and Brazil’s taxes on top of that), then China is better at just $0.08 per kilowatt hour.

Is that due to the massive Three Gorges Dam power plant on the Yangtze? Probably not. Is it due to subsidies by the state? Probably. Regardless, keeping the lights on in China is cheaper than it is in Brazil and Mexico.

Abundant labor, from skilled to unskilled, weak unions, stable currency and politics, world-class logistics and a safer place to do business makes China better than the rest.

Looking at the big emerging markets as a possible alternative and it is clear: Either Brazil, Mexico and India reform their onerous tax rates, improve their infrastructure to help exporters and drastically reduce violent crime rates, or they will never be competitive with China for foreign capital.

In a global economy, where capital looks for the best return, they’re at least three steps behind.

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