The China-plus-one ‘reality check’ investors need

While the dominant economic narrative has been that supply chains are shifting out of China or to include other countries the so-called “China-plus-one” strategy) amidst rising geopolitical competition and that the ASEAN countries are obvious beneficiaries, the truth is more nuanced, according to Jingting Liu, senior lecturer at James Cook University, Singapore.

“The leading FDI destinations over the last decade haven’t changed much – the top investing destinations are the US, EU, parts of Asia and ASEAN,” Liu told the Top1000funds.com Fiduciary Investors Symposium.

“But more recently, we do see a switch. Some of these regions and economies are gaining share and momentum while some are losing it. Post-pandemic, Latin America, the US and the EU are gaining share – but China is losing that FDI momentum.”

Some of that can be explained by the tariff increases that came out of the Liberation Day announcement – but it also didn’t seem to have an impact on the sentiment of firms wanting to expand overseas. 

“FDI seems to be losing steam and traction in China… and this decline is rather broad-based,” Liu said. “The decline in US-led FI has been quite pronounced, and the decline is almost across all sectors. But perhaps it’s the manufacturing-related investment that has the largest or steepest percentage decline, and that’s consistent with the story of the supply chain shifting out.”

China seems to be on a “diverging path” to all its neighbours in the region as an FDI destination – but what stands in stark contrast to that is the “surge” in China’s outward FDI.

“Until 2024, much of that FDI goes to ASEAN, but last year the rest of Asia also picked up in terms of interest from Chinese firms [wanting to] expand overseas… the other top destinations include Asia, Africa, the EU and Latin America,” Jingting said.

The composition of that FDI is also changing amidst the imposition of export controls and barriers by other countries targeted at strategic sectors – those critical to economic and national security, like semiconductors, materials related to the energy transition, telecommunications, pharmaceuticals and critical minerals.

“After 2018, when most Chinese firms are being hit by export controls, their outward FDI is also increasingly tilted towards these strategic industries. We have policy targeting this and FDI shifting into these industries when Chinese firms are investing abroad.”

The first order impact is that countries are receiving more investment related to semiconductors, and the green and digital economies. And that is also translating into industrial upgrading for the receiving countries.

“We do see production capacity shifting alongside these FDI inflows; inside the region, within ASEAN, two economies that are particularly evident in exhibiting the trend is Vietnam and Indonesia. After 2018 – coincidentally or not – their import has shifted more toward capital goods, and when we look at the composition of import from China, they’re importing more.”

Jingting calls that the “China-plus-one reality check”.

“What goes a little bit unnoticed, compared to the import barrier – the import tariff – is the export barrier, which could serve as choke points in production. And those have accelerated Chinese firms’ outwards FDI and expansion.”

“For those host economies receiving that influx of FDI, we find that, besides a shift in investment patterns, there’s also a shift in the trade pattern; these countries are importing more capital goods, signalling a shoring up of capacity for production, as well as more imports of critical inputs for production.

“And within ASEAN, there is some indication of relocation that could mean a production shift beyond just trade rerouting.”