Imaginechina via AP Images
An employee at work at a Shanghai pharmaceutical company, December 12, 2022
Despite all of President Biden’s efforts to contain China and bring production home, there is more interpenetration of the two economies today than ever. Recently released 2022 trade statistics show that U.S. imports of products from China totaled $536.8 billion in 2022, a 6.3 percent increase from 2021. U.S. exports to China grew far less—by 1.6 percent to $153.8 billion. And these figures may understate the imbalance, because they don’t capture the entire supply chain of inputs made in China.
Locked Up in Chains
There are several parts to this dependence. First, U.S. producers that rely on Chinese production for inputs are insufficiently committed to diversifying sources of supply. A prime offender is Apple, which contends that it’s just too difficult to relocate production. Apple’s main assembly plant in Zhengzhou makes about three-quarters of the world’s iPhones.
But Apple’s main cellphone competitor proves that Apple’s story is nonsense. South Korea–based Samsung, which once also relied on China-based production, has successfully diversified. According to the Financial Times, Samsung closed its Chinese plants in 2019, and now builds more than three-quarters of its cellphones in six countries, from Argentina to Vietnam.
A more urgent example is the pharmaceutical industry. When the COVID pandemic broke out, face masks and hospital gowns were suddenly in short supply. Americans who had never given much thought to supply chains learned that China was the prime supplier of all this vital stuff; and China had given priority to its domestic needs. Eventually, easy-to-make products like face masks materialized from China and elsewhere.
Far more alarming is America’s continued dependence on China for the ingredients that go into drugs. American pharmaceutical giants dominate drug production, but at least half of all the chemical ingredients for these drugs, known as APIs (for “active pharmaceutical ingredients”), come from China. And this figure probably understates the dependence, since there are no reliable statistics. APIs that appear to originate elsewhere may in fact originate in China. This dependence has not diminished since the pandemic began.
Barry Lynn, author of the prophetic book End of the Line, which warned of a potential supply chain catastrophe, says that the U.S. would run out of vital prescription drugs in about a week if China withheld exports of APIs in an escalated crisis or another COVID shutdown—and that mass panic would result. The administration has no plan either to deal with such an emergency or to revive domestic API production.
Once, U.S. companies made nearly all of the APIs that went into domestically produced drugs. Then, most of this production shut down as Big Pharma found it cheaper and more profitable to outsource it to China. Despite the risks, there is little industry interest in bringing this production home.
Unlike semiconductors, manufacture of APIs is pretty much basic chemistry. There are remnants of API production in some regional clusters, around Richmond, Atlanta, and northern New Jersey, and some state-level efforts to increase production as economic development, but nothing remotely adequate to the need if the goal is to secure national supply.
A related problem is the lack of reliable data on supply chains. The government doesn’t collect it, and industry treats sources of supply as trade secrets, as do the suppliers. Compounding the dearth of transparency, there are often several tiers of suppliers. The supplier in tier two may not, and often doesn’t, know where her vendor in tier three sources his supplies. It may look as if there is plenty of diverse sourcing, but all roads may lead to tier four—in China.
The Mexican Trojan Horse
A separate problem is China’s use of third countries as platforms for increased exports to the U.S., using inputs designed, financed, controlled, and produced in China. These can be quasi-satellite Asian economies such as Vietnam, or countries on America’s doorstep, notably Mexico.
When the U.S. negotiated the North American Free Trade Agreement (NAFTA), later revised to the U.S.-Canada-Mexico Agreement (USMCA) after extensive back-and-forth between congressional Democrats and the Trump administration, the goal was not to give China a tariff-free launching pad for exports to the U.S. But that’s what is occurring. The “C” in USMCA, which officially stands for Canada, is turning out to stand for China.
Chinese companies, encouraged by both the Xi government and Mexico’s federal and state governments (which welcome the economic development), have massively increased their investment and production in Mexico. Since late 2021, the Mexican border state of Nuevo León has gained $7 billion in new capital investment, of which 30 percent is from China. Maquiladoras producing for the U.S. market, which were once U.S.- or Mexican-owned, are now increasingly Chinese-owned. And all of their supplies come from China.
To make matters worse, Mexico, with the support of the Chinese government, brought a complaint to the trilateral dispute settlement body under USMCA that would allow products with a larger fraction of Chinese content to qualify as North American content. As I wrote in a recent post, the Biden administration is considering how to oppose this.
Lately, there has been a huge buzz about “friendshoring” or “nearshoring,” as the more trade-friendly alternative to a more explicit commitment to produce in America. A lot of the enthusiasts fail to look beneath the surface of the slogan. It makes sense to diversify sources of supply and to give tariff preference to nations that share our values. But when friends such as Mexico and even some of our European allies are cavalier about their own supply chains, friendshoring becomes a euphemism for China-sourcing.
Chinese Production Made in USA
Exhibit C is the strategy of encouraging foreign companies to produce within the U.S. Manufacturing here and creating American jobs would make them eligible for Biden’s subsidies, tax credits, and tariff favoritism. This may be good policy when it leads Taiwan’s TSMC or Korea’s Samsung to build large factories in Arizona. But it’s much trickier when it comes to Chinese companies.
In Boston, nearly a decade ago, state and local leaders made a deal with a Chinese company, CRRC, to build a factory in Springfield to revive the railcar industry in western Massachusetts and build an initial 340 subway and trolley cars for Boston’s transit authority, the MBTA. Even better, the hundreds of new local jobs would all be union.
The result has been a disaster. Cars have been late and defective. According to a recent investigative piece by The Boston Globe, only about 90 have actually been delivered, and the MBTA has repeatedly had to pull cars out of service because of a variety of serious defects, including a battery explosion, derailment, loose brake bolts, and hazardous electrical arcing. It’s been compelled to temporarily replace them with antiquated cars that were mothballed a decade ago.
It turns out that this strategy of encouraging Chinese companies to produce in the U.S. is fool’s gold. Most of the value added stays in China. The U.S. gains only final assembly, has no control over the engineering, and thus doesn’t really capture manufacturing advantage. And of course, China gets to produce inside U.S. tariff walls.
Worse, as anyone who has purchased, say, sweaters made in China knows all too well, the product looks good at first glance but often turns out to be shoddy. In the case of the MBTA railcars, everybody now looks bad, from the MBTA management to the union labor, and nobody has adequate leverage over Chinese quality control.
Los Angeles is a variant on the theme. In one of the earliest such deals, dating to 2008, a Chinese company based in Shenzhen agreed to build a new factory in Lancaster, California, to turn out electric buses for the L.A. transit district. The American subsidiary was named BYD, for Build Your Dreams.
But when the first buses rolled off the line in 2015, they turned out to be plagued with defects, ranging from failing to meet specifications on range to wheels falling off. According to an investigation by the L.A. Times, internal emails show that agency staff called them unsuitable, poorly made, and unreliable for more than 100 miles.
In 2017, after negotiations with unions and the community group Jobs to Move America, BYD agreed to go union. With more worker feedback and a community benefits agreement that includes apprenticeship and pre-apprenticeship training, the defects began to improve, according to Hector Huezo, California director of Jobs to Move America.
We need to create a truly domestic railcar and electric bus industry from the ground up, not one based on Chinese transplants. And that need extends to a number of other industries.
While Biden’s several industrial policies are a good start, they don’t solve the problem when the U.S. has lost production and engineering capacity altogether. In the case of industries such as railcars or the chemicals for pharmaceuticals, we may need to look to the World War II example, where government sometimes partnered with existing companies as contractors and sometimes created industries from scratch.
The Defense Production Act potentially gives government that authority. And in California, the state has gone into the business of manufacturing generic insulin.
The Biden administration has changed the direction of policy and ideology. But if we are serious about containing China and rebuilding domestic production, the challenge has just begun.
