Inertia is not helping China’s inland provinces

There is an interesting new Federal Reserve paper by Ryan Monarch that looks at some very detailed data on the relationships between US companies and their Chinese suppliers. The main finding is what he calls the inertia in these relationships: US importers tend to be reluctant to change Chinese suppliers, even to get a lower price. And when they do change suppliers, they often go to one that is located not very far from the old one. Here’s the key graphic and the author’s summary:


Two facts are clear from Figure 1. First, there is a significant share of U.S. importers who maintain the same supplier over time. Even though the number of potential exporting choices is increasing over this time period, the share of importers using the same supplier year-to-year is 45.9%. As a benchmark, given that there are an average of 30 Chinese exporters to the U.S. per HS10 product in the data, if importers were choosing their partners randomly each year, the probability of staying would be 1/30, or 3%. Thus path dependence is far higher than would be expected if importers were choosing their supplier randomly. Secondly, among those firms who do choose to switch, approximately one-third of all importers remain in the same city as their original supplier. Using a similar benchmark as above, random exporter selection would imply a 12-13% chance of staying in the same city. Thus there is strong inertia keeping firms in their original city, even if they choose not to use the same supplier as before.

Much of the rest of the paper is about how making it easier for US companies to find trusted new suppliers could lower import prices. I’m more interested in a different angle: what this importer inertia means for the Chinese suppliers and for regional development within China.

Chinese exporters are clustered in the coastal provinces, and for years people have been talking about how rising labor costs in those provinces will push manufacturing inland. The government has embraced this putative trend as a development strategy, building up infrastructure in the inland provinces to lower transport costs and actively encouraging relocation (see for instance this good Reuters piece on the drive to develop textile manufacturing in Xinjiang). Yet despite conventional wisdom and government policy, the inland provinces’ share of Chinese exports is only marginally higher than it was a decade ago.


Inertia helps explain why: existing trade relationships, concentrated in the coastal provinces, change only slowly, and when they do change the geographic shift is likely to be close. The need to maintain customer relationships is thus likely another reason for why manufacturers in the coastal provinces are not in fact so terribly eager to relocate inland. Here is a good observation from a recent Bloomberg article on Guangdong:

By moving elsewhere in China, factories may be able to trim wage bills or gain access to cheaper land, but they lose the concentration of suppliers, logistics and services that Guangdong has built up over 30 years. Gao Dapeng, CEO of Desay SV Automotive Co., which makes car navigation systems in Huizhou, said the overall cost saving of moving to an inland province like Chongqing is only about 10 percent, and it would mean the plant would be hundreds of miles from its suppliers. He said the company is not sure if the relocation is worth that.

It seems like the network effects and economies of scale and scope that China’s coastal provinces have developed are fairly powerful advantages, against which the cheaper labor and cheaper land in inland provinces are not proving as attractive as expected. Or to put it a different way, the cost of switching suppliers remains high, despite policies aimed at reducing it. The same issue could be affecting the lower-wage Asian economies who have been trying to grab export market share from China–which they have, but not as much as some economists expected, as Mark Magnier reports in the WSJ.


  1. That moving average may be somewhat misleading. In Jan-Apr 2016 the proportion accounted for by other provinces stood at 24.3%. The Foxconn relocations have likely changed the dynamic in a lot of places: to overcome inertia you really need a landmark firm to relocate, taking its suppliers with it or building a new network where it’s moved.


  2. I’d agree that having “anchor” factories (similar to how shopping malls have anchor stores) helps greatly to build up an ecosystem of suppliers and enable the buildup of industry in a new location. This has happened in Vietnam and elsewhere, with large manufacturers essentially bringing their supply chain with them and trail-blazing for other firms and SMEs to follow. I would say, however, it’s not merely that simple.Supply chain is definitely a huge factor, but there are others.

    One of the big issues creating inertia is the gap in rule of law between coastal provinces and the inland ones. Guangdong has a high level of reciprocity with Hong Kong in legal terms, it has relatively good rule of law in the industrialized areas, and the local government, if still “grey”, is not likely to show up one day and “appropriate” your factory. This is not going to happen in the PRD, but rural Hunan… no guarantees. I’ve had too many stories of local bosses trying to set up even within province in places like Chaoshan or Huizhou and being skint by the local locals.

    Human resources is another thing – and it’s a huge issue in running a manufacturing company in China. The absolute levels of engineers, technical personnel and sales/operations people are high, but the levels of experienced workers and management personnel… low. We set up a factory 100 miles outside of the PRD and simply couldn’t recruit experienced people out there. There were no locals with the requisite skills – everyone had to be brought in from other cities and paid accordingly. It’s another vital part of the supplier ecosystem that gets overlooked quite a bit.


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