Why Prospect of US-China ‘Decoupling’ Is Getting Serious
For companies weighing a presence in China, concern about not being in the game has tended to eclipse the risk of being caught up in the country’s geopolitical rivalry with the US. The benefits of access to China’s vast, skilled workforce, modern logistics and low manufacturing costs helped to drive US-China trade to a record last year, even as the pandemic continued to disrupt industrial supply chains. Now, there are nascent signs that a “decoupling” of the world’s economic superpowers, predicted during much of the past decade, is starting to happen. While US officials prefer to say they’re “derisking” trade with China, the term describes a more targeted approach to the same phenomenon.
1. What’s ‘decoupling?’
The obvious analogy is to personal relationships — decoupling being the opposite of pairing up. But trading partners can break up, too. The UK did that with the European Union through Brexit. And sanctions on Moscow forced many countries to ditch Russian exports. With China and the US, decoupling isn’t seen as an all-or-nothing proposition that ends in an abrupt divorce. Most experts say it will be a slow, steady reduction in their economic inter-dependence — China traditionally serving as the world’s factory floor, the US its biggest consumption engine. Decoupling is seen as one reason why Chinese President Xi Jinping courted French President Emmanuel Macron in April, or why the US struck a deal with Japan for minerals needed to make electric vehicles.
2. What are the roots of ‘decoupling?’
China joined the World Trade Organization in 2001, the heyday of enthusiasm for free markets. The US-China trading partnership, covering about $690 billion of goods last year, proved hugely beneficial to both sides and it has supercharged the global economy over the past two decades. But confidence in globalization started to subside with the shock of the 2008 financial crisis and the ascension in 2012 of Xi, who pushed to assert China as a top global power. Then Donald Trump rode his “Make America Great Again” slogan to the White House in 2017. He accused Beijing of unfair economic policies and launched a trade war, seeking to rebalance the US trade deficit with China with tariffs on Chinese products.
3. How have the tensions evolved?
Trump’s
successor, Joe Biden, has maintained a hard line on Beijing. His administration has attached urgency to cracking down on intellectual property theft by Chinese entities and shoring up national security with measures such as China-focused export controls and investment restrictions and by boosting access to critical minerals. A big objective of the US’s Inflation Reduction Act, for instance, is to reel in China’s market power over raw materials such as lithium, cobalt, nickel and magnesium — key ingredients for electric motors and batteries and other essential drivers of the green-energy transition. Biden’s $50 billion CHIPS and Science Act aims to do something similar to reshore production of high-tech equipment, such as semiconductors, and includes new rules that restrict China’s access to it. In an attempt to cool tensions, Biden’s White House, echoing the language of the European Union, has taken to calling its strategy “derisking,” rather than decoupling, a distinction that hasn’t eased concern in Beijing. US Treasury Secretary Janet Yellen in April warned “a full separation of our economies would be disastrous for both countries.”
China's Grip on the EV Supply Chain
The country dominates much of the battery industry
Source: BloombergNEF
4. What transactions are being affected?
The short answer: those on which tariffs and export controls are imposed. The Trump administration’s tariffs on about two-thirds of imports from China are still in place, while Biden has targeted sales of advanced semiconductors and the tools to make them. The impacts of such moves can be unpredictable, rippling across industries beyond those targeted by the measures. For example, measures to curb Chinese access to military technology could hit production of washing machines as they contain chips also used in missiles. Chad Bown, a trade expert at the Peterson Institute for International Economics in Washington, recently spiced up the decoupling debate with new research showing how some US imports can decouple from China while others reach new highs. Chinese imports that were still subjected to 25% tariffs in 2022 — goods like semiconductors, IT hardware and some consumer electronics — were almost 25% lower than their pre-trade war levels, his research showed. On the flip side, goods without any Trump-era tariffs were 42% higher.
5. Is decoupling showing up in overall trade data?
It’s hard to see tectonic shifts yet, but another dive into the weeds did unearth some evidence. According to a March report by the New York University Stern School of Business and parcel-delivery giant DHL, the US-China trade relationship is starting to show a “general pattern” of decoupling. This research said that in 2022, the share of imported Chinese goods as a percentage of total US imports fell to 16.6%, down from 21.6% in 2017 — the last year before Trump launched the trade war. The value of US goods exported to China in 2022 as a percentage of total US exports fell to 7.3% from 8.4% in 2017. The report concluded, though, that it’s too soon to announce the end of globalization and a split of the world economy into rival blocs. It’s more that globalization’s myriad relationships are changing as some of the biggest economies move on to find other partners or invest in themselves.
6. What is driving the fragmentation, apart from US-China tensions?
Part of the trend is a reaction to the Covid-19 pandemic, and the way supplies of a single component could be disrupted, throwing into disarray lean supply chains spanning the globe and jamming up production of a host of finished products across multiple regions for months. As a result, companies are seeking more resilient supply chains — padded with more inventories or outfitted with better visibility — as well as a diversification of sources. For some big companies, that means making sure China isn’t their only factory, or pulling out entirely, and setting up production in countries such as Vietnam, Mexico and Turkey. However, companies will find it difficult to replace the immense production capacity and relatively low costs that China offers.
7. Why is that?
For a company like Apple Inc., which has moved some assembly of its iPhones to India, China’s workforce and production ecosystem are virtually irreplaceable. The country has hundreds of smaller suppliers feeding into mammoth assembly plants, giving Apple the scale and flexibility to respond to demand. Also consider a recent Financial Times article that laid out China’s push to become an ocean shipping juggernaut, with an investment of at least $40 billion between 2016 and 2021 in coastal port infrastructure alone. China has 76 port terminals able to service ships carrying more than 14,000 20-foot containers, while potential rivals across South Asia have a combined 31, the paper said. So moving manufacturing away from China ultimately means higher costs for merchandise importers. “No country has built port infrastructure ahead of demand like China has, and thus the cost of re-sourcing — irrespective of where — will involve a transportation premium owing to comparable inefficiency of other countries’ transport networks,” Peter Tirschwell, vice president of maritime and trade at S&P Global Market Intelligence, wrote on Twitter. In other words, decoupling from China likely comes with costs for companies and, ultimately, consumers. The International Monetary Fund estimates the long-term cost to global output from economic fragmentation could be as high as 7%, an assessment that considers shocks including Brexit and Russia’s invasion of Ukraine.
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