First published: 16-03-2023
It is widely agreed that that China’s relentless and pronounced integration into the world economy over the last 3-4 decades propelled its rise to become a major economic power and the world’s top dog in exports and supply chains.
During this era, China acquired 3 economic personalities, first as a customer, then also as a feisty competitor, but now also, importantly, as a strategic adversary and rival.
It is of course, in this last guise, that China has acquired a rather more notorious reputation as more broadly defined national security concerns have clashed over the alleged and actual benefits of engagement.
Clearly these tensions are most acute in Washington and Beijing, but America’s allies and would-be partners in Asia from Japan down to Australia and from India to the Philippines, and pretty much all of the EU are hardly bystanders. On top of state interests, of course, there are also parallel and related interests on the part of multinational firms.
If the last 3-4 years have taught us all something, it’s about
- the fragility of supply chains that we used to think were resilient and predictable;
- the dangers of reliance on sole source suppliers and the need for greater diversity of supply; and
- given the rising focus on climate change mitigation, the significance of checking ESG boxes when it comes to sourcing and producing thousands of miles from home, or closer to one’s home.
The comments that follow are mostly about the US and China, and about firms. But there really isn’t any place to hide for other countries and firms. However much they might like to think they have different interests from the US, prefer not to take sides in Sino-US rivalry, or maybe even are partial to a sort of promiscuity of interests that span US and Chinese positions over time and variously, it seems increasingly likely that where national security is concerned, everyone will have to get off the fence sooner or later. Recent developments in Asia involving Japan, South Korea, and the Philippines for example even India to a degree, suggest the pressures are leaning this way.
China is disengaging, self-relying
Decoupling is not a one-sided phenomenon, propagated by politicians in liberal leaning democracies, as the Chinese narrative sometimes suggests. China, itself, has been actively pursuing forms of disengagement for many years, notwithstanding its centrality in the global economic system. In recent years, not much time passes without Xi Jinping or senior leaders advocating for self-reliance. Indeed, the term figured prominently at the 20th Communist Party Congress in October 2022 and at the just concluded National People’s Congress in March 2023.
As is well known, China’s support for Putin’s invasion of Russia has underscored Beijing’s desire to loosen its links with the liberal democratic order and establish new governance systems and arrangements that are more in keeping with the CCP’s own standards, systems and beliefs. Much of the effort of disengagement is occurring in the things China excels at, like manufacturing, or wants to ringfence as national security. Above all, China wants to sanction-proof its economy, for fear that the US and others impose additional sanctions related to supporting Russia, or to human rights, but most importantly in the event that Taiwan should become a military bone of contention.
China has long campaigned against the US dollar’s and America’s dominance of the global monetary system, while remaining deeply dependent on it. It probably doesn’t get the irony. Be that as it may, China is keen to push the Yuan’s case for internationalisation in trade and commerce, encourage other countries to hold reserves and establish swap lines in Yuan, and build financial infrastructure for payments and clearing that by-passes the reach of the US as well as other western financial agencies.
But wanting to displace the US dollar eventually and having the system and capacity to be able to do this are two entirely separate things, and it is not likely that the Yuan will make any material headway in this direction for the foreseeable future – and certainly not as long as China maintains both strong trade surpluses because its savings exceed its investment, and tight controls over the outward movement of capital. Unless either one of these gives way, and China is committed to both, the Yuan will be an also ran. Nevertheless, China will try regardless to paddle its own canoe, at whatever cost it brings.
To return to manufacturing, the truth is that China is as anxious to de-americanise its own supply chains, as the US is to de-sinify its own. And no one would imagine for a moment that this isn’t part of China’s long-run objective is to change the global governance system in its interests, and to struggle to prevail as the world’s dominant power in commerce, science and technology.
It’s hard to be precise about when self reliance became a feature in China, but China’s industrial policy has always been biased to favour local firms from the era of ‘indigenous innovation’ to the releases of the Made in China 2025 strategy in 2015, and subsequently multiple others including on AI, semiconductors, quantum computing, battery and electric vehicle technology and so on. The emphasis has certainly deepened under Xi as economic growth per se has become relatively devalued in favour of technological dominance, national security and political control.
The 20th Party Congress certainly endorsed this emphasis while the political and administrative reforms announced at and after the National People’s Congress in 2023 affecting science and technology testify to an intensified, party-state effort to ‘do it yourself’ in this essential area.
The CCP’s policy infrastructure basically has 3 features:
- to eliminate dependencies on foreign countries and firms for critical technologies and products on which it still depends a lot even though these sectors are billed as Chinese, for example, technology, smart phones, semiconductors, cloud services, AI, aerospace, batteries and EVs, and machinery;
- to facilitate the domestic dominance of local firms; and
- to leverage domestic strengths into global competitiveness and dominance, not least by exploiting China’s relations in the Global South via the Belt and Road and the newer Global Security and Civilisation Initiatives
These features can also be found in the campaign or concept known as Dual Circulation Strategy (DCS), first embraced by Xi in 2020. The rhetoric accompanying DCS was about the domestic circulation of goods and services joining the international circulation to deliver a more balanced economy.
The interesting parts of DCS though are
1) that it is inherently contradictory since international circulation depends on high levels of global competitiveness which require the suppression of wage costs, while domestic circulation requires high levels of wages and salaries to promote domestic demand; and
2) that it is as much a political concept, as an economic one. To the extent, it looks to favour domestic firms, it entails
- quite specific policies of purchase and supply from which multinational and other foreign firms will sooner or later be excluded or marginalised;
- the widespread use of subsidies, state funding and soft budget constraints to bolster local champions – it’s estimated that about $500bn of R&D funding has already been provided under a range of MIC25 initiatives; and
- a range of extractive polices to acquire know-how and products from foreign firms including JV, technology transfer and licensing requirements.
China’s policy of self reliance or disengagement is of course strong on intent, but highly uncertain as regards outcome and effectiveness. An Economist magazine investigation found that China’s attempts at self-reliance are least likely to work where supply chains are longer and more complex. These included MRNA vaccines, agrochemicals, aerospace, semiconductors, computer operating systems and payments systems.
Part of the problem China faces is that while self reliance is designed to promote local firms, these same firms suffer when they are shut off from foreign competition and expertise.
As is the US
The more conventional side of the decoupling discussion, hinges a lot around initiatives in the US but it is easy to point fingers, as China’s narrative does, and cast the US political establishment as a villain of the globalisation peace, so to speak. However, this is to overlook, if not ignore, many years in which China has exploited its ‘emerging market’ status to persist with and indeed deepen non-market activity and structures, and under Xi Jinping, the sea-change in the CCP’s governance structure with regard to economic, financial and foreign policy. If there has been a disengagement from the global system since 2012, it has surely been at China’s instigation as it has pursued a much more nationalistic industrial policy and ideological agenda.
US National Security adviser, Jake Sullivan, said in 2022 that ‘The post Cold War is over, and a competition is underway between the major powers to shape what what comes next’.
The ‘what comes next’ phrase is doing a lot of work here, and it’s important to note that the competition – also with the EU and other liberal leaning democracies – isn’t about who can come up with the best stuff and make the most money out of it, which is what the great US-Japan arguments were about in the 1980s and 1990s. Rather, it is about who will be in pole position when it comes to governance, standards and the values underlying human interactions and exchange.
It is in this light then, that at the government level, we can now see an infrastructure of restraint aimed at China that the US government has built since 2018 in the Treasury, the Department of Commerce, the US Trade Representative, the Department of Justice and Congress. Congress already scrutinises closely inward investment into the US, and is considering legislation now that would do the same to outward investment too.
During 2022, moreover, the Congress approved important pieces of legislation proposed by the Biden Administration including the so-called Inflation Reduction Act, which is predominantly about climate change mitigation and putting US firms back in the manufacturing driving seat, and the Chips and Science Act, which authorises the investment of $280 billion to underpin and strengthen US semiconductor capacity and R&D, and create regional high-tech hubs and a bigger STEM workforce.
Further, in October 2022, the US government widened significantly the export control, licensing and investment screening machinery, designed to restrict Chinese firms’ access to US semiconductor technology, through the introduction of complex regulations. These differed from preceding initiatives in that it is no longer individual Chinese firms that are named and targeted, but the entire Chinese advanced semiconductor sector.
Make no mistake. The US strategy is to change the geography of semiconductor and advanced technology supply chains in the 2020s and beyond, by not only encouraging leading firms to invest outside China (preferably in the US), but also restricting China’s access to technologies on which it (so far) depends heavily.
By acting unilaterally, the US government could have created a rod for its own back, but in the early months of 2023, it will have been pleased to learn that not only had Japan and the Netherlands, as well as Taiwan, effectively signed up to the new US export control regime, but that a rapprochement of sorts between South Korea and Japan may well have brought the former on board too. This would then pretty much tie up all of the world’s major semiconductor states. More on this at the end of this piece.
Firms are decoupling
It is certainly fair to say that decoupling or disengagement, defined as the unravelling of decades of economic integration, is not going to happen quickly or any time soon, in the absence of outright conflict. But the Russian invasion of Ukraine tells us that when push comes to shove, it can. Of course, Russia is no China, and the latter plays an essential role in global commerce and the world economy.
Yet, as already stated, both the US and China are intent on lowering the intensity of their involvement, and we have no reason to believe they will not persist or succeed.
Multinational firms will also be the agents of this trend, notwithstanding regular denials.
For example, Evan Greenberg, a former chair of the USA China Business Council and Chubb CEO, said earlier last year that decoupling was an economic impossibility. Like many other corporate titans of course, he has vested interests.
It is certainly true that if you are looking for evidence of decoupling in trade, much as former President Trump tried to convince us to do, you will not find what you are looking for.
For the record, while total trade between the US and China amounted to about $655 billion in 2017, it was almost $730 billion in 2022. Exports rose about $24 billion to $154 billion, and imports from China rose over $32 billion to $537 billion. So, no decoupling then. Or maybe it’s more nuanced.
First, given that trade flows are subject to many things, not least business cycles and the pandemic, you should try and see where trade flows are relative to what they might have been if the pre-Trump had prevailed, and in this respect, it is possible to say that US exports and import are well below trend.
Second, in any case, trade flows and values are determined not so much by tariffs as by domestic factors, notably savings and investment. The Trump school of trade never exhibited an awareness of this but economists know better how trade is determined.
On the other hand, you can most certainly find evidence of decoupling in data on foreign direct investment, for example. Back in 2015-16, tens of billions of dollars of Chinese investment poured in to US, and into venture capital deals in which there was at least one Chinese investor. Ever since then, the flows have pretty much dried up. Two-way flows of US foreign direct investment in China and Chinese foreign direct investment in the US are a long way from the highs reached in calmer times a few years ago, notwithstanding the US remaining a top slot in terms of favourite lace for FDI, and China having changed from a new provider of FDI to the rest of the world to a net recipient – and then only because of the way in which round-tripping flows from Hong Kong are recorded.
Decoupling evidence is also on ready display
- in the IT sector, where firms are having to establish parallel arrangements and standards in intellectual property, software and communications, and other technology areas where China and the US/others are building bifurcated systems
- among SMEs and other firms with less complex supply chains, which are looking at future investment elsewhere or recalibrating supply chains outside China
- in sectors in advanced technology, biomedicine, and hospital equipment where Beijing, for example, restricts market access and emphasises Chinese brands, or local content
- and among firms in China that have relatively low upstream exposure, ie to raw materials, components and production, and or to low downstream activity, ie to Chinese consumers directly.
The behaviour of foreign firms is now going to be key, especially in the wake of the abandonment of zero-Covid. Self-evidently, the relief at being able to rotate staff and travel and live normally will have been welcomed by foreign firms. However, while they were historically always willing to put up with the idiosyncrasies of the CCP’s operating environment, the zero-Covid experience and the sharper and more ideological governance system being established by Xi Jinping seems to be changing attitudes to business in China.
The CCP is not seen as fundamentally supportive of markets or private enterprise that doesn’t serve the party. Zero-Covid demonstrated a side to the CCP that may have been known but was on rude display. China-centric supply chains have proven to lack resilience and predictability. And geopolitics have already brought export controls, the blacklisting of firms, market access restrictions, sanctions related to human rights in Xinjiang and Hong Kong, and secondary sanctions risk in relation to Russia. Few business people expect things to improve any time soon.
Larger firms and those that are in China specifically to sell in to the Chinese market probably have every intention to stay, and, perhaps at worst, are looking to re-globalise not de-globalise, by investing elsewhere in Asia, such as Japan, India and Malaysia, or Mexico or Turkey.
Yet there is no question that companies are gradually being drawn into the crosshairs, where, whatever their corporate and shareholder missions, they are having to make choices about whose rules to follow and whose to flout.
The EU Chamber of Commerce, for example, representing more than 1,700 firms in China, issued a formal report on decoupling and on how its members were preparing for it. And in 2022, it formally stated that China’s government has allowed ideology to trump the economy, pointing out that roughly a quarter of its member firms are looking at future investment outside China.
And in an October 2022 survey, the American Chamber of Commerce in Shanghai stated that a record 52 per cent of its members’ parent companies had become less confident in China, while just over a third had already redirected investment to other foreign countries. Comparable sentiments were expressed in the Business Climate survey of the American Chamber in Beijing in a report published in March 2023.
Decoupling is still a bit ‘horses for courses’. Not every supply chain, sector or product is affected. But it is increasingly relevant in areas that impinge on national security, data governance, services, storage and transfer, and technology systems, where firewalls are being erected directly through market access and negative lists, and indirectly through the application of government-determined standards and licensing requirements.
It is also noteworthy that the US had also initiated measures under the Holding Foreign Companies Accountable Act to de-list up to Chinese firms that failed to comply with SEC audit requirements. Despite an agreement in August 2022 that Chinese firms would comply, it is not known to what extent this is in fact so, or whether a Chinese government stipulation that firms’ headquarters in China would not have comply is acceptable the US.
Postscript on semis
The regulations affecting semiconductors represent the most extraordinary form of decoupling, which will have far-reaching consequences.
By way of background, it is interesting to note that Apple, which unlike Samsung for example, remans heavily dependent on China supply chains, recently announced it was going to source US-made semiconductors from a new TSMC facility in Arizona, and relocate a rising share of iPhone and iPad production to India. There have also been reports that Samsung and Intel are constructing new fabs in Texas, Ohio and Arizona, and Intel is building a new fab in Magdeburg in Germany.
These projects are going to take time, but in a way, that’s the point.
As firms take on board the reality of doing business in a highly fractious geopolitical environment, the US gov wants them to think ahead to a time, say by 2030, when the industry landscape will have changed and when Taiwan accounts for maybe a half or less of advanced chips. In other words, a much more geographically diverse universe of advanced manufacturing of chips – and possibly other sectors too over the coming decade.
The new semiconductors export controls regime does not affect less sophisticated, consumer-sector chip applications, but does take a whole-of-industry approach to the advanced integrated-circuit ecosystem to address what the White House sees as a whole-of-government problem in China.
The regulations target high-end applications and functions involving the supply of inputs, tools, production and fabrication equipment, software, and the activities of Americans working in or for Chinese enterprises in the sector.
In addition to provisions for export controls for about a dozen different types of products and parts used in semiconductor production that were not previously subject to such controls, there are new regulations that apply specifically to China, which other restraints did not, at least by name.
US firms can no longer supply Chinese firms with advanced chip-making equipment unless they first obtain a licence. The new rules are also designed to prevent the supply of designated semiconductor-production items and transactions for specific end uses, such as supercomputers, AI, and semiconductor development and production. Moreover, US citizens and green-card holders are banned from working on certain technologies for Chinese companies and other entities, and from providing support and know-how to them.
The US government is clearly no longer willing to stand by while its principal adversary uses party-state acquisition and procurement policies to access sophisticated technologies, whether US-made or foreign-made with US inputs. It is particularly concerned about products that have so-called ‘force multiplier’ properties. In other words, semiconductor technologies that have ostensibly commercial uses, such as machine learning or climate modelling but which can be applied equally to advanced military applications and to the repression of human rights.
Inevitably there will be carve-outs, and bypass efforts, and we have already seen US firms lobby their own govt to dilute some of the restrictions, and Chinese firms re-HQ to Singapore or move entities to other countries as a way of getting round the regulations. However, in all likelihood the combination of stringent export controls in Industrial countries to contain China, and America’s own efforts to strengthen its own capacity to out-compete will have durable and meaningful effects in key, if not all national security and advanced industrial sectors.