Decoupling: Separation or Divorce?
September 28, 2020
A new term has penetrated the trade wonkosphere recently: decoupling. The term refers to the process of separating the Chinese and U.S. economies, but, of course, as with most things in economics it is more complicated than that. It is hard to tell what is going on, because what people say and what they do are not always the same, and it is hard to predict whether actions taken will be temporary or permanent—separation or divorce. It is also hard to allocate blame, or credit, depending on your point of view.
It does seem clear that the leaders of both countries are embracing decoupling. Xi Jinping has pronounced the United States an unreliable supplier, but even before that he was planning for China to develop global champions in 10 critical technologies with the explicit aim of competing against and ultimately displacing Western leaders in those sectors. This is reflected in the “Made in China 2025” initiative and will likely be a key element of the 14th five-year plan currently being drafted. His goal appears to be to make China independent of Western technology to the extent he can.
Meanwhile, the Trump administration has been encouraging U.S. companies to leave China and remove Chinese products from their supply chains and has been blocking Chinese investment in the United States, which has dropped dramatically anyway because of Covid-19 and Chinese efforts to limit outbound investment. Much of the administration’s argument is national security-based, as in the Huawei case, which is an easier sell to Congress and the public than more abstruse arguments. Both presidential candidates have advocated reshoring—bringing U.S. companies home—in varying degrees of detail. This is not exclusively aimed at China, but China is clearly a primary target.
But are people following their government’s lead? In China, they don’t have a lot of choice, although manufacturers there, as well as the government, know they remain dependent on Western products, particularly semiconductors, in the short term. So, the goal is aspirational, but the government is taking serious steps to implement it.
In the regular surveys taken by U.S. business associations in China, only a small number of respondents indicate they plan to leave, and majorities say they are not even considering it. Many U.S. companies are in China to serve the Chinese market in non-critical economic sectors and not to ship products back to the United States. It would make no economic or political sense for them to leave.
The dilemma for U.S. companies, particularly in the information and communications technology (ICT) sector, is that China is simultaneously their best customer and their biggest threat. They see what is coming but are reluctant to give up significant short-term profits. The Trump administration wants them to choose and is in the process of forcing them to do so by controlling the export of their technology. This will turn out to be counter-productive, as the companies plow their Chinese profits back into R&D. Blocking those earnings will make them less competitive in the long run and will compromise their ability to keep our military supplied with cutting-edge technology. So, there is pushback on the administration’s policy, and companies are waiting for the election results to see if they might produce a new president with a new policy.
The result is that in both countries reality is lagging behind policy and will probably continue to do so. Companies will attempt to do what makes economic sense for them in the absence of government compulsion to do something else. Of course, just as it may be economically sensible to stay put, sometimes it is sensible to move, not because of government pressure but because of economic realities. Wage rates in China have been rising for a long time, and companies where labor is a significant part of their cost of production have either left for countries with lower wages or are considering it. Many companies are considering shortening their supply chains—a trend that began before Covid-19 and that has accelerated since. Companies want to reduce transportation costs and times, want to be near their customers, and are increasingly concerned about supply chain reliability and resiliency. As the ongoing Chinese crackdown on its Uyghur minority illustrates, companies also have to worry about their association with upstream producers participating in human rights violations. That is not only an issue of government requirements but of concern about consumer boycotts. And, of course, the China tariffs—and their retaliation—are indirect pressure to rethink supply chains.
Last, keep in mind that decoupling and reshoring are not the same thing. Companies may decouple, but they will not necessarily come back to the United States, where production costs remain high. Big winners are expected to be Vietnam and Mexico, with other beneficiaries in Southeast Asia and possibly Central America. The result is that a government reshoring policy may be successful only at the front end. Companies may leave China but go somewhere other than the United States.
Where does this all lead? Decoupling will grow because both governments want it to and because some companies will find it in their economic interest, but it will be incomplete. That is not likely to change regardless of who wins the November election or as long as Xi Jinping remains in power. Unfortunately, that means we are heading for a fragmented global economy driven by government policy and increasingly separate internets driven by divergent internet governance policies. That is not in anybody’s economic interest, but the divorce may be too late to head off.
William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies in Washington, D.C.
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