Why economic decoupling to contain or punish China is doomed to fail

Economic decoupling is neither new nor radical. Rather, it represents the march of companies seeking new markets and optimising costs, while minimising the likelihood of disruption
China is simply too big a market and too integrated into the global economy to be contained or cut off

Simon Lacey

Published: 9:15am, 22 Oct, 2020

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Not a week goes by without a report about Western companies moving their operations out of China. Such reports mischaracterise the phenomenon as something new and unexpected, fuelled largely by the politics of great-power rivalry. In truth, and as usual, things are a little more complicated.

Reconfiguring supply chains away from one market or another is part of a longer-term trend underpinned by textbook forces of supply and demand, and the need for companies to hedge risks. This makes for dull reading, as it lacks conflict and does not portend an unprecedented or hugely disruptive unravelling of the global order, and thus life as we know it, so commentators barely bother to wade into the details.

But as big Asian economies developed their own large consumer classes, multinational companies have moved production closer to these customers. Wages in China have also steadily risen, undercutting its attractiveness as a low-cost manufacturing base.

Trump’s trade war and the impact of Covid-19 shutdowns have accelerated these trends, making it easier to present them as part of a new cold war.

Trump’s trade war put political risk front and centre for strategic sourcing decisions, while Covid-19 showed how China had become the sole or major source of supply for many critical inputs, exposing supply chain vulnerabilities that nobody had given much thought to during the decades-long drive to maximise efficiency.

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To separate long-term economic trends from short-term political posturing, business leaders and politicians need to consider three questions. First, what risks or vulnerabilities need to be addressed through supply-chain reconfiguration?

Second, to what extent are these risks or vulnerabilities mitigated by moving production away from politically contentious geographies (which include China and the United States) Finally, what costs would supply-chain reconfiguration impose on producers and consumers?

Any serious non-ideological analysis should produce answers that resemble something of the following.

First, businesses value certainty and predictability, which political risk can undermine. Also, supply chains can be made more robust and resilient by diversifying suppliers, but this strategy has its limits – for example, when an international disaster affects many or most markets in similar ways (like a pandemic).

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To answer the second question, business leaders and politicians need to think hard about how long and deeply they believe the current disruptions will last.

Some parts of the value chain can be moved, but both the US and China offer unique advantages simply unavailable to the same extent in other markets, at least not any time soon.

This limits companies’ flexibility to relocate elements of their value chains elsewhere, especially if they want to be close to their customers or to cutting-edge research and development capabilities, both of which the US and China are well-endowed with.

The third question can only be answered after a comprehensive supply-chain audit, but one thing is clear: decoupling will raise costs across the supply chain, costs that will ultimately be borne by consumers in the form of higher prices and less purchasing power.

Economic decoupling is nothing new, radical or particularly contentious. Rather, it represents the onwards march of companies seeking new markets and optimising production and transport costs, while minimising the likelihood of disruption.

No one from the global business community is talking about cutting off China completely. And despite the political rhetoric from Washington, US investment in China rose 6 per cent year on year in the first six months of this year in yuan terms.

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Moreover, China led the global economy to recovery after the 2008-09 financial crisis, and is likely to do the same after Covid-19. Companies know this, and consequently CEOs in the US, Europe, Japan, South Korea, Australia and elsewhere are making sure they keep one foot firmly planted in China, even as they seek ways to manage newly exposed political and supply-chain risks.

To be sure, China has lost some of its allure with rising wage costs, an ageing population and slower economic growth; and tensions with the US have added complexity to locating production or other elements of businesses there, even as China continues to reform towards a more open economy.

But Western companies are not about to abandon China en masse, nor is there any reason to think that their doing so would benefit the West. Even most of the recent reporting about technological decoupling is little more than tech companies hedging their bets with a China-plus-one strategy.

As politicians in Washington stoke tensions ahead of the US presidential election, it is all the more important to think about what is actually happening in the real economies where people live and work, and the repercussions that increasing tensions could have if allowed to continue unchecked.

Economic decoupling to contain or punish China is both nonsense and counterproductive, since it does not serve global interests. China as a market is simply too big and too integrated into the global economy to be contained or cut off.

Moreover, the economic relationships forged over many decades between the US, European Union and hundreds of other economies that make up the global trading system together with China, are far too important to be sacrificed on the altar of short-term political expediency.

This is not to deny that China’s rapid rise has proven disruptive or that its state capitalism involves profound challenges for the rules-based trading system. But trying to enforce an economic or technological cordon sanitaire to bring China’s leadership to heel, or somehow contain its growth, is guaranteed to fail and only serves to bring the world closer to conflict.

Simon Lacey is Senior Lecturer in International Trade at the University of Adelaide and was previously vice-president of trade facilitation and market access at Huawei Technologies, China

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