China-US decoupling will mean poorer world and no real winners, IMF warns
- International Monetary Fund report shows focusing foreign direct investment among geopolitically aligned countries could reduce global output by around 2 per cent
- Report suggests China and closely associated Southeast Asian economies are likely to suffer the most
China and closely associated Southeast Asian economies are likely to suffer the most as a more divided global investment landscape driven by geopolitical tensions takes shape, the International Monetary Fund (IMF) has warned.
But while the US and its allies may appear to be “relative winners”, they are also likely to face considerable economic costs as they pursue stronger national security or technological leadership, according to an IMF report released on Wednesday.
The report said the strategy of focusing foreign direct investment (FDI) among geopolitically aligned countries could reduce global output by around 2 per cent in the long term.
Although few believe a full break-up between the world’s two largest economies is on the horizon, the geopolitical rift between Beijing and Washington is widening, casting a shadow over the world economic outlook.
This decline has been extremely uneven across regions, with the emergence of relative winners and losers as both source and host of FDI
The IMF report used modelling to predict the long-term effects of FDI fragmentation, amid increasing concerns that business communities and other countries will be caught between the two powers if they proceed with a partial decoupling.
Disrupted supply chains in the wake of the Covid-19 pandemic and the fallout from Russia’s invasion of Ukraine have added to the strains on the existing architecture of global economic integration.
Global FDI declined by almost 20 per cent from the second quarter of 2020 to the end of 2022, compared with the post-global financial crisis period measured from the first quarter of 2015 to the first three months of 2020, the IMF report said.
“This decline has been extremely uneven across regions, with the emergence of relative winners and losers as both source and host of FDI,” it said.
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The researchers found that Asia had become less relevant, both as a source and destination of investment, losing market share vis-à-vis almost all other regions.
Notably, FDI to and from China fell by even more than the Asian average, while the US and Europe saw smaller declines of flows and even increases in some cases.
Outward direct investment from the US to China shrank by much more than the average global decline, but American investment to other regions – particularly emerging European markets – was more resilient, the report said.
Against a backdrop of speculation that Vietnam will dethrone China as the world’s factory, the IMF report labelled Hanoi as one of the “relative losers” among the biggest recipients of US direct investment.
Rising geopolitical tensions are a key driver of FDI fragmentation, as bilateral FDI is increasingly concentrated among countries that share similar geopolitical views
“Relative winners” included Canada and South Korea, which are politically closer to the US, the researchers found.
“Rising geopolitical tensions are a key driver of FDI fragmentation, as bilateral FDI is increasingly concentrated among countries that share similar geopolitical views,” they said.
“Fragmentation – and specifically the lack of recovery of FDI to China – is even more apparent for foreign investment in [research and development] and in specific strategic industries, such as the semiconductor industry,” the report said.
Both the US and the European Union have launched initiatives to strengthen domestic chip production and reduce reliance on imports through export controls and other measures.
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Washington last year updated its restrictions on China’s access to high-end US chip technology, equipment and even talent. And in March, the Commerce Department issued detailed rules under the Chips Act to curb firms taking federal funds from expanding in China.
The Netherlands and Japan are the latest countries to join the US-led export controls effort.
Japan last week said it will restrict exports of 23 types of semiconductor manufacturing equipment. China’s commerce ministry responded with a call for Tokyo to correct its “wrong practice”.
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It was the first time China has targeted a US semiconductor company, in a move seen by some analysts as a “warning signal” to its neighbours amid the increasing tech tensions.
Modelling by the IMF researchers indicated that emerging markets are more vulnerable to the shift in foreign investment than advanced economies.
The team developed simulations centred on the hypothetical prospect of a China-US decoupling “which is likely to be the most economically consequential form of fragmentation”, they said.
The report estimated global output at about 1 per cent lower after five years if the world splinters into US-centred and China-centred blocs, with India, Indonesia, Latin America and the Caribbean remaining nonaligned.
A fragmented global economy is likely to be a poorer one. While there may be relative – and possibly absolute – winners from diversion, such gains are subject to substantial uncertainty
Losses would be likely to further increase, with the cumulative impacts of lower investment inflows on capital stocks and productivity driving long-term output lower by 2 per cent, it said.
In this scenario, the deepest losses would be felt by Southeast Asian countries in the China bloc, while the impact on the Chinese economy would be greater than the effects on the US and EU.
But the IMF warned that the consequences for the US bloc would also be “non-negligible”, given the strong economic links of some members – such as Japan, South Korea and the European Union – with China.
“A fragmented global economy is likely to be a poorer one. While there may be relative – and possibly absolute – winners from diversion, such gains are subject to substantial uncertainty,” the report said.
The IMF report also warned of the “large economic costs” of pursuing enhanced national security or maintaining a technological advantage over rival countries.
“These costs need to be considered carefully,” the report said, pointing out that they would fall on the leading country as well as those aligned with it.
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In a meeting last week with Premier Li Qiang in Hainan, IMF managing director Kristalina Georgieva said the organisation is ready to work with Beijing to deepen cooperation over economic policy regulation and prevent trade fragmentation.
Georgieva was in China for the Boao Forum for Asia, held in Hainan, as well as the China Development Forum in Beijing.
Chinese officials used the two conferences to step up a charm offensive aimed at reassuring foreign investors and multinationals, shaken by years of zero-Covid controls, geopolitical entanglements and Beijing’s higher focus on self-reliance.
FDI in China rose by 1 per cent to US$39.7 billion in January-February, a slowdown from the 8 per cent growth it saw throughout last year, according to Chinese commerce ministry data.
