Global reset – Economic decoupling (Part 3: US decoupling – Costs, flaws and revising the strategies)
Phuah Eng Chye (15 January 2022)
The US, and the West, has struggled to formulate a coherent response to China’s rise. The US has set itself on a path towards decoupling but the heavy costs suggest there are flaws in the decoupling strategies.
Decoupling costs
A study, co-authored by the U.S. Chamber of Commerce China Center and the Rhodium Group, warns “disengagement expectations have broadened from trade and high-tech FDI to include most all areas, ranging from the flow of goods and portfolio investment to restrictions on journalists and students. In each of these channels, the state of play has moved from concept to implementation. Comprehensive decoupling is no longer viewed as impossible: if the current trajectory of U.S. decoupling policies continues, a complete rupture would in fact be the most likely outcome”. “Trade is way down from the 2017 benchmark…two-way FDI is at a decade low; tourism and student exchanges were projected to decline even pre-pandemic and now have plummeted; and supply chains in telecommunications and semiconductors are being profoundly and permanently cut by Washington’s view of China’s technology national champions as national security risks”. “Military-to-military engagement has been irregular; diplomatic relations have been curtailed with the closure of consulates; cooperation in international organizations, including the WTO and WHO, has been curbed. Decoupling is real, and given bipartisan support for it in the U.S., it is likely to endure in one form or another”.
“A robust accounting of aggregate costs from a hard decoupling scenario would run to the hundreds of billions of dollars annually, and a full decoupling scenario would be even more costly. Lost welfare gains from trade liberalization; shrinking export markets; written-off assets built up over decades; and disrupted U.S. jobs, investments, and expectations predicated on trillions of dollars of annual trade and investment between the world’s two largest economies: these are the stakes”. The US Chamber of Commerce-Rhodium Group study assessed aggregate costs of decoupling to the US economy as follows:
- The US would forgo $190 billion in GDP annually by 2025 if 25% tariffs were expanded to cover all two-way trade.
- US investors would lose $25 billion per year in capital gains and potentially experience one-time GDP losses of up to $500 billion if decoupling leads to the sale of half of the U.S. foreign direct investment (FDI) stock in China.
- The US would lose between $15 billion and $30 billion per year in services trade exports if future flows of Chinese tourists and education spending are reduced by half from their pre-COVID levels.
In addition, US manufacturers face substantial disruption and opportunity costs and would be challenged by “reductions in market growth outlook, capacity expansion, hiring plans, research budgets, and long-term competitiveness…face heavy secondary impacts in third countries, and these impacts will deepen costs and competitiveness challenges”. “One particularly important intangible concern facing companies is the loss of their reputation as a reliable partner” as “reliable supplier anxieties about U.S. partners are not just a concern limited to doing business in China, but extend to U.S. business relationships around the world”.
In the semi-conductor industry, “policy uncertainty – be it the constant risk of additional tariffs, broader export controls, U.S. content rules, or other technology restrictions – makes U.S. firms less reliable partners and suppliers in global markets that take decades of research, design, high-skill training, and capital expenditure to secure. This not only reduces Chinese OEMs’ willingness to acquire U.S. chips but also creates risks for firms in allied countries that may be forced to sacrifice access to the world’s largest and fastest-growing semiconductor market in order to continue working with U.S. chipmakers. Hasty decoupling that forces foreign firms to de-Americanize their semiconductor activities because they are unwilling to disengage with China threatens U.S. chipmakers’ foundational position in global technology value chains and the attendant strategic benefits to U.S. security interests”. In addition, “having Chinese rather than U.S. and allied IP at the foundation of new technology value chains and global technology standards could create comparative advantages for China that last for decades”. “Given the importance of semiconductors to U.S. national security, the U.S. should consider the merits of targeted federal investments to create a stronger semiconductor supply chain on U.S. soil…Yet it should also accept that, due to no obvious substitute for the large and growing Chinese market, it is critical that U.S. chip firms retain access to the Chinese market and are able to reinvest revenues from their China sales back into US-based chip production and R&D to maintain their global leadership position, enabling the U.S. to set the standards for the future. This outcome is preferable to a bifurcated global semiconductor ecosystem that diminishes overall U.S. leadership and influence over the global development of new technologies”.
In goods with high substitutability such as lower-value-added chemicals, the vacuum left by US decoupling could be quickly filled by competitors. “The biggest implication is that U.S. import tariffs diminish the competitiveness of U.S. manufacturers. As the price of doing business with U.S. companies rises under tariffs, foreign competitors simply become lower-cost suppliers in global supply chains”.
The US Chamber of Commerce-Rhodium Group study also envisaged “U.S. business R&D at home to support operations in China would fall and companies from other countries would reduce R&D spending related to their China ambitions in the U.S. The longer-term implications could include supply chain diversion away from U.S. players, less attraction for venture capital investment in U.S. innovation, and global innovation competition as other nations try to fill the gap”. “Decoupling is likely to shrink the talent pool that industries of the future will draw from, adding to the risks facing U.S. technology and innovation leadership”. In addition, portfolio investment flows from China could be deployed elsewhere and this would diminish “the central role of the U.S. as the crossroads of global capital flows”.
Jiakun Jack Zhang and Samantha A. Vortherms note the tariffs are aimed at pushing “more companies to divest from China and shift supply chains to the United States. Tariff proponents argued the setbacks to the Chinese economy would give U.S. negotiators more leverage over China at the negotiating table”. Instead, tariffs “resulted in collateral damage to the U.S. economy without pressuring China to change its economic policies”. They “estimate that less than 1 percent of the increase in U.S. firm exits during this period was due to U.S. tariffs. And U.S. firms were no more likely to divest than firms from Europe or Asia…Most of these firms are already in China, for China…most U.S. companies adopted an apolitical strategy. They didn’t exit China, but also didn’t put public pressure on Washington to roll back the tariffs…Smaller companies and those newer to China were more likely to exit. Firms with older and larger subsidiaries in China face higher sunk costs from leaving China altogether, which makes them more likely to continue China operations…And despite the trade war, foreign investment inflows into China grew by 4.5 percent from 2019 – and hit a record $144.37 billion in 2020. There’s little sign that U.S. multinationals have embraced the idea of decoupling from China”.
Flaws in decoupling strategies
Aside from inconsistencies due to the administration changeover, there are several strategic flaws.
First, strategic goals of decoupling are unclear. Perhaps, it was initially intended to exert pressure on China to change its behaviour. When this didn’t happen, there didn’t seem to be a follow-up plan. At most, it is interrupting China’s technology advance and expansion into Western markets. In any case, China has blunted the impact of decoupling by expanding in emerging markets and re-circulating Chinese spending on foreign goods and services within its domestic markets. In contrast, decoupling costs have been significant for the US. The burden of measures such as tariffs and sanctions (including on Hong Kong) seems to have fallen on US consumers, investors and MNCs. While decoupling reduces the benefits of globalisation to US firms, it doesn’t generate compensating benefits for US workers. In fact, US workers are likely to lose out on spin-off benefits of globalisation such as cheaper goods and reverse investment inflows. In addition, the negative impact of decoupling on global growth and cooperation comes at an inopportune time with the US struggling to cope with the pandemic and large fiscal deficits. Longer-term, it does not appear likely that decoupling can stop China’s expansion, change its behaviour, reverse US deficits nor catalyse meaningful production reshoring. Neither will it preserve US or Western domination of the global order. This suggests a need to rethink the strategic goals of decoupling.
Second, as an ancient Chinese military adage advises, war should not be waged over a broad front. In this regard, the US has misread the whole-of-government approach to launch an all-out attack across a broad front – trade, human rights, China’s border disputes, its political ideology, state enterprise, technology, data, education, finance and knowledge. In my view, a whole-of-government approach should be predicated on coordinating vast resources to attack specific targets. A broad front, as epitomised by containment, is a flawed strategy. The US will find itself increasingly preoccupied with managing conflicts and trade-offs among allies, needing to offer concessions, and policing and enforcing to stop evasion and defections. This is not a viable long-term strategy as the US is spreading its resources too thinly to cover the expansion in vulnerabilities. As it shifts its focus to the Indo-Pacific, it leaves a vacuum in the Middle East. China can bid its time, make it costly for allies and pick its spots to break the encirclement. Allies also feel betrayed if and when the US cuts bilateral deals with China. Even if the encirclement is successful, it will mean a shrunken pie for the US and its allies.
Third, containment strategies are unsuited to the information age. How do you contain elements that are modular (individuals, data), ambiguous (intangible), transient (fluid, dynamic and subject to rapid obsolescence) and complex (converged, combinational)? The earlier cold war was physical with land troops and weapons used to demarcate and enforce boundaries. The current confrontation is being fought over individuals, firms, finance, technology and information. In the cold war, travel was prohibited and defecting Russian scientists and talent were welcomed by the West. In decoupling, Dan Wang thinks “the U.S. government’s attempt to keep China from stealing technology has degenerated into a squeeze on its own scientists…creating a climate of fear that chills legitimate scientific collaboration and may drive away foreign-born scientists who would otherwise make their discoveries in America”. In technology, there is no such thing as permanent chokepoints. The US and Western MNCs can temporarily control some gates but if they don’t maximise its benefits, these technologies will become obsolete and lose their value. China can “by-pass what the enemy holds”, leverage on its strengths of speed and scale to develop an alternative ecosystem. Containment is really a form of retreat whereas the US really needs a strategy based on advance.
Blayne Haggart argues “to the extent that the internet becomes the splinternet, it will not be because authoritarian challenger states have tried to seize power over the internet, but because the one state that has largely underwritten the entire project has decided that an internet based on its very self-interested version of internet freedom and maximized interconnection is no longer in its interest. When the hegemonic power decides that the rules change, they change. The irony is that these recent US actions are likely to diminish, not increase, US internet hegemony and power. Hegemony is driven by interdependence, the creation of indispensable connections with the hegemonic power at the heart of the deal. By attempting to sever all ties with China, the United States is not only creating a more splintered internet. It effectively is putting China, and likely many other countries, outside its sphere of influence”.
Fourth, US decoupling strategy lacks flexibility. Good strategies maximise the degrees of freedom. Instead, the US has adopted strategies that narrow choices without visible paths to resume cooperation. In this regard, the US have focused on issues such as human rights, border disputes and national security concerns where it thinks China will be unable to respond in kind. Backing China into a corner rachets up tensions and is useful for rallying support from allies and China’s neighbours. But this also puts China in a position where it sees little benefit in making concessions. This implies outcomes will be mainly determined by confrontation and retaliation; a game of chicken rather than diplomatic negotiations. It forces China to prepare to strike at the flanks to restore the balance of power; which the US doesn’t seem well prepared for. The harsh rhetoric increases the risk of a populist backlash to negotiating a settlement with China. This deprives the US of the flexibility to calibrate policies, such as trade tariffs, that are damaging its own interests. A better strategy is to guide diplomatic conversations and relations to a middle ground where there is room to negotiate and de-escalate.
Revising decoupling strategies
One often overlooked point is the strategic goal of decoupling is not, and should not be, a clear separation of the two economies. In this context, decoupling is a tool and should not be the ultimate objective. Decoupling should be used to minimise the risks posed not only by a rising China but by a changing global landscape as well. Consistent with this, there is room to revise decoupling strategies in the following manner:
- Calibrate the China policy. The China threat[1] functions as an expediency to unite divided political forces within the US. But it is also the main source of strategic flaws. It should not blindly pursue strategies that turn the US and China into each other’s problems rather than opportunities. The key question is whether the US-China relationship is a dependent or inter-dependent one. If it was a dependent relationship, then China had little choice but to comply with US wishes. Events demonstrate otherwise; that US-China has an inter-dependent relationship and indiscriminate attempts to contain China generally have significant adverse consequences on the US.
For example, James Galbraith thinks the China threat to the US semiconductor industry “is not some nefarious disruption of components or materials” but “a possible fall in the final demand”. “China is the world’s largest semiconductor market, both for home use and for incorporation into products sold elsewhere”. “Without the Chinese market, the American firms that presently dominate the high-end design processes would collapse”. He concludes “China is a now-developed country with about twenty percent of the human population; its advantages are stability and scale…cannot now be taken away without destroying the world as it is…But the US position, as an economy with only one-fourth the population, equally now depends on the Chinese market, and on downstream Chinese firms supplying applications to the world. While precautions against natural disasters and pandemics can be taken…the greatest risk to the supply chain…is disruption of normal trade relations with China. In short, as an objective economic matter…United States has an overwhelming interest in peace” and “the integration of the global economy cannot be undone”. For example, rather than seek across-the-board relocation of production chains out of China, a calibrated response would be to let China remain bogged down in low-value add industries.
The Committee on Capital Markets Regulation points out large-scale delisting of Chinese issuers “would potentially undermine the United States’ role as the world’s largest capital market. It could also cause U.S. investors to access these investments in overseas markets where they enjoy fewer protections than at home. In addition, these issues increase the risk that the United States and China engage in tit-for-tat escalation by, for example, further restricting investment in each other’s companies, which would segment global capital markets, undermine the efficient allocation of capital, and harm both sides. For instance, if policy disputes affecting U.S.-listed Chinese issuers remain unresolved, China may respond by reorienting its market opening away from U.S. issuers and investors and towards institutions from Europe and Japan”.
The calibration of US decoupling strategies should take into account the concerns of MNCs as their support is essential for decoupling strategies to be effective. Conversely, MNCs need clarity on government policies on their China operations and collaboration with Chinese firms and individuals to calibrate their long-term plans in an increasingly policy-driven environment. There is currently too much ambiguity and political vicissitude for them to cope with.
At the macro level, the US-China relationship has a central role in the global economy. If either US or China falters, there is undoubtedly a global fallout which would affect both countries. This highlights the need to avoid all-out policies with excessive costs and risks. This reflects the need for the US to be clear-minded and not eliminate opportunities to tap into China’s strengths and to leverage on globalisation to help itself. Towards this end, the US appear to be recalibrating by exploring “recoupling” options but it also seems to reducing policy space as some aspects of its policy is hardening.
- Managing the relocation of global supply chains. The relocation of global supply chains is a critical battleground for global power. Commerce Secretary Gina Raimondo[2] states “the US intends to initiate a new economic framework for the Indo-Pacific next year…we are equally focused on restrengthening our relationships with our allies – in Europe, in the Indo-Pacific and around the world…We don’t think everything can be domestically produced, so we want to work with our allies and friendshore.”
Nikos Tsafos argues “supply chain resilience is not just about building capacity in the United States. It would be foolish and counterproductive to turn away from international trade in a drive to reshore at all costs. Locating manufacturing facilities in partner countries is a necessary part of any sensible U.S. international economic strategy”. In addition, technological diversification is “an important element in supply chain resilience” and “a necessary part of technological leadership”. “Building manufacturing capacity in partner countries could support U.S. firms with leading technologies and could create new trade routes that bypass or lessen China’s dominance”. He cites the recent $500 million loan granted by the U.S. International Development Finance Corporation (DFC) “to First Solar to build a solar manufacturing facility in India. First Solar’s cadmium telluride (CdTe) thin-film technology is an alternative to crystalline silicon, an industry now dominated by China…First Solar is a technological and regional counterweight to China: it has a differentiated technology, and its manufacturing footprint goes from the Midwest to Southeast Asia, a key battleground in the geopolitical rivalry between the United States and China”.
The strategy of strengthening its industrial production backyard to displace China face several challenges. First, the US should be cautious of adopting China’s whole-of-government and industrial policy approaches. This approach works in China because the government control many levers of decision-making. In the US, government policies are subject to intense negotiations, scrutiny and, too often, lawsuits. The US needs a more agile approach that balances government “intervention” and commercial decisions to minimise costs and failures. Second, it needs to consider how it would manage competition for production facilities among other countries and MNCs. Third, candidates (such as Mexico and India) were disadvantaged by structural impediments – such as trade, investment and licensing barriers; political, legal and social instability; and infrastructure deficiencies. If these countries are unable to overcome their impediments, then relocation strategies are unlikely to come to fruition. Fourth, as new locations come onstream, it will lead to a situation of excess capacity, intense competition for resources and shrinking export opportunities. On the demand side, market access would be reduced by governments protecting their preferred suppliers.
- Redefining the US role in a changing global landscape. The focus on China misses the larger context of challenges from a changing global landscape causing US dominance to fade. In this context, the Biden administration has discarded the Trump “isolationist” approach by shifting from America First to Allies First with the aim of squeezing China’s space and “maneuvering them into unfavorable positions, frustrating their efforts, precluding their options while expanding our own, and forcing them to confront conflict under adverse conditions”[3]. But the US may have overlooked the threats posed by the rise of other countries. The confrontation with China may end weakening the bargaining position of both superpowers and helping other countries to rise.
On its part, China seems to be making steady progress in building an alternative international ecosystem (such as BRI). In contrast, the US doesn’t seem to recognise the limits of traditional weapons (e.g. sanctions) nor the declining prestige of traditional groups (such G7). The creation of multiple forums (QUAD, AUKUS) is just adding to the confusion by further fragmenting its alliances. While still in the driving seat, the US should take the opportunity to redefine its global role in cognizance of a more assertive or “autonomous” world.
- Set goals and KPIs for decoupling. How would you know if decoupling strategies are on the right track and what would constitute success? The current strategies do not seem to address US needs and, in fact, may make it more difficult for the US to overcome its economic and social challenges. There is a need to clarify decoupling goals and establishing milestones to track progress. Possible indicators include progress in diversifying sources of imports, reducing imports, relative connectivity and openness of own and partner economies and leadership in technology and innovation. Greater emphasis should be placed on factors critical to US’s future success as backsliding (rather than advancement) would negate any advantage gained from decoupling. Examples of goals includes entrepreneurship, education, infrastructure, equality, and its robust democracy (including free speech, rule of law and freedom of individual choice).
Conclusion
Decoupling is a means of acknowledging the reality the US and China are on divergent paths. But the evidence is that the US decoupling gameplan is faulty and that its strategic bearing needs to be corrected. In particular, it needs to inject greater realism (and less politics) into its strategies and enhance its contingency planning when events don’t go the way as expected.
China has the advantage of the clarity of its long-term vision and its ability to adjust rapidly to changing situations. In contrast, the US is handicapped by being over-extended and bogged down by legacy. It is not an issue of tinkering with its decoupling strategies. The main challenge for the US is to reinvigorate its vision for the 21st century.
References
Anthony H. Cordesman (6 January 2021) “The Biden transition and U.S. competition with China and Russia: The crisis-driven need to change U.S. strategy”. Center for Strategic and International Studies (CSIS). https://csis-website-prod.s3.amazonaws.com/s3fs-public/publication/2020811.Burke_Chair.AHC_.GH9_.pdf
Blayne Haggart (3 September 2020) “The last gasp of the internet hegemon”. Centre for International Governance Innovation (CIGI). https://www.cigionline.org/articles/last-gasp-internet-hegemon
Bloomberg (18 November 2021) “US to launch a new Asia framework”. Taipei Times. https://www.taipeitimes.com/News/biz/archives/2021/11/18/2003768049
Committee on Capital Markets Regulation (October 2021) “Assessing the future of U.S listings by Chinese companies: A call for structured dialogue”. https://www.capmktsreg.org/wp-content/uploads/2021/10/CCMR-Report-Future-of-US-Listing-by-Chinese-Companies-10.22.2021-004.pdf
Dan Wang (18 December 2021) “China hawks don’t understand how science advances”. The Atlantic. https://www.theatlantic.com/ideas/archive/2021/12/china-initiative-intellectual-property-theft/621058/
James Galbraith (25 June 2021) “China and supply chains – The White House review’s focus on US dependence”. Originally published at the Institute for New Economic Thinking website. https://www.nakedcapitalism.com/2021/06/james-galbraith-china-and-supply-chains-the-white-house-reviews-focus-on-us-depenedence.html
Jiakun Jack Zhang, Samantha A. Vortherms (22 September 2021) “U.S. tariffs on Chinese goods didn’t bring companies back to the U.S., new research finds”. Washington Post. https://www.washingtonpost.com/politics/2021/09/22/us-tariffs-chinese-goods-didnt-bring-companies-back-us-new-research-finds/?utm_source=reddit.com
Nikos Tsafos (10 December 2021) “DFC deal to boost U.S. solar industry and strengthen clean energy supply chains”. Center for Strategic and International Studies (CSIS). https://www.csis.org/analysis/dfc-deal-boost-us-solar-industry-and-strengthen-clean-energy-supply-chains
Phuah Eng Chye (5 June 2021) “Global reset – Two whales in a pond”. http://economicsofinformationsociety.com/global-reset-two-whales-in-a-pond/
Phuah Eng Chye (18 December 2021) “Global reset – Economic decoupling (Part 1: China’s socialism big bang)”. http://economicsofinformationsociety.com/global-reset-economic-decoupling-part-1-chinas-socialism-big-bang/
Phuah Eng Chye (1 January 2022) “Global reset – Economic decoupling (Part 2: China’s global discourse for the 21st century)”. http://economicsofinformationsociety.com/global-reset-economic-decoupling-part-2-chinas-global-discourse-for-the-21st-century/
U.S. Chamber of Commerce China Center, Rhodium Group (2021) “Understanding U.S.-China decoupling: Macro trends and industry impacts”. https://www.uschamber.com/sites/default/files/024001_us_china_decoupling_report_fin.pdf
US-China Economic and Security Review Commission (November 2021) “2021 Report to Congress”. https://www.uscc.gov/sites/default/files/2021-11/2021_Annual_Report_to_Congress.pdf
[1] See the 2021 US-China Economic and Security Review Commission report to Congress.
[2] See Bloomberg.
[3] See Anthony H. Cordesman.