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August 24, 2020

Responding To: Is U.S.-China Decoupling Really Feasible?

Divorce Without Decoupling: The U.S. and China’s Messy Affair

Cathy Sun

Months into a global pandemic, pundits and Twitter citizens alike see the complete deterioration of U.S.-China relations as an inevitable cliff the two countries are barreling toward. With barbed hostilities and heated exchanges traded over a global health blame game, it is no surprise that many see COVID-19 as the final death knell to economic interdependence. The break between the United States and China will be far from clean, however, and it is a separation long in the making. Rather than a complete decoupling, the United States and China are facing something much more like a divorce—marked with flared tempers, deep suspicion, and inextricable claims over shared assets.

De-globalization is not news—it has been a trend for more than a decade. By 2018, foreign direct investment (FDI) had fallen by 70% from its peak in 2007, and international trade stagnated even before the novel coronavirus hit. Moves to diversify supply chains began at least since 2011, when natural disasters in Japan and Thailand heightened the importance of managing production risks. After this time, many non-Chinese companies adopted a “China + 1” sourcing strategy in developing production capacity. The U.S.-China trade war has, if anything, simply accelerated this process. Wang Tao, a managing director and head of Asia Economic Research at UBS investment bank in Hong Kong, described the long history of de-globalization during the event “U.S.-China Decoupling: Separating Myth From Reality” held by the Georgetown Initiative for U.S.-China Dialogue. According to Wang, global supply chain shifts had started occurring even before U.S.-China trade frictions, owing to factors such as lower labor costs, environment costs, and access to networks, that incentivized companies to move overseas. Moreover, China has long been seeking to establish its independence from the United States, particularly in import substitution. Dan Wang, a Beijing-based technology analyst at Gavekal Dragonomics, further noted at the same Georgetown event that Chinese FDI into the United States has long been declining over years while U.S. FDI into China has remained relatively stable in the same period, signaling Chinese intentions to decouple, but not necessarily U.S. desires to do so.

What the coronavirus has done, then, is to introduce a new dimension to de-globalization by providing additional justification for reshoring the production of security-relevant goods. Robert Lighthizer, the U.S. Trade Representative, has said the COVID-19 crisis highlighted the need for “strong and diverse supply chains with trusted trade partners” and how “depending purely on cheap imports for strategic products can make us vulnerable in times of crisis.” As countries around the world have awakened to their dependence on China for exports of protective equipment, some such as Japan and the United Kingdom have already outlined plans and funds to facilitate reshoring. Companies such as Apple, Google, and Microsoft have made efforts to increase production in places such as Vietnam and Thailand, and are considering shifting manufacturing capacity to countries like India and Mexico. In the near-term, the pandemic will likely and visibly encourage countries including the United States to localize more production to build resilience and strengthen independence. As Dan Wang emphasized, the developed world is now calling for a substantial reshoring of supply chains away from China.

But the process of decoupling will be far from a clean and easy separation, quite unlike the bombastic proclamations of U.S. President Donald Trump. The idea that the United States will simply be able to cut economic ties with China at any point is challenged by on-the-ground complications. U.S.-China trade currently shows no signs of slowing—in April, U.S. exports to China rose from a 10-year monthly trough of $6.8 billion to $8.6 billion, while imports from China sharply increased from $19.8 billion in March to $31.1 billion. According to the Rhodium Group, U.S. companies have also announced $2.3 billion in new direct investment projects in China for the first quarter of 2020, which is only a slight dip in 2019’s quarterly average, in spite of COVID-19. Politics and business may importantly intersect with each other, but they are distinct entities for a reason. Bill Reinsch, a senior adviser at the Center for Strategic and International Studies, highlighted that it took over two decades for the U.S. and Chinese economies to grow together, and decoupling will be no easy feat. “The president can’t simply order everybody to come home. Businesses will make rational, economic decisions,” Reinsch said. Moreover, faced with a global pandemic, many companies have been challenged by unprecedented demand shocks and forced to navigate in the dark—with reduced incentives to seek new investments. Diversifying production translates into new complexity and new costs, which companies are likely averse to at this time. This is evidenced by a survey from the American Chamber of Commerce in China, in which 70% of U.S. companies reported no plans to relocate production and supply-chain operations or sourcing in the short-term.

However, just because decoupling is slow does not mean it will not happen—though it will be far from decoupling in its truest sense. China is no longer the lowest-cost country for production, and labor-intensive manufacturing will likely move to Southeast Asia and countries like Mexico in the near future for economic reasons. COVID-19 has certainly also brought more political attention to economic vulnerabilities and the need for moving production closer to home, especially when it comes to medical devices and other security-relevant products. We will likely see accelerated diversification in pharmaceuticals and the semiconductor industry. However, complete economic bifurcation is unfeasible. Echoing Wang Tao’s words, the messy separation between the United States and China has been more so about diversification rather than decoupling. The vast majority of companies in China still only want to move less than half of their production capacity overseas, which is significant, but not radical. As of now, China still has advantages that will maintain its centrality in manufacturing, including mature supply chains, a massive market, well-built infrastructure, and skilled labor. There are also capabilities that China does not have, and relies upon other countries for, as highlighted by Jimmy Goodrich, vice president for global policy at the Semiconductor Industry Association. At the aforementioned event hosted by the Georgetown Initiative for U.S.-China Dialogue, Goodrich pointed out that in the electronics sector, semiconductor designing, building, and fabricating are largely diversified and outside of China. China dominates in the final stage of assembly, but even its front-end chip fabrication process is at least half foreign-dominated.

In short, while the United States and China are certainly headed towards reduced economic interdependence, they are still deeply intertwined in the supply chains and the markets—and perhaps for good reason, economic and otherwise. As the pandemic continues to unfold with great uncertainty, the messy divorce between the United States and China will continue to play out with much dramatic flair, diplomatic crossfire, and fundamentally, the inability to ignore the other.

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