Decoupling vs. De-risking

By Joel Wong

The chances of a complete US-China decoupling are considered low, but a form of “de-risking” or selective decoupling is already underway and likely to continue. Here’s a breakdown of the factors influencing this:

Factors suggesting decoupling is unlikely to be complete:

Deep Economic Interdependence: The US and Chinese economies are significantly intertwined through trade, investment, and supply chains built over decades. Untangling this completely would be economically painful for both nations and the global economy. Many companies rely on China for manufacturing and as a key market.

Global Supply Chains: Supply chains, especially for strategic products, remain intertwined with China. Companies that have sought to replace China in the US market have also increased their import-dependence on China indirectly through other countries.

China’s Domestic Market: China’s large and growing domestic market remains a significant draw for many international businesses. Companies are unlikely to completely abandon this market.

Financial Ties: China holds a significant amount of US Treasury securities, and US investment in China, while facing restrictions in some sectors, still exists. Complete financial decoupling has not begun.

Factors driving de-risking and selective decoupling:

Geopolitical Tensions: Rising tensions over trade imbalances, human rights, Taiwan, the South China Sea, and global influence are pushing both countries to reduce their reliance on each other in strategic areas.

National Security Concerns: The US is increasingly focused on limiting China’s access to advanced technologies, particularly in semiconductors, to protect its national security and maintain a technological edge. Export controls and investment restrictions are key tools in this effort. China is also emphasizing self-reliance in critical technologies.

Trade War Legacy: The tariffs imposed during the first Trump administration, while some have been modified, have created an incentive for companies to diversify their supply chains.

China’s Industrial Policy: China’s “Made in China 2025” and similar policies aim to reduce reliance on foreign technology, which has been seen by some in the US as unfair competition and a driver for decoupling in certain sectors.

Shifting Trade Patterns: China’s exports to the US as a percentage of its total exports have decreased, while exports to Southeast Asian and Belt-and-Road countries have grown. Similarly, the US trade deficit with China has fallen, and Mexico has become the US’s top source of imports.

Reduced Investment Flows: Chinese outbound foreign direct investment (FDI) to Western countries, particularly the US, has significantly decreased in recent years.

Current State and Future Trends:

De-risking over Decoupling: The prevailing approach appears to be “de-risking,” which involves reducing vulnerabilities and dependencies on China in critical areas rather than a complete separation.

Technological Decoupling: This is the most pronounced area of decoupling, with both countries focusing on developing their own technological capabilities and restricting access to certain technologies.

Trade Diversification: Companies are increasingly looking to diversify their supply chains to other countries in Asia, Mexico, and even reshoring some production back to the US or Europe. However, this process is gradual and costly.

Political Influence: Domestic political forces in both the US and China significantly influence the trajectory of the relationship and the likelihood of further decoupling. Hardline approaches in the US and China’s focus on national rejuvenation and security contribute to the tensions.

Economic Impacts:

Costly for Both: Even partial decoupling or significant de-risking will likely lead to economic costs for both the US and China, including potential GDP losses, job losses in certain sectors, and increased costs for consumers.

Global Impact: Decoupling or fragmentation could significantly harm the global economy by disrupting trade flows, investment, and technological collaboration.

Sector-Specific Effects: Certain industries, such as aviation, semiconductors, and medical services, could face substantial losses from decoupling.

In conclusion, a complete and abrupt decoupling is highly improbable due to the significant economic inter-dependencies. However, the trend of de-risking and selective decoupling, particularly in strategic technology sectors, is likely to continue as both nations navigate geopolitical tensions and prioritize national security and economic resilience.

The extent and pace of this decoupling will depend on future political decisions and global events.