China Is Still the Next China
The pandemic has made the U.S. decoupling push both more urgent and more difficult to achieve.
By Phillip Orchard -May 11, 2020Open as PDF
At the end of last year, the coronavirus slipped through China’s borders. Now, Washington wants U.S. firms in China to do the same, evidenced by the Trump administration’s recent announcement of a whole-of-government initiative to move U.S. production and supply chain dependency away from China. This week, lawmakers are expected to introduce White House-backed legislation that would give subsidies to U.S. manufacturers who leave China. The White House, which in the midst of its trade war last year explicitly called for U.S. firms to come home, is also reportedly imposing new tariffs on imports from China and gradually expanding its list of Chinese-made products deemed a national security risk.
Washington is not alone in feeling that Chinese consolidation of supply chains for many essential goods was exposed by the coronavirus as an intolerable threat. In early April, Japan unveiled a $2.2 billion funding package to shift key supply chains away from China, and Germany has called for an EU-wide effort to bolster continental manufacturing of essential health care goods. Meanwhile, alternative low-cost manufacturing hubs are waiting with open arms. India, for example, is reportedly courting more than 1,000 U.S. firms in China and setting up special economic zones twice the size of Luxembourg to house them. With the U.S. apparently warming back up to multilateral trade and investment blocs in the form of its proposed “Economic Prosperity Network” – essentially a repackaged and expanded Trans-Pacific Partnership – the prospects of a coordinated effort to construct a more stable global trading system are increasing.
But if the U.S and China are indeed moving toward an economic divorce, it’ll be the sort of “it’s complicated” breakup where neither side really has the stomach for the legal fees or the emotional strength to remain estranged. And the coronavirus pandemic will in some ways make the break up even more difficult. In short, volatility in the global trading system isn’t going away.
Long Time Coming
The U.S.-China economic relationship was rocky even before the outbreak. The seeds were sown nearly half a century ago, when Western firms began rerouting their supply chains through East Asia and thereby igniting a boom in global trade and prosperity. Following China’s accession to the World Trade Organization in 2001, the center of gravity of global manufacturing shifted firmly to the Middle Kingdom, where a bottomless labor pool allowed foreign firms to unlock unimaginable economies of scale. China became the world’s largest exporter in 2009. Until about a decade ago, the U.S. heartily supported its efforts. It developed a taste for low-cost imports and fell head over heels for Chinese consumers and investors. It nurtured hopes that China would be disinclined to challenge the global system if it was integrated with that system. At times, the U.S. and China’s commercial relations stabilized their broader bilateral relationship.
The trade-offs of this system crystallized after the 2008 financial crisis, which in the U.S. exposed how the middle class had been gutted by the loss of manufacturing and revealed the structural problems that fueled inequality. Beijing, stung by the brief collapse in Western demand and under immense social pressures of its own, figured it had little choice but to more aggressively move into high-value industries that more advanced economies have dominated for decades – even if it had to renege on its WTO commitments and antagonize countries whose consumers fueled China’s rise. Many in the U.S. believed they had underestimated China’s ability to make the leap into more advanced manufacturing, and underestimated just how much leverage Chinese consumers and manufacturers would give Beijing – and how willing it was to use its leverage over foreign firms and foreign governments. China’s external vulnerabilities, meanwhile, compelled it to see just how much its newfound economic and military heft could be used to reshape the regional order around its needs.
In other words, the change from competition to confrontation between the U.S. and China has been a long time coming. The launch of the U.S.-China trade and tech wars in 2017 merely announced its arrival. COVID-19 kicked it into overdrive.
The pandemic did this, in part, by exposing just how much China had become a single point of failure in supply chains of essential goods in critical sectors like pharma. For example, China produces around 80-90 percent of the global supply of active ingredients for antibiotics. Chinese export restrictions and bottlenecks led to shortages of personal protective equipment, test kits and vital medical equipment, including products made by U.S. firms in China. The pandemic also exposed chronic quality control problems in China, with several embattled countries having to discard much-needed shipments of faulty Chinese masks and test kits. (To be fair, the global rush to source pandemic supplies has created a profiteer’s paradise just about everywhere.)
But if the issue were merely about making the system more resilient to unexpected crises – eliminating chokepoints in supplies of essential goods, building in redundancies, and so forth – there wouldn’t be nearly the sense of urgency behind the push to decouple. Most U.S. companies will be wary enough of overdependence on chokepoints in China to want to diversify on their own accord. The U.S. government and others could just boost stockpiles of essential goods, incentivize domestic production in key sectors, and establish plans in advance to ensure diversity of foreign suppliers and so minimize the risk of disruption at home. Indeed, emergency preparation could be a cornerstone of a U.S.-China relationship defined by cooperation against mutual threats, with the U.S. combining its R&D power with China’s unparalleled production capacity to prevent the next super-spreading virus from doing nearly so much damage.
But, of course, this isn’t just about the pandemic. It’s also about existing fault lines in the international system and immense new political pressures unleashed by COVID-19. Beijing is fronting as a country that’s spearheading global cooperation. Yet, it evidently can’t help but spread disinformation about the pandemic both at home and abroad – and it’s mostly still acting like a government with a crippling fear of mass dissent. Collaboration is taking a back seat to other needs in Washington, too. Accusations that China somehow intentionally unleashed the virus on the world are nonsensical, as is the notion that China needs to pay a price to address problems that nearly laid waste to its own economy and thus the ruling Communist Party. Revenge is not a valid strategic motivation, and punitive actions typically backfire – sometimes catastrophically so. Still, this is an election year, so the Trump administration has plenty of reason to keep public anger focused squarely on Beijing’s misdeeds, both real and imagined. And there are enough legitimate strategic and economic concerns about Chinese supply chain dominance to justify the White House’s move to gain leverage over Beijing by exploiting its need for foreign investment and technology – and to push forward potentially costly and/or politically difficult measures it already wanted to introduce.
Nothing Free
The problem for the U.S., though, is the same one it’s faced for the past three years: It’s really difficult to disentangle its economy from the Chinese without doing more harm than good, and the bulk of U.S. firms in China just don’t want to leave.
To be sure, for companies that were already wary of issues like rising labor and land costs, risks of intellectual property theft, and government coercion, the fact that Beijing’s micromanagerial and censorial tendencies contributed directly to a disruption in their operations might just be the straw that broke the camel’s back. But for most, when they crunch the numbers, it becomes clear that “the next China” will still be China for years to come. According to an AmCham China survey of U.S. firms in China about the effects of the COVID-19 crisis conducted in March – before China’s success in containing the virus and getting factories up and running was apparent – just four percent said they are actively considering moving some or all of their operations abroad. (Some 55 percent said it’s too soon to tell.)
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There are several reasons for their reluctance, but three stand out. First, in manufacturing sectors considered essential or key to national security, there’s nowhere else with China’s combination of skilled labor, well-oiled infrastructure, ability to move entire towns around to meet the land and logistics needs of major firms, the degree of innovation that comes from industrial clustering and tight-knit supplier networks, and invaluable proximity to other high-value ecosystems in East Asia. It’s not uncommon for major U.S. manufacturers to demand not only tax incentives from Chinese provincial governments but land and purpose-built infrastructure as well – and for authorities to deliver with astonishing speed. Firms have been moving bits and pieces of operations to South and Southeast Asia, plus assembly hubs in Latin America and Eastern Europe that provide easy access to dominant consumer markets. But even the most attractive of these locations – Malaysia, Thailand, Vietnam, Mexico, India, Ethiopia – lack the skilled labor pools and/or infrastructure and regulatory environment to compete with China at scale. And each are grappling with chronic problems – natural disasters, organized crime, terrorism, labor unrest, meddlesome governments – sometimes at levels worse than in China. None are immune to epidemics.
Second, China’s consumer base is simply irresistible. Companies will put up with plenty of market barriers and government coercion just to tap into it. It’s an overlooked fact that, in combination with Hong Kong, Chinese imports now nearly match those of the U.S. The number of automobiles GM sold in China fell 15 percent last year and still surpassed U.S. sales by more than 200,000. U.S. firms like Qualcomm at the center of the U.S.-China tech war rely heavily on the revenues they gain from China to fund R&D and thus, somewhat paradoxically, maintain their innovation edge over their Chinese competitors. The best way to ensure access to this market is to put up with the headaches of manufacturing in China. This is why most companies actively moving some operations abroad are doing so only partially – just enough to establish a “China plus one” supply chain model with parallel links that builds redundancy and ensures access to both the U.S. and Chinese markets.
Finally, moving is expensive and time-consuming. This is a problem now more than ever, with companies suddenly starved for cash amid the fallout of the pandemic. All told, relocation is generally a three- to five-year process, according to the Economist Intelligence Unit. Companies will be loath to take on the costs of moving unless it becomes clear exactly how the current surge in U.S.-China trade tensions will shake out – especially considering the possibility that U.S. tariffs might follow them to other destinations.
There’s not a lot the U.S. can do about these issues – and none of its options are cost-free. It can (and may) raise tariffs again on imports from China, but tariffs are a largely ineffective tool of coercion and a tax borne primarily by U.S. businesses and consumers, which is a bad idea at the height of an economic crash. It can (and will) strengthen restrictions on imports of national security-sensitive goods, but doing so risks crippling U.S. firms and ceding market share to foreign competitors – especially if the definition of security risks is applied too broadly. Both of these, moreover, would almost certainly provoke Chinese retaliation and would thus make things more expensive. Washington can subsidize the costs of relocating outside of China, but to do this for everyone would cost the U.S. trillions of dollars and do nothing to address the potential loss of competitiveness of U.S. firms that follow suit.
The U.S. has every reason to want to pry itself apart from the Chinese economy – in key sectors such as pharmaceuticals and sensitive emerging technologies, it’s inevitable – but there’s no reason to think Washington can do it quickly, cheaply or efficiently. It will struggle to strike an optimal balance that preserves national security without undermining its own ability to innovate and compete in global markets. And it will be impossible to achieve all of its oft-conflicting political, economic, security and strategic goals.
TAGSChinacoronavirusEconomyTradeUnited States
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Phillip Orchard
Phillip Orchard
https://geopoliticalfutures.com/author/porchard/Phillip Orchard is an analyst at Geopolitical Futures. Prior to joining the company, Mr. Orchard spent nearly six years at Stratfor, working as an editor and writing about East Asian geopolitics. He’s spent more than six years abroad, primarily in Southeast Asia and Latin America, where he’s had formative, immersive experiences with the problems arising from mass political upheaval, civil conflict and human migration. Mr. Orchard holds a master’s degree in Security, Law and Diplomacy from the Lyndon B. Johnson School of Public Affairs, where he focused on energy and national security, Chinese foreign policy, intelligence analysis, and institutional pathologies. He also earned a bachelor’s degree in journalism from the University of Texas. He speaks Spanish and some Thai and Lao.
