Economics and finance, Trade and industry, International relations | Asia, East Asia, The World

3 November 2020

Concerns about over-reliance on China in the United States may be well-founded, but actually breaking off from the ‘factory of the world’ is much easier said than done, Ragul Palanisami writes.

Since assuming office, the Trump administration has often spoken about ‘decoupling’ the American and Chinese economies, and his trade war against China includes supply chain decoupling as one of its primary objectives.

The COVID-19 pandemic has further pushed this desire for decoupling, both in terms of rhetoric, and through legislation introduced in Congress mandating the internalisation of ‘critical’ supply chains. Outside the United States, other countries have announced incentives to attract multi-national corporations (MNCs), which are drafting plans to diversify their supply chains in the aftermath of the coronavirus pandemic.

In order to double down on its earlier strategy of decoupling from China, the Trump administration has recently announced the Economic Prosperity Network and Clean Network programs. These initiatives aim to establish an alliance of trusted partners – which excludes China – by complementing action taken by individual countries to reduce supply chain dependence on China.

However, a total decoupling from China is probably not going to happen for decades to come, for several reasons.

Firstly, China is no longer a simple assembly site for electronic goods, as it was 15 years ago, and has become a manufacturer of key components in its own right. China has also become specialised in more technologically sophisticated manufacturing, making its value to importers very hard to replicate and relocate.

More on this: Could China end the trade war?

Moreover, it is almost impossible to attain the level of supply chain integration found in China anywhere else, and investors in China usually maintain strong relationships with dealers and suppliers that have been built over decades and guarantee a high degree of quality assurance to consumers.

Secondly, in the past goods produced in the region were destined for western markets, but in recent years the East Asian region has driven its own demand, enabled by the demand growth inside China. The huge size of the Chinese domestic market also means that MNCs will be unenthusiastic about moving out of China.

Third, the United States’ withdrawal from the original Trans-Pacific Partnership (TPP) agreement has played out in favour of China. This is because with the United States inside the TPP, trade diversion away from China would have been much higher, especially with the United States still serving as a major market for merchandise exports.

Trump’s exit from the original TPP clears the path for China to exert a much greater influence on the economies of Southeast Asia and to devise trade rules for the entire Asia-Pacific region.

Fourthly, low-end electronics manufacturing has already begun to move away from China to countries in South and Southeast Asia as wages in China has grown in the last decade.

More on this: What coronavirus could mean for Australia’s trade with China

Still, any final decision on relocation is made only after reconciling the downsides in destination countries, in terms of regulatory uncertainties and poor infrastructure, with their advantages in offering low labour and operation costs.

Finally, various Chinese provincial governments have begun to take measures to retain businesses and to attract new ones. For instance, in 2018, the Guangdong provincial government released a policy measure to open up the province further to foreign investments.

The policy allows for the setting up of wholly-owned foreign enterprises in various high-tech sectors, where previously only joint ventures were permitted. Besides the relaxation in foreign investment rules, the provincial government has also begun to offer various incentives, cash rewards, tax breaks, research and development support, and intellectual property protection to foreign investors.

For the United States, there are a number of factors that could make a move of supply chains outside China attractive. These include rising wages, mounting compliance costs, strict environmental regulations, and social insurance obligations. Still, this move may be slower to come than American policymakers are hoping.

While the web of free trade agreements signed between the countries in the Asia-Pacific region could facilitate a shift in supply chains, China still has strong advantages when it comes to manufacturing.

The huge domestic market of China is one reason for MNCs to maintain a strong presence there even in the difficult conditions imposed by the trade war.

Though many countries in the region offer potential alternatives to China, MNCs are reluctant to shift their production bases to these countries, as the costs of relocation still outweigh the benefits, and will remain so for some time to come.

The trade war and the incentives offered by countries in the wake of the coronavirus pandemic could cause some companies to reconsider their decisions, but at the end of the day it is not easy for MNCs to brush aside the advantages offered by China as a manufacturing base.

Ultimately, this means that despite its potential benefits for the United States, a full-scale relocation of supply chains outside China is unlikely to happen any time soon.

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