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US-China decoupling is much harder than Donald Trump thinks

Despite threats and incentives, companies like Chinese manufacturing

| China
Employees work on a smartphone production line in Wuhan. In advanced electronics, companies have barely shifted out of China at all, despite cajoling from Trump.   © Visual China Group/Getty Images

James Crabtree is an associate professor in practice at the Lee Kuan Yew School of Public Policy at the National University of Singapore. He is author of "The Billionaire Raj."

The coronavirus pandemic appears to be pushing the world firmly down the path of economic decoupling. U.S. President Donald Trump recently doubled down on his usual aggressive stance, musing on May 14 that "we could cut off the whole relationship" with China.

A few days earlier Robert Lighthizer, his hawkish trade adviser, hailed the end of "the era of reflexive offshoring," claiming companies manufacturing in emerging nations like China would soon bring production back home.

More measured voices talk instead about diversification, for instance by adding new facilities in Southeast Asia to complement existing Chinese factories, but even as decoupling becomes post-pandemic conventional wisdom, there has been little reckoning with how it might be accomplished in practice, let alone whether it is desirable.

For a host of reasons, moving supply chains out of China is likely to be a trickier and more gradual process than it at first appears.

Companies find themselves facing ever-louder calls to return to domestic shores, or at least to leave China. The European Union Chamber of Commerce in Beijing recently warned its members to reduce excessive reliance on China. President Emmanuel Macron has pledged to make strategically important products in France, most obviously medical equipment.

Japan launched a $2 billion research fund to help its companies rethink their supply chains, widely portrayed as encouraging reshoring. Others are looking to benefit from decoupling: India says it is in talks with hundreds of international businesses to persuade them to shift production from China instead.

In the immediate term, China enjoys one obvious advantage, namely that its economy is open for business. Manufacturers still face lockdowns in rivals like Malaysia and Thailand, or indeed India. As the world races to find new sources of masks and personal protective equipment, China is set to win more business, not less.

The production line of protective clothing at a factory in Minhou County: China is set to win more business, not less.   © China News Service/Getty Images

Looking to the future, it is far from clear that U.S. or Japanese companies actually want to shift much production out of China in the first place. Countries like Vietnam, often cited as alternatives, are tiny by comparison and offer nothing like the professionalism, range and scale of manufacturing options found in Shenzhen and other Chinese hubs.

Global companies are hardly likely to rush to close Chinese factories or cancel sourcing contracts if the alternatives are less reliable and more expensive. Facing political pressure, they might talk instead about diversification as they expand production in future. But there is an obvious problem with this approach, namely that few are likely to expand any time soon, in the face of terrible global recession.

Multinationals are then unlikely to abandon China for a final reason: most make in China to sell to Chinese buyers in the world's most important growth market. Chinese foreign direct investment into the U.S. has collapsed of late, but American FDI into China actually edged up to $14 billion in 2019, according to research company Rhodium -- even as Trump's trade war tariffs began to bite.

None of this is to deny a broader trend toward deglobalisation. The longer the pandemic continues, the more likely it is that China-centric supply chains will be disrupted and refashioned. China will see more of what consultants McKinsey dub "declining global exposure" as its economy becomes less reliant on exports. Global manufacturing is set to become more fragmented by region and less dominated by China.

Yet these gradual supply chain shifts, which are driven more by changing costs than geopolitical anxieties, are less likely to occur in "strategic" industries like health care products than in low-tech sectors like toys, where Mattel and other U.S. manufacturers are already moving to Latin America.

In short, none of this adds up to anything approaching actual decoupling. Many multinationals might experiment with a so-called "China + 1" strategy. But almost by definition this is likely to leave China as their dominant supplier. "There appears to be no increased rush to move out of China," as UBS put it bluntly in a recent report.

This is clearest of all in advanced electronics, where companies like Apple have barely shifted out of China at all, despite cajoling from Trump. Last week Nikkei Asian Review reported that the U.S. company appeared to be strengthening its Chinese presence by encouraging one of its Chinese suppliers to make investments that would reduce its reliance on Foxconn, the Taiwanese contractor that dominates iPhone production.

All of this leaves a dilemma for those anxious about overreliance on China. Anything approaching full decoupling would come at a huge cost, even if it were possible to achieve it. But some measure of diversification is probably desirable for most advanced economies, especially as geopolitical tensions between Beijing and Washington worsen. Managing this will be tricky, given so many companies do not want to rip up existing Chinese plans.

Rather than harboring fantasies about bringing jobs home, as Lighthizer does, governments in Europe, Japan and North America would be better advised to focus.

This means picking a few genuinely strategic industries in which more reliable supply is now deemed politically essential, potentially including medical devices, pharmaceutical inputs and defense equipment. Governments could then stockpile essential items while also offering subsidies to companies to build more resilient and diverse supply chains or in some cases, if there were no better options, to try and manufacture domestically.

But they must also recognize that this will be a piecemeal and painful process, resulting in products more expensive and possibly of lower quality than those sourced abroad. Put another way, for all the talk of decoupling, China is set to remain a critical manufacturing hub for most multinational companies for the foreseeable future.

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