Commentary | 21 November 2018

Why the US should not simply decouple from China without building new partnerships

Originally published in South China Morning Post

Originally published in South China Morning Post

Washington’s new foreign policy buzzword, “decoupling”, has a rather bland ring, especially given the momentous phenomenon it describes – of the world’s two biggest economies, the United States and China, splitting apart. For the White House, the phrase is shorthand for the administration’s commitment, through taxes, tariffs and other punitive measures, to disentangle its companies and their technologies from China’s supply chains.

But without a broader American economic strategy for the region, it’s hard to see how a decoupling between the two countries will work out for the US and friendly countries in Asia. Far from bringing business out of China, America might ensure that global supply chains remain anchored there after all.

As Henry Paulson, the former Goldman Sachs chief and erstwhile US treasury secretary, said in a speech in November: “I now see the prospect of an economic Iron Curtain, one that throws up new walls on each side and unmakes the global economy, as we have known it.”

Asia is home to the most important global supply chains – from electronics to textiles, to IT to cars – distributed across a vast range of countries. Due to the nature of these cross-border links, and China’s central role within them, a trade war with Beijing means a trade war with Asia.

The very model of Factory Asia – which has allowed developing countries to master the global age, starting with Japan in the 1950s – may be heading for extinction. This alone makes many countries and businesses nervous.

The US has many, often contradictory, reasons for taking a tougher line with China on trade. They range from managing protectionist sentiment at home, to guarding core technologiesand capabilities, prising open China’s closed markets, and the national security objective of restricting China’s continued rise.

China’s massive bilateral trade surplus with the US would seem to indicate that Washington has great leverage over Beijing in this contest, something that Donald Trump has often cited as a reason the US will win any trade war with China. But such views ignore a number of mega-trends in the region, starting with the fact that China is becoming less reliant on the US for its economic health, and more intertwined with Asia.

Today, bilateral trade with the US accounts for 14 per cent of China’s trade flows. The US share of Chinese exports in trade in value-added terms actually declined from about 30 per cent in 2002, just after China joined the World Trade Organisation, to 20 per cent in 2011. Since the global financial crisis, China has both overtaken the US as the world’s largest trading nation and seen its gross domestic product growth become less dependent on exports.

China’s trade-to-GDP ratio is 38 per cent. By comparison, Vietnam’s trade as a percentage of GDP is over 200 per cent. This suggests China is less susceptible to the downsides of a bilateral trade war, but the region at large, which, by and large, is strategically friendly to the US, may be much more so.

As things stand, China does 70 per cent more trade with the Indo-Pacific region annually (US$2.5 trillion) than does the US (US$1.4 trillion). Research by the Lowy Institute shows the importance of the US as an export destination for Asian countries is declining relative to an increasingly affluent China. The average export share in 24 Indo-Pacific countries to China is 23 per cent, and just 12 per cent for the United States.

In other words, the economic leverage in Asia rests as much with China as it does the US.

US Vice-President Mike Pence’s speech articulating the China policy reset in early October was spurred by the bipartisan conviction in Washington that engagement with Beijing won’t alter the one-party state’s determination to supplant the US in Asia and compete in a hostile manner globally.

Washington may be right on this point. As Beijing has integrated into the global system, it has showed virtuosity in playing the power game beneath the threshold of out-and-out conflict with the US. This is evidenced by everything from China’s creeping takeover of the South China Sea to the theft of intellectual property and the protection and subsidies for swathes of its domestic economy to build national champions to take on the world.

The US also argues, on that basis, that they are late to the decoupling game. Beijing’s signature policies, such as “Made in China 2025”, are all aimed at displacing foreign technology, especially from the US, and climbing the value chain. In effect, America is playing catch-up, US officials say, to protect the technology, skills and capabilities it needs for its national defence and economic independence.

Some regional economies may benefit from decoupling, by luring multinationals now based in China to relocate. There is already evidence that Malaysia and Taiwan are doing just that. But for most countries, including major industrialised allies like Japan and South Korea, decoupling plus “America first” might be toxic. The East Asian tigers see their economic ties with China as a lifeline to be managed, not severed.

The US could try a different approach, partnering with regional allies and Europe on shared concerns, like the abuse of intellectual property rights and nationalist technology ambitions. Instead, Trump has signalled a return to a world where rules-based globalism matters less than raw heft.

Were Washington to be more strategic, it would also embrace the trade pact that Trump left in one of his first decisions in office, the Trans-Pacific Partnership. Re-joining it would provide the region with a real, rules-based alternative to the Chinese system.

There is no question of the need for enhanced resilience against China’s exploitation of vulnerabilities in complex supply chains. Unfortunately, decoupling runs the risk of throwing the baby out with the bathwater.

Globalisation will still involve the US and China – but not the two countries together. The danger is a more hazardous variant of globalisation, less homogeneous and dominated by mutually exclusive zones of influence. Poorly handled, wholesale decoupling will do little to advance Washington’s resolve to compete against an illiberal peer competitor on the world stage. To the contrary, it may only entrench China’s growing gravitational pull.