What’s Stopping Companies from Pulling Supply Chains Out of China

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About the authors: Christopher S. Tang is a University Distinguished Professor and Edward W. Carter chair in business administration at the UCLA Anderson School of Management. Richard S. Paegelow is the managing director of Inline Translation Services in Glendale, California. 

President Biden and China’s President Xi shook hands on Nov. 14 for the first time since Biden became U.S. president. This in-person meeting on the sidelines of the G20 Summit meeting dialed down the tension and may prevent a new cold war between both countries. At least for now.  

Some may criticize Biden for not declaring a clear trade policy with China at this meeting. But there are advantages in not acting precipitously. Biden is in effect buying time for U.S. firms to build resilient supply chains.  

Indeed, Biden is paving the path to decouple from China. However, he needs to remove a few roadblocks that are impeding reshoring efforts.  

Despite the political rhetoric, U.S. firms still very much rely on China’s manufacturing capabilities.  Containerized imports from China fell 5.5% in October due to the ongoing trade war and China’s Covid-19 lockdowns. But China continues to capture 35% of total U.S. containerized imports. 

The Biden administration is implementing two strategies that are intended to enable U.S. firms to reduce their supply-chain dependency on China.  

The first strategy is to encourage firms to diversify their supply base globally beyond China. In May, Biden launched the Indo-Pacific Economic Framework for Prosperity to strengthen trade relationships with 12 initial partners that include India, Japan, and South Korea and represent 40% of the world’s GDP. The purpose of this initiative is to improve supply-chain resilience by friend-shoring from countries with shared values. This initiative fills a void created by the administration’s rejection in late 2021 of a plan for the U.S. to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership. 

The second strategy is to encourage firms to reshore their manufacturing operations back to the U.S. for critical products such as semiconductors and electric vehicles. Biden maintained the 25% tariffs on $250 billion of Chinese imports imposed by former President Donald Trump. In August, Biden also signed the Inflation Reduction Act and the CHIPS and Science Act. The laws provide subsidies and tax incentives that intend to strengthen U.S. competitiveness in electric vehicle and semiconductor manufacturing and create more domestic jobs in the clean energy economy.  

These strategies have promise, but there are four major elements in the way of companies moving their supply chains out of China and back to the U.S. and its allies.

First, reshoring strategies need to deal with higher labor costs in the U.S. compared to other markets. To keep costs down, U.S. manufacturers must leverage automation and information technology. Advanced robotics and artificial intelligence can streamline workflow and improve efficiency. By increasing labor productivity and paying higher wages to fewer workers, firms can keep the effective labor cost down. However, some labor unions are steadfastly against automation, especially at the ports. As a case in point, although U.S. ports were ranked among the least efficient ports in the world in 2021, the union representing workers at 29 West Coast ports continues to fight against automation in the on-going contract negotiation with terminal operators. The Biden administration needs to strike a balance between union interests and business needs to modernize manufacturing. Doing so would help create jobs in union states. 

Second, complex environmental regulations discourage U.S. firms from reshoring their manufacturing operations back to the U.S. There is a need to simplify Environmental Protection Agency regulations to strike a balance between environmental protection and supply chain security. The EPA removed unnecessary and inappropriate burdens on the U.S. energy sector in August 2020 after Trump requested a thorough review. Biden should request the EPA to review burdens and streamline its review process in the semiconductor and electric vehicle sectors. 

Third, better metrics would help. There is a need for a concrete, widespread measure of “supply chain resilience” just like the simple metric “returns on assets.” Some firms will be reluctant to reshore because of Wall Street’s embrace of asset-light companies whose intellectual property and brands offer potentially spectacular returns on minimal capital. To counteract this biased valuation of firms, Biden can ask the Securities and Exchange Commission to consider including supply chain resilience as an additional risk factor that manufacturing firms must disclose publicly. Doing so would encourage more firms to commit to reshoring by investing in tangible assets such as factories and equipment. 

Fourth, better tax incentives could  encourage reshoring, or at least discourage offshoring.  In 2022, there is no immediate urgency for firms that invested heavily in an offshore model to reshore their operations. The Tax Cuts and Jobs Act approved in 2017 allows companies to “offshore” their profits to reduce tax. Under the law, no U.S. tax is imposed on offshore profits that do not exceed 10% of tangible assets the company holds offshore. A proposed global minimum tax of at least 15% would discourage offshoring. It would cut the ability of corporations to reduce taxes by transferring portions of their businesses to foreign countries with lower tax rates. The implementation of this 135-country tax agreement has been slow, but Biden can help to prod it along. 

By putting measures like these in place, Biden can help ensure that the next handshake will take place in very different economic conditions. 

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