Is China-Decoupling A Myth?

For the second year running, trade and investment between the U.S. and China have increased. This, despite Washington’s escalating campaign to choke off the flow of strategic technologies to its geopolitical rival. On the surface, such contrasts would seem to refute the claim that the two economies are decoupling.

The numbers are clear. 2022 witnessed an historic high in U.S.-China bilateral trade—$690 billion in combined imports and exports, according to the U.S. Census Bureau. Imports from China increased by $31 billion from the previous year, while U.S. exports also increased by $2.4 billion. This followed a similar upward trend in 2021.

These figures reveal the mindset amongst a presiding generation of CEOs, who, for decades, have come to rely on China as a growth strategy no-brainer. Consider that in July of 2021, the American Chamber of Commerce in Shanghai conducted a survey of 300 American companies and reported that, despite growing animosities between the two countries, 60% had increased their investments in China since the prior year. More than 70% of American manufacturers said they had no plans of moving their production out of China. All this, while the Biden administration was mobilizing “China-free” supply chain initiatives amongst allies and blacklisting Chinese companies.

Wall Street also remains bullish on China. A new investment wave had already begun in 2020, after Beijing removed foreign ownership caps on local fund ownership, and Goldman Sachs, JP Morgan, Citigroup, Morgan Stanley and others ploughed more than $75 billion into China’s financial markets. Blackrock, the American investment firm, announced it would set up a $1 billion mutual fund, the first foreign firm to gain approval for a wholly owned fund in China.

These numbers may just be the tip of the iceberg. Bloomberg has reported that offshore holding companies in tax havens, such as the Cayman Islands, obscured another $1.4 trillion of foreign investment into China, making the inflow of foreign money at least three times higher than the official numbers on the books.

China’s 2023 departure from zero-Covid policies, meanwhile, sparked a surge of investor enthusiasm.

The great China paradox

All of this leads to one giant, wicked paradox. How can China be America’s chief adversary, and, simultaneously, a vital supply chain partner as well as a manufacturing hub, and a growing market?

There exists, however, the very real and ongoing issue of bifurcation in global supply chains. “Strategic” goods and services linked to China are decoupling. Ecosystems involving semiconductors, supercomputing, biotech, and quantum science, among others, will continue to decouple as Washington and Beijing engage in techno-nationalist competition and hybrid warfare.

A major problem is the accumulation of trade and investment that finds itself languishing inside a figurative grey zone, where so-called “dual-use” technologies— seemingly harmless commercial items that can also be applied to military uses—can go from enjoying day-to-day trade, to being suddenly blacklisted. Over time, the grey zone will swallow up ill-advised China investments as export controls negate well-established supply chains. The inevitable result will be a wider China-decoupling.

The question, then, is to what extent will bifurcation in the tech landscape become a catalyst for more general China-decoupling? The answer is that it will accelerate the trend more than most expect.

Bifurcation of the technology landscape

Washington’s semiconductor blockade has already effectively decoupled supply chains between American and most Chinese tech companies of consequence. This includes Huawei and ZTE (telecommunications); SMIC and YMTC (semiconductors); DJI (drones); Dahua, Megvii, SenseTime, and HikVison—all of which are from the AI, surveillance software and hardware sectors.

Prior to the imposition of U.S. sanctions and export controls, the above brands accounted for billions of dollars in trade with American and other foreign MNEs. In 2018, Huawei, alone, purchased $70 billion in components from foreign suppliers, including $11 billion from Intel, Micron and Qualcomm. All of this effectively ended with the latest round of U.S. export controls on semiconductors in October of 2022.

The problem now facing MNEs in China is the growing list of goods that will soon end up in the sanctions bucket. In the case of Huawei, Washington is now mulling an all-out ban on the transfer of any American technology. Such a move, when applied beyond Huawei to other selected firms and industries, will create a domino effect regarding general China-decoupling.

The grey zone

Technologies with potential military applications are in virtually every kind of commercially available good, from laptop computers, smartphones and cloud infrastructure to electric vehicles and washing machines.

Such dual-use items enable entire business sectors, including the medical and pharmaceutical fields, mining, energy, agriculture, and cleantech. Here, the inconvenient truth is that as the U.S.-China geopolitical rivalry grows more confrontational—think South China Sea, Taiwan, the Indo-Pacific theater, or any unanticipated incendiary event—sweeping new U.S. exports controls and sanctions could suddenly disqualify a big chunk of in-China operations for American firms.

If the recent Chinese “balloon-gate” reveals anything, it’s that Beijing’s intelligence gathering activities are geared toward fighting a future war with America. Washington’s immediate reaction to the incident was to add 6 Chinese aerospace companies to the commercial blacklist. It would seem an underwhelming response, but, over time, many more entities in the gray zone will suffer the same fate as the U.S. looks to curtail China’s military capabilities by choking off every conceivable kind of technology transfer. The inevitable outcome is more general China decoupling.

Regarding Wall Street, investors will struggle to achieve transparency and, therefore, traceability regarding China investments. Washington is currently in the process of rolling out new outbound investment controls, requiring a financial institution to give assurances that the entities it invests in are not linked to the People’s Liberation Army (PLA) and Chinese Communist Party apparatus—a virtually impossible task. This will eventually disqualify a big chunk of opaque investments and lead to more general decoupling within financial markets.

Those pouring money into China have yet to properly fathom the immensity of these forces. Until then, many will regard U.S.-China decoupling as a myth.