Is China-Decoupling A Myth?

For the second consecutive year, trade and investment between the United States and China increased. This, despite Washington’s growing campaign to stifle the flow of strategic technology to its geopolitical rival. At first glance, such contrasts seem to refute the claim that the two economies are decoupling.

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

These numbers reveal the mindset of a generation of CEOs who for decades have come to rely on China as an obvious growth strategy. Consider that in July 2021, the American Chamber of Commerce in Shanghai conducted a investigation of 300 U.S. companies and reported that, despite growing animosities between the two countries, 60% had increased their investment in China since the previous year. More than 70% of US manufacturers said they have no plans to move production out of China. All this while the Biden administration mobilized “China-free” supply chain initiatives among its allies and blacklisted Chinese companies.

Wall Street also remains bullish on China. A new wave of investment 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 plowed more than $75 billion in Chinese financial markets. Blackrock, the US investment firm, has announced it will set up a billion-dollar mutual fund, the first foreign company to win approval for a wholly-owned fund in China.

These numbers may just be the tip of the iceberg. Bloomberg reported that offshore holding companies in taxation heavenlike the Cayman Islands, have obscured an additional $1.4 trillion of foreign investment in China, making the influx of foreign money at least three times higher than official figures on the books.

China’s departure from zero-Covid policies in 2023 has, meanwhile, sparked renewed investor enthusiasm.

The great Chinese paradox

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

There is, however, the very real and persistent problem of bifurcation in global supply chains. “Strategic” goods and services linked to China are decoupling. Ecosystems involving semiconductors, supercomputing, biotechnology 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 languishes in a figurative gray area, where so-called “dual-use” technologies – seemingly innocuous commercial items that can also be applied for military purposes – can pass from daytime enjoyment at today’s trade, to be suddenly blacklisted. Over time, the gray area will engulf misguided Chinese investment as export controls negate well-established supply chains. The inevitable result will be a broader decoupling from China.

So the question is to what extent will the bifurcation in the tech landscape become a catalyst for a more general decoupling from China? The answer is that it will accelerate the trend more than expected.

Bifurcation of the technological landscape

from washington semiconductor The blockade has already effectively decoupled supply chains between US tech companies and most major Chinese companies. This includes Huawei and ZTE (telecommunications); SMIC and YMTC (semiconductors); DJI (drones); Dahua, Megvii, SenseTime, and HikVison, all of which belong to the AI, surveillance software, and hardware industries.

Before the imposition of sanctions and export controls by the United States, the aforementioned brands accounted for billions of dollars in trade with American and foreign multinationals. In 2018, Huawei alone purchased $70 billion worth of components from overseas suppliers, including $11 billion from Intel, Micron and Qualcomm. All of this effectively ended with the latest round of US semiconductor export controls in October of 2022.

The problem currently facing multinationals in China is the growing list of goods that will soon end up in the sanctions basket. In the case of Huawei, Washington is now considering a total to forbid on the transfer of any American technology. Such a decision, when applied beyond Huawei to other selected companies and industries, will create a domino effect regarding the general decoupling from China.

The gray area

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

These dual-use goods enable entire industries, including medical and pharmaceutical, mining, energy, agriculture and clean technology. The inconvenient truth here is that as the geopolitical rivalry between the United States and China becomes increasingly divisive – think of the South China Sea, Taiwan, the Indo-Pacific theater or any unforeseen arsonist – new US export controls and sanctions could suddenly disqualify a large chunk of China operations for US companies.

If recent Chinesedoor balloonreveals something is that Beijing’s intelligence gathering activities are geared towards a future war with America. Washington’s immediate reaction to the incident was to add 6 Chinese aerospace companies to the commercial blacklist. That would seem like a disappointing answer, but over time many other gray area entities will suffer the same fate as the United States seeks to reduce China’s military capabilities by stifling any kind of technology transfer imaginable. The inevitable result is a more general decoupling from China.

Regarding Wall Street, investors will find it difficult to obtain transparency and therefore the traceability of investments in China. Washington is currently rolling out new outbound investments controls, forcing a financial institution to ensure that the entities it invests in are not linked to the People’s Liberation Army (PLA) and the Chinese Communist Party apparatus, a virtually impossible task. This will eventually disqualify a large portion of opaque investments and lead to a more general decoupling within financial markets.

Those pouring money into China have not yet fully understood the immensity of these forces. Until then, many will regard the US-China decoupling as a myth.