The US and China on the path to economic decoupling

The process is not irreversible and it won't be quick, but it might lead to a very different world: more divided, more politically unstable and more expensive

Since China opened up to the rest of the world economies, the country has engaged in a process of deep economic integration with the United States. In order to understand the strong economic ties between Washington and Beijing it can be useful to think about the iPhone, maybe the most famous smartphone in the world. It is designed in the United States and assembled in China; so, it encapsulates the know-how of US’ high tech companies and the manufacturing capacity of China. The iPhone can be understood as a symbol of globalization and economic integration between different parts of the world endowed with different comparative advantages. For China the main comparative advantage has historically been the low cost of production inputs, such as labour and land. This has allowed the Asian dragon to become a crucial node in the global value chain and to undertake an incredible economic development trajectory. The United States has been among the actors that has benefitted the most from the opportunity provided by the opening up of China.

In order to become more competitive, American companies have relocated the first stages of their production to China, exploiting its very low cost. It is fair to say that the two superpowers have exploited each other: China became the “factory of the world”, feeding American consumption (and world consumption) with its cheap goods and sustaining American debt with its savings and foreign dollar reserves obtained by the exports. At the same time, American technology and investments played a crucial role in sustaining China's economic growth and rise. The economic partnership between the US and China has been beneficial also for the stability of global order: it prevented military confrontation between two actors that differ deeply in their values and interests. Consistently with the International Relations’ theory of Neoliberalism, economic interconnection has allowed two hostile powers to peacefully coexist.

Nonetheless, it seems that nowadays the peaceful coexistence between the two powers is becoming increasingly difficult. Many years of astonishing rise has led China to become a superpower and so, since the advent of Xi Jinping, it has switched to the “assertive mode”, willing to defend at all costs its core interests. Differently, the US has experienced a decrease of its relative power in the world; rather than being a consequence of the United States becoming weaker, it is the result of other states, such as China, closing the gap by becoming stronger. The re-balancing of power between China and the US means that the world will now face a situation of greater geopolitical instability. Washington has changed its attitude, feeling threatened by China's rise, and this, in turn, has become a threat for Beijing's interests. A recent example of their fragile relationship was the visit of Nancy Pelosi to Taiwan and its consequences. The visit triggered a sharp reaction by Beijing, sharper than any reaction in the past, leading to a diplomatic crisis and to an abrupt break in their cooperation in several areas, including those of common interest, such as combating climate change. If needed, China seems to be ready to openly and directly confront the United States for protecting its domestic interests.

This new scenario makes one question increasingly relevant: is it possible that in the next few years we will see a complete decoupling between Washington and Beijing? It is a very tricky question and the answer will depend not just on the actions of the two main actors but also on all the rest of the international system. The Ukrainian crisis is something that has not involved directly neither of the two superpowers, nonetheless it has contributed substantially to change their relationship. The fracture between those who support Putin’s action (or refuse to condemn him) and those that stand for Ukraine, might accelerate a process that had already started before the pandemic.

What is Washington doing?

Donald Trump and Joe Biden, the Republican and the Democrats, differ in almost every aspect. Nonetheless, there is one point that they share: they are concerned about the rise of China and how this is going to affect the global system. For these reasons, Biden has continued the path started by Trump. He retained the tariff imposed by the former US’ President on imports from China and took further steps to ban US companies’ investments in 59 Chinese firms that have ties to the Chinese military or surveillance equipment. Some of those companies, such as Huawei, were already on a blacklist. The most recent and relevant step in the direction of decoupling has been the CHIPS and Science Act, which invested $52bn into semiconductors while promising a further $170bn to support research in other related fields.

The measure followed the diplomatic crisis with the People Republic of China resulting from Pelosi visiting Taipei; the aim is to explicitly address the overdependence on Taiwan for the microchip’s supply, due to the increasingly unstable relation with Beijing, and re-affirm the leadership of the US in the market. The law is part of a broader effort displayed by the Biden administration to stimulate the industrial policy of the country: an infrastructure law passed last November assigns more than $20bn for new clean-energy technologies such as carbon capture and nearly $8bn for electric-vehicle charging stations; an act passed in August, allocates $370bn to combat climate change, including investments in clean vehicles and renewable energy. Altogether, this may add up to $100bn of annual spending on industrial policy over the next five years to emancipate the US from Chinese manufacturing products. In 2010 China overtook the United States to become the largest value-added manufacturer in the world. Washington may not be interested in regaining the head of the manufacturing sector, but it wants to be independent from China. The worsening relationship between the two actors is forcing the return to a kind of neo-mercantilist approach in the management of US-China relations.  Economic interconnection is seen through a security lens and so, as something potentially dangerous that must be limited.

In order to develop a concrete and feasible decoupling strategy, unilateral policies will not be enough. Biden needs to mobilize a collective action which involves both the historical allies of Washington and the countries that have substantial trade and investment ties with China. The US’ government has undertaken some steps in this direction, including the agreement reached in last June’s G-7 summit on the Build Back Better World (B3W) partnership, which is openly an attempt to counter China’s Belt and Road Initiative (BRI). B3W seeks to strengthen the cooperation among G-7 countries while making substantial investments in the developing countries of the Global South. The investments, consistently with the BRI, encompass different sectors related to infrastructure, financial coordination, and economic development.

Decoupling from China is not just cutting ties with Beijing, it means also ensuring the safeguard of the global value chain by creating and strengthening new links.

Decoupling is not easy

The decoupling between the United States and China might lead to a very different world: more divided, more politically unstable and more expensive. Many companies are already starting to adapt to this hypothesis, which by now doesn't seem so remote. Nonetheless, it would be superficial to assume that this process is going to happen quickly: the business relationships, investments and supply chains are not something that can be taken apart easily. For Washington, the Chinese market is still one of the most attractive long-term growth bets. For Beijing, the access to foreign (American) technology is still crucial and breaking ties immediately with the US could lead to a sudden break in Chinese companies' learning curve.

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