WHEN IT COMES to tracing the geography of global supply chains, few companies provide a better map than Foxconn,
the world’s largest contract manufacturer. This year the Taiwanese
giant has built or expanded factories in India, Mexico, Thailand and
Vietnam. The Chinese production sites once beloved by Western companies
are firmly out of fashion. Souring relations between the governments in
Washington and Beijing have made businesses increasingly fretful about
geopolitical risks. As a consequence, in the first half of the year,
Mexico and Canada traded more with America than China for the first time
in almost two decades. The map of global trade is being redrawn.
At
first glance, this is almost exactly what is desired by America’s
policymakers. Under first Donald Trump and then Joe Biden, officials
have put in place an astonishing array of tariffs, rules and
subsidies—an executive order introducing outbound investment screening,
the latest sally, is expected soon. The aim is to weaken China’s grip on
sensitive industries and, in a motivation that mostly goes unspoken,
prepare for a possible invasion of Taiwan.
This attempt to “de-risk” trade with China is the cornerstone of the
White House’s foreign policy. Yet despite extensive efforts, and the
reshaping of trade seemingly evident in headline statistics, much of the
apparent de-risking is not what it appears.
Instead
of being slashed, trade links between America and China are
enduring—just in more tangled forms. The American government’s preferred
trading partners include countries such as India, Mexico, Taiwan and
Vietnam, in which it hopes to spur the “friendshoring” of production to
replace imports that previously would have come from China. And trade
with these allies is rising fast: just 51% American imports from
“low-cost” Asian countries came from China last year, down from 66% when
the Trump administration’s first tariffs were introduced five years
ago, according to Kearney, a consultancy. The problem is that trade
between America’s allies and China is also rising, suggesting that they
are often acting as packaging hubs for what, in effect, remain Chinese
goods. This flow of products means that, although America may not be
buying as much directly from China as before, the two countries’
economies still rely on each other.
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For
evidence, look at the countries that benefit from reduced direct
Chinese trade with America. Research by Caroline Freund of the
University of California, San Diego and co-authors investigates this
dynamic. It finds that countries which had the strongest trade
relationships with China in a given industry have been the greatest
beneficiaries of the redirection of trade, suggesting that deep Chinese
supply chains still matter enormously to America. This is even truer in
categories that include the advanced-manufacturing products where
American officials are keenest to limit China’s presence. When it comes
to these goods, China’s share of American imports declined by 14
percentage points between 2017 and 2022, whereas those from Taiwan and
Vietnam—countries that import heavily from China—gained the greatest
market share. In short, Chinese activity is still vital to the
production of even the most sensitive products.
Exactly
how the re-routing works in practice differs across countries and
industries. A few products can be sourced only in China. These include
some processed rare earths and metals where Chinese companies dominate
entire industries, such as the gallium used in chip production and the
lithium processed for electric-vehicle batteries. Sometimes exports to
America and the rest of the West from their allies are nothing more than
Chinese products that have been repackaged to avoid tariffs. Most
often, though, inputs are simply mechanical or electrical parts that
could be found elsewhere at greater cost by an assiduous importer, but
are cheaper and more plentiful in China.
Pass the parcel
All
three types of phony decoupling can be found in China’s backyard. The
latest official data, published in 2018, concerning exports by the
Association of Southeast Asian Nations (ASEAN), a
regional club, show that 7% by value were actually attributable to some
form of production in China—a figure that is probably an underestimate
given how difficult it is to disentangle trade. Fresher data suggest
that China has only grown in importance since then. The country has
increased its share of exports to the bloc in 69 of 97 product
categories monitored by ASEAN. Electronic exports, the
largest category, which covers everything from batteries and industrial
furnaces to hair clippers, have exploded. In the first six months of the
year Chinese sales of these goods in Indonesia, Malaysia, Thailand, the
Philippines and Vietnam rose to $49bn, up by 80% compared with five
years ago. There is a similar pattern in foreign direct investment,
where Chinese spending in crucial South-East Asian countries has
overtaken America’s.
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Factories
farther afield are also humming with Chinese activity, perhaps most
notably in the car industry. In Mexico the National Association of
Autopart Makers, a lobby group, has reported that last year 40% of
nearshoring investment came from sites moving to the country from China.
A rich supply of intermediate goods is duly following. In the past year
Chinese companies exported $300m a month in parts to Mexico, more than
twice the amount they managed five years ago. In central and eastern
Europe, where the car industry has boomed in recent years, phony
decoupling is even more conspicuous. In 2018 China provided just 3% of
automotive parts brought into the Czech Republic, Hungary, Poland,
Slovakia, Slovenia and Romania. Since then, Chinese imports have surged,
thanks to the rapid adoption of electric vehicles, of which the country
increasingly dominates production. China now provides 10% of all car
parts imported into central and eastern Europe, more than any other
country outside the eu.
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Tighter
trade links between America’s allies and China are the paradoxical
result of America’s desire for weaker ones. Companies panicked by
worsening relations across the Pacific are pursuing “China plus one”
strategies, keeping some production in the world’s second-largest
economy, while moving the rest to countries, such as Vietnam, that are
friendlier to Uncle Sam. Yet American demand for final products from
allies also tends to boost demand for Chinese intermediate inputs, and
produces incentives for Chinese firms to operate and export from
alternative locations. Although Apple, the world’s largest company by
market capitalisation, has moved production outside China in recent
years, this comes with a caveat: much of the production still relies on
Chinese companies. The tech giant lists 25 producers in Vietnam on its
official suppliers list. Nine are from mainland China.
How
concerning should this state of affairs be to American policymakers? In
the worst case—a war in which supplies of goods between China and
America are almost completely severed—dealing only indirectly with China
or with Chinese firms on the soil of third countries is probably an
improvement on Chinese production. Moreover, companies are adapting to
security rules so as to reduce costs for consumers. But that carries its
own risks: a belief that decoupling is under way may obscure just how
critical Chinese production remains to American supply chains.
The
fact that so much production in Asia, Mexico and parts of Europe
ultimately relies on imports and investment from China helps explain why
so many governments, particularly in Asia, are at best fair-weather
friends to America, at least when it comes to shifting supply chains.
After all, if forced to choose sides once and for all, exporters would
suffer mightily. A recent study by researchers at the IMF
models a scenario in which countries must pick between America and
China, with their decision on which of the two superpowers to side with
decided by recent voting patterns at the UN. Such a scenario, the researchers calculate, would reduce GDP by as much as 4.7% for the worst-affected countries. Those in South-East Asia would be struck particularly hard.
Frenemies
Given
that most countries are desperate for the investment and employment
that trade brings, America has been unable to convince its allies to
reduce China’s role in their supply chains. Many are content to play
both sides—receiving Chinese investment and intermediate goods, and
exporting finished products to America and the rest of the West.
Ironically, then, the process driving America and China apart in trade
and investment may actually be forging stronger financial and commercial
connections between China and America’s allies. Needless to say, that
is not what President Biden had in mind. ■