Economy · August 6, 2022

The US and China are separating, but not as fast as you think

Before Chinese fighters roared and its ballistic missiles screamed in the seas off Taiwan last week, analysts had already begun plotting, from foray to inaction, what investors could expect next.

The consensus among those forecasters was poor and, if anything, now there is even less. Both the US and China have spent the past few days debating the definition and conditions of the status quo, but the status quo now seems unequivocally on the move. The safest analytical bet, in that context, is on a greatly accelerated economic decoupling between the US and China, but how likely is it to move from the current highly selective form to a broader split?

Beyond the three days of Chinese military exercises that are expected to end on Sunday and the petulantly imposed sanctions on Nancy Pelosi herself, the possible consequences of the US House Speaker’s visit to Taiwan lie on a broad speculative spectrum. China’s abrupt suspension on Friday of bilateral meetings and cooperation talks on everything from defense policy coordination to drug trafficking lengthens the list of plausible bad scenarios.

Decoupling sounds believable. There is already visible political momentum on both sides. There is nothing to suggest greater closeness in perspective, and many things foreshadowing the divergence that is expanding far beyond the two core players, including Chinese missiles landing in Japan’s exclusive economic zone for the first time. The decoupling narrative, however, is characterized by strict limits of both time and scale, and should not be overlooked due to the events of the past week.

Proponents of the faster decoupling thesis have a fair amount of evidence on their side. The Made in China 2025 program is all about technological autonomy, and the Biden administration has so far done little to reduce the hawkish tone towards China set by its immediate predecessor.

This week, in a decoupling milestone, the US president will sign the Chips and Science Act passed by Congress in late July. This results in more than $ 50 billion in federal grants to companies building advanced semiconductor manufacturing in the United States, requiring all recipients of such funding not to upgrade any China-based factories for a decade. Non-American companies are included, and the decoupling lure for South Korean chip makers could prove decisive. Japan, which may soon be confronted with Beijing’s efforts to force its high-tech companies to design certain products in China, may also feel greater decoupling pressure.

The narrative could also take hold outside the United States and its closest Asian allies. In a note to clients last week, analysts at Gavekal Dragonomics identified a growing consensus within the EU to treat China as both an economic and security threat. Politics could become increasingly defensive based on that understanding, although the lobbying power of European companies with large investments in China remains formidable and a full-fledged debate on decoupling remains at some distance.

For now, at least, there are three significant constraints on the history of accelerated decoupling. The first is that the US’s ability to bring in others with the program may be more fragile than it appears, even with a close ally like Japan. As decoupling is increasingly driven by legislation or regulation, the questions about the underlying intention will intensify. Efforts to protect national and economic security are fine; Deliberately limping China’s economy will earn fewer converts.

The second is that, on both the Chinese and US sides, corporate resistance to accelerated decoupling will be fairly substantial, no matter how noisy the policy becomes. Trade relationships, investments, and supply chains are not trivial ties that can be resolved quickly, and the Chinese market is still the most attractive long-term growth bet. Chinese companies still cannot afford a steep exit from foreign technology and a sudden break in their learning curve.

The third problem is time. In late July, the US Senate proposed a new bill that could theoretically create tax incentives that would take the electric vehicle battery production chain out of China (which dominates in all key areas) and into the United States. . This is logical stuff, given the direction the EV markets are heading. The bill would superficially fit the history of rapid decoupling. The reality, according to analysts at Goldman Sachs, is a somewhat quieter process that would involve lead times of between four and seven years for each of the six main points in the supply chain.

Decoupling is happening and could increase the political volume on decoupling to unprecedented levels last week. Any real acceleration, however, can be illusory.