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The global economic map is reshuffling, and predictions abound on where the pieces will land. As companies scramble to protect themselves from U.S. President Donald Trump’s trade wars, the growing technology rivalry between the United States and China, and the disruptions caused by the COVID-19 pandemic, will the long-promised “reshoring” of manufacturing back to higher-wage countries finally take place? Will the U.S. and China “decouple” their economies, particularly for the technologies of the future? If so, how will Europe, Japan and others respond?
For the moment, the big winner is uncertainty. We have moved from a world in which companies and their customers knew the rules of the game of global commerce, to one where many decisions are fraught with risk. Now, on top of the usual uncertainty inherent in predicting economic or consumer trends, companies face added political, legal and medical uncertainties that will inevitability discourage risk-taking, dampen investment and harm economic growth. Some companies will respond better than others to that uncertainty—and perhaps profit handsomely in the process. But many others will be faced with all but impossible choices.
The larger consequences for the global economy will depend a great deal on the actions of governments, especially the most powerful, like those of the United States and China. If they treat the world economy as a zero-sum competition—one in which both economic gain and national security are at stake—then the uncertainty will be magnified and the costs will escalate. If they can find ways to cooperate in managing the transition to whatever new economic order emerges after the pandemic, then the disruptions should be manageable. So far, though, the signs are not encouraging.
The Trade Unraveling
Much of what national governments do in the economic sphere at home is to reduce uncertainty. Governments enforce contracts, uphold intellectual property rights, use interest rates to minimize swings in the economy and, in a hundred other ways, try to reduce the inherent risk of economic activity.
International commerce has always had a much higher degree of uncertainty. There is no global currency, no binding global legal system, no court of last resort. The “beggar thy neighbor” measures of the 1930s—in which the world’s leading economies raced against each other to impose discriminatory tariffs and devalue their currencies in a futile quest for temporary competitive advantage—deepened the Great Depression and showed the dangers of unconstrained economic nationalism. From 1929 to 1932, trade among the industrialized nations fell by more than 30 percent.
What has long been at most a niggling concern—that companies are overextended and their supply chains lack resilience—is now at the center of economic policy debates.
In part to address these issues, the modern global trade and financial system built after World War II—which was first drawn up at the Bretton Woods Conference in 1944 that led to the establishment of the World Bank and the International Monetary Fund—created the conditions for trade and investment by bringing unprecedented predictability to global commerce. Starting with the General Agreement on Tariffs and Trade in 1948, trade negotiators were able to constrain economic nationalism by agreeing to a set of rules and norms that would bring more certainty to anyone wanting to do business across international borders. World trade grew 27-fold between 1950 and 2008, and the average trade-to-GDP ratio for countries, a measure of their integration into the global economy, rose from an average 25 percent in the 1960s to 60 percent in 2015. It was aided by the most ambitious step of all: the creation in 1995 of binding rules for resolving disputes through the successor to the General Agreement on Tariffs and Trade, the World Trade Organization—perhaps the closest thing human beings have ever created to a genuine international court.
China was an especially important part of this story. China’s economy grew at double-digit rates following the introduction of economic reforms under Deng Xiaoping in 1979, and its admission to the WTO in 2001 was an accelerant, largely removing the risk for companies that exports from China to the West would be hit with punitive tariffs. By the mid-2000s, foreign firms accounted for more than half of all of China’s exports and imports, while China’s own high level of domestic savings provided further resources for the expansion of industry. In 2010, China surpassed the United States to become the world’s largest manufacturing country.
But over the past decade, all this trade progress has stalled, at first gradually and then more dramatically with Trump’s trade wars not only with China, but with close American allies and trading partners like the European Union, Canada and Mexico. According to the WTO, trade growth began stalling with the Great Recession and its aftermath, and then slowed more in 2018 and 2019 as trade tensions began to rise. Now, the coronavirus pandemic is halting global trade even further. The economic shutdowns caused by COVID-19 are expected to result in a decline in trade volumes this year of between 13 and 32 percent. Foreign investment has similarly slowed. According to the United Nations Conference on Trade and Development, global foreign direct investment in 2019 was already down 25 percent from its 2015 peak of $1.8 trillion, and is now expected to fall by as much as another 40 percent in 2020.
Predatory trade policies have been on the rise, leading to a return to economic nationalism. After Xi Jinping became China’s leader in 2012, the country began to move away from a private sector-led development strategy to one that relies more on state-owned enterprises backed by heavy state subsidies. That, coupled with Xi’s so-called “Made in China 2025” initiative to acquire a dominant position in emerging technologies, was already fueling Western antagonism well before Donald Trump entered the White House in 2017.
Workers arrange face masks at a factory in New Taipei City, Taiwan, Aug. 12, 2020 (AP photo by Chiang Ying-ying).
But Trump arrived in Washington with his own fully formed set of grievances over trade that went back to the 1980s, when Japan’s rising economy prompted threats of regulation and tariffs from the U.S. With a veteran of that era, Robert Lighthizer—who had served as President Ronald Reagan’s deputy trade representative—steering Trump’s trade policy, his administration wasted little time in dusting off the old playbook and throwing out the rules of the WTO that the United States had agreed to in 1995. Trump imposed global tariffs on steel and aluminum imports on specious national security grounds, to the particular detriment of not just China, but also Taiwan, Japan and the European Union. His duties on imported washing machines similarly affected U.S. allies and trading partners in South Korea and Mexico. New tariffs on solar panels became part of a much larger, targeted broadside against China that led to tariffs on most Chinese goods—raising the average U.S. tariff on Chinese imports from just 3 percent in early 2018 to more than 20 percent by mid-2019. The “phase one” trade deal that Trump struck with China in January and has touted ever since left most of those tariffs in place. Trump has also continued to escalate trade spats with the EU and Canada, recently adding new tariffs on Europe in a dispute over aircraft subsidies, and reimposing tariffs on Canadian aluminum.
The higher tariffs imposed by Trump had already forced many U.S. companies to seek alternatives to Chinese-based production when the pandemic, which broke out initially in Wuhan, led to a temporary shutdown of many manufacturing facilities in China. As the virus spread, shortages of pharmaceuticals and medical and protective equipment, much of which is produced in China, led to growing concerns in the U.S. and Europe over their dependence on China for critical medical supplies. As a result, what has for decades been at most a niggling concern—the fear that companies are overextended globally and that their supply chains lack resilience—is now at the center of economic policy debates.
Reshoring or Reconfiguration?
From Japan to the United States to Europe, political leaders are moving to try to address what are now seen as significant vulnerabilities in global supply chains, turning to subsidies and other policy tools to try to plug those holes. The turnabout is most striking in the United States, which has long been allergic to using the government to shape market outcomes, at least outside of the defense industry. Republicans who were once dismissive of such initiatives have now become their champions. Marco Rubio, a Republican senator from Florida, is urging the U.S. to adopt a “sweeping pro-America industrial policy” in which government incentives would be used to bring supply chains home in sectors deemed critical, such as pharmaceuticals and medical equipment, and high-tech industries such as rare earth mineral processing, semiconductor manufacturing and advanced telecommunications. The Trump administration is considering a $25 billion “reshoring fund” to encourage companies in essential industries to repatriate production; support for such initiatives crosses party lines. Democratic presidential candidate Joe Biden’s economic platform calls for creating 5 million manufacturing jobs by mobilizing “the full power of the federal government to bolster American industrial and technological strength.”
Other countries are moving in a similar direction. In its record economic stimulus package to deal with the pandemic, the Japanese government allocated more than $2 billion to subsidize moving costs for any company—regardless of sector—that agrees to shift production from China back to Japan, with lesser help for those moving from China to third countries. Iris Ohyama, a Japanese plastic manufacturer that makes face masks in China, was among the first to take advantage of the deal by setting up a new facility in Japan where it plans to make 150 million masks per month. The Japanese government announced in July that it was distributing $653 million from the fund to 87 companies, most of them small and mid-sized firms in the medical equipment and chemicals sectors. The European Union, meanwhile, has aimed for a middle ground, unveiling a supply chain strategy that will involve bringing back some critical industries from Asia, though its plan is focused more on diversifying sources of supply, rather than on reshoring.
The efforts are most apparent in the medical and pharmaceutical sectors. Every advanced economy in the world is heavily dependent on imports in these sectors; some 50 to 80 percent of active pharmaceutical ingredients in European drugs, for example, come from China and India. France is leading initiatives to reduce that dependence, especially for drugs needed for the fight against COVID-19, such as the painkiller paracetamol and other intensive care drugs. India, which depends on China for nearly 70 percent of its active pharmaceutical ingredients, is also encouraging producers to move home.
At the end of the day, China retains enormous economies of scale and has a developed supply chain that will be difficult for other countries to replicate.
The U.S., for its part, has made funds available through the Defense Production Act—a Cold War-era law that enables the White House to control key domestic industries during a crisis—to speed production of drugs and medical equipment in short supply. Eastman Kodak, the beleaguered photography company, received a $765 million loan in late July to produce ingredients for generic medicines needed in the fight against the coronavirus—news that initially sent its shares skyrocketing, though the loan is now under review over allegations of insider trading by Kodak executives. The Trump administration has so far allocated more than $3.2 billion under the Defense Production Act to expand the production of test swabs, masks and COVID-19 tests, as well as to support meat, steel, and semiconductor companies, and other industries deemed critical during the pandemic. But it is not clear how much difference these efforts can make. The United States still remains overwhelmingly dependent on imports of medical supplies, much of which comes from China.
At the end of the day, China retains enormous economies of scale and has a developed supply chain that will be difficult for other countries to replicate. The story is similar in many other sectors, from cars to consumer goods. Global supply chains are so deeply intertwined, and the market opportunities in emerging economies so vast, that most companies are likely to resist patriotic demands from governments to come back home. China accounted for nearly 30 percent of all global growth over the past five years—twice as much as the United States. Western companies simply cannot afford to walk away from that opportunity.
And indeed, the evidence so far suggests that most companies are leaving their existing supply chains intact. Those that have moved away from China have mostly set up shop in other Asian developing countries, especially Vietnam. Google has shifted most of the production for its new Pixel 4A smartphone from China to Vietnam, and Microsoft has done the same with its Surface tablet. Apple’s Taiwanese contract manufacturer Foxconn has recently started rolling out iPhone 11s from a new production facility in Chennai, India.
The most recent “Reshoring Index” from the consultancy Kearney suggests that Trump’s trade war has depressed Chinese imports into the U.S., which dropped 17 percent between 2018 and 2019. But rather than shifting to U.S. suppliers, buyers instead largely turned to imports from other Asian economies and from Mexico; U.S. manufacturing remained flat, with declining exports offsetting any gain from reduced imports. According to Kearney’s report, the United States has been unable to boost manufacturing due to shortages in skilled labor and slow productivity growth—challenges that will continue to hamper growth, even with the trade war putting Chinese manufacturing at a disadvantage. In 2017, the U.S. made a big push to incentivize domestic companies to invest in automation—and thereby increase their competitiveness in the global market—as part of a package of big corporate tax cuts. But the uncertainties caused by the trade wars and the pandemic have dampened enthusiasm for new investments.
Still, prolonged uncertainty could change these calculations for some companies, making overseas dependencies more of a risk. A new study from McKinsey Global Institute estimates that between 16 and 26 percent of global exports are in industries where companies have strong incentives to shift production to avoid disruptions. In one sector, high-tech goods, the shift is already well on its way.
The Recoupling of Economics and Security
If trade wars and a pandemic were the only risks, many companies might choose to ride out the storm and stay where they are. China’s network of suppliers, the size of its educated labor force and its sophisticated infrastructure are difficult to replicate; countries like Vietnam and Mexico are at best partial substitutes. And relocating from China, or setting up additional production facilities as supplements, is expensive, at a time when the pandemic recession is hurting profits.
Left on their own, companies would likely pursue a mix of strategies that give them the best of both worlds. Heavy equipment manufacturers like General Electric and Caterpillar, and auto companies like General Motors and Volkswagen, have long pursued local production strategies, producing in China for its large domestic market, while also establishing export facilities in other countries. But for high-tech companies, governments are quickly foreclosing that option. The United States, in particular, has come to see China not just as an economic rival, but as a growing military threat. The days of “Chimerica,” when pundits imagined a world where the close economic interdependence of the two giants would lead to cooperation on larger global issues, seems part of a distant past.
Over the past year, the Trump administration has launched a concerted effort to stifle China’s drive for a leading position in the newest technologies, fearing that its progress poses a growing danger to the United States. In a speech in July, Secretary of State Mike Pompeo accused China of “ripping off our prized intellectual property and trade secrets” and “sucking supply chains away from America.” Trump’s trade adviser, Peter Navarro, has accused China of deliberately sending out Chinese nationals to “seed and spread” the virus in the rest of the world. He is even calling for China to pay “compensatory damages” to other countries for the resulting economic harm.
U.S. Secretary of State Mike Pompeo at a news conference on Huawei in Washington, July 15, 2020 (AP photo by Andrew Harnik).
China, too, has become increasingly hostile and dismissive toward the United States. U.S. blunders over the past two decades, including the war in Iraq, the burst of the housing bubble that triggered the global financial crisis in 2008, and its botched response to the coronavirus pandemic have all encouraged China to become more assertive. Trump’s outbursts against China have prompted equivalent return fire. In March, the Chinese Foreign Ministry spokesman Zhao Lijian tweeted an accusation that the coronavirus had originated in the U.S. and was brought to Wuhan by the U.S. Army. The ministry’s Twitter account has also directly attacked Trump, emulating his insulting style and liberal use of all caps.
Underlying the mutual war of words is an increasingly zero-sum view of U.S.-China relations. The Trump administration’s recent strategy document on China accuses Beijing of backsliding on political and economic reform. China’s Communist Party has, it argues, “chosen instead to exploit the free and open rules-based order and attempt to reshape the international system in its favor.” Beijing has doubled down, though, imposing a new national security law on Hong Kong that has led to an aggressive crackdown on free speech in the former British colony, despite China being well aware that it would be accused of violating its commitment to permit Hong Kong to maintain a more open political system until at least 2047. While the move resulted in economic sanctions from the U.S. and other countries, China increasingly behaves as if the loss of Western markets is an acceptable price for stifling any internal dissent.
The shift in relations has been most apparent in high-tech trade. Over the past several decades, China became the critical hub for many Western high-tech supply chains. The United States ran a trade deficit of $132 million in advanced technology products last year, all of it from trade with China. The European Union similarly ran a €73 billion deficit in high-tech trade with China. China also supplies nearly 80 percent of the rare earth minerals used in the U.S., which are critical for many high-tech products, from electric vehicles to motors to solar panels and wind turbines. China has also become the world’s largest and fastest growing market for semiconductor chips, critical components for the manufacture of everything from smart phones to satellites. The Trump administration has recently been clamping down on those exports, arguing that semiconductors and the equipment to make them are critical national security assets, and that U.S. companies should be barred from selling them to China.
The biggest target has been Huawei, the telecommunications company that is the world’s largest maker of equipment for new 5G wireless networks. Huawei had captured nearly 30 percent of the global market by 2019, but the United States has barred its companies from using Huawei equipment, and is pressing the rest of the world to follow suit. The U.S. has accused Huawei—with considerable evidence—of stealing intellectual property from Western companies and violating U.S. trade sanctions. It also fears that Huawei products could be used for espionage purposes, an argument that has been persuasive to some U.S. allies. Japan, Australia and the U.K. have so far followed Washington’s lead in banning Huawei equipment from their telecom networks, and many others have imposed significant restrictions.
The Trump administration has also tried to cripple Huawei’s technological capabilities, which still depend heavily on semiconductors designed or manufactured outside China. The administration placed Huawei on the so-called “entities list” in May 2019, meaning that U.S. companies are now required to get a government license to sell U.S.-produced chips to the telecom giant. Then, in May 2020, the administration announced it would also forbid companies that use U.S.-made equipment to manufacture semiconductors from selling their chips to China. That move will cut off Huawei’s main chip supplier, Taiwan-based TSMC, from providing chips for Huawei’s smartphones.
The U.S. has taken broader actions, as well, aimed at cutting off technology cooperation. The administration is threatening to cancel visas for any Chinese graduate students or researchers who first studied at Chinese universities that have links to China’s People’s Liberation Army. And the administration is considering a broader visa ban on Chinese Communist Party members and their families, a policy that could affect 270 million people.
What both global companies and smaller countries need, but will likely not get, is some roadmap to the rules of the future economic order.
China, meanwhile, has pushed for influence in obscure bodies that set global technology standards, aiming to define the future of tech on its own terms. More likely, the emerging high-tech order will be based on rival technology blocs, one organized loosely around China and the other around the U.S. Many companies will be forced to choose between China and the West, doing business in one or the other. Other countries, too, are being pushed to pick sides. It is far from clear that they will choose the United States.
Europe has struggled to respond. Its companies are heavily reliant on U.S. semiconductors and cannot afford to run afoul of U.S. export controls, but they are also reluctant to forgo the Chinese market, even though European 5G firms such as Ericsson and Nokia stand to benefit from Huawei’s troubles. Smaller countries that have profited from trade with China, or received Chinese loans and grants for projects under the Belt and Road Initiative, are similarly torn; two-thirds of the world’s nations already trade more with China than they do with the United States.
Managing the New Uncertainty
What both global companies and smaller countries need, but will likely not get, is some roadmap to the rules of the future economic order. Moving production out of China is costly. If relations between China and the West continue to deteriorate, the companies that make the move now will be the winners in the long term; but if the situation stabilizes, those who stayed put will reap the rewards. If some decoupling from China is inevitable, then a more gradual shift to the new order would be preferable, but that will take cooperation between governments—most importantly the United States and China—which seems unlikely.
There will be significant losses all around. The rollout of 5G capabilities, which are critical to future innovation and promise many improvements for companies and consumers, has already slowed. The U.S. semiconductor industry, which is the foundation of the country’s tech economy, will be seriously weakened if it loses the Chinese market. As one industry insider has put it, “The idea that we can decouple from China and our industry will still be successful is not tethered to reality.” China, too, which remains well behind the United States in many tech fields, will see its ambitions curbed by decoupling.
The alternatives are difficult and messy—the normal stuff of diplomacy. Scott Kennedy of the Center for Strategic and International Studies has called for a strategy of “principled interdependence,” in which the United States diversifies its supply chains and targets its sanctions, but does not aim to cut the global tech industry in half. A similar approach would make sense more broadly. As the trade war and the pandemic revealed, the old system was brittle. In their search for efficiency and cost-savings, global companies had left themselves and the societies they serve far too vulnerable.
The global economic challenge of the moment is managing a gradual transition to a more resilient world. But it is far from clear that governments are prepared to meet it.
Edward Alden is a senior fellow at the Council on Foreign Relations, and the Ross Distinguished Visiting Professor at Western Washington University.
