China Can’t Afford to Decouple from the West

Since former U.S. President Donald Trump launched his trade war against China in 2018, Chinese leaders have gone from mocking the idea that the world’s two biggest economies might decouple, to worrying about losing access to American technology, capital and markets, to thinking that China might be better off disengaging from its main rival on its own terms. They shouldn’t be too eager to sever economic ties to the West, however. The costs of decoupling are likely to be far greater than any possible benefit.

China’s fears about its dependence on the U.S. aren’t unwarranted. Indeed, the U.S. and its allies are also taking costly steps to lessen their reliance on mainland-based supply chains. For their part, Chinese authorities have undertaken an extensive security review of supply chains and launched initiatives to bolster food and energy security. Regulators are seeking better control over the vast troves of data held by Chinese technology companies, forcing one of the biggest, Didi Global Inc., to delist in the U.S. and transfer to Hong Kong, while effectively blocking others from listing on U.S. exchanges. China has launched a massive effort to build up its chipmaking capabilities and wean itself off Western suppliers.

At the same time, Chinese leaders should know far better than most the risks of self-isolation. Decades of inward-looking policies under Mao Zedong left tens of millions of Chinese dead and the country entrapped in poverty. Only after Deng Xiaoping introduced his liberalizing reforms in 1979 did the economy begin to take off. Severing ties forged over four decades of integration with the West will make an already slowing Chinese economy less, not more productive.

Nor is there much reason to think China can succeed in its aim of achieving self-sufficiency by fiat. While the country’s technological capabilities have grown immensely over the years, the government can hardly take credit. Years of massive investments have not paid off. One academic study estimates that China spent 550 billion yuan ($88 billion) supporting various industrial projects between 2006 and 2013 yet produced only 145 billion yuan in net profits for domestic firms and 230 billion yuan in export gains. In other words, China’s industrial policy during this period generated a net loss of 175 billion yuan ($28 billion).

Beijing has also greatly underestimated the challenge of establishing a sanctions-proof chipmaking industry. The foundation of global technology supply chains is specialization. Individual players — companies in different countries — acquire unique capabilities, enabling them to focus on a particular technology and constantly innovate. No single country or company can dominate or monopolize the entire supply chain.

According to the Semiconductor Industry Association, there are more than 30 types of specialized semiconductor product categories. Making a chip requires as many as 300 different inputs, which are in turn processed by more than 50 types of specialized equipment. Even the U.S., the industry leader, is incapable of building a completely indigenous semiconductor supply chain. While China reportedly is planning to spend $1.4 trillion over the next five years pursuing that goal, the odds of success are slim.

China’s efforts to reduce its reliance on food imports, which reached $108 billion in 2020, seem similarly destined to fail. Because about a quarter of the country’s food imports come from the U.S., Chinese leaders fear Washington could impose an embargo in any future confrontation, as it did after the Soviet Union invaded Afghanistan in 1979.

The costs of eliminating that dependence are likely unsustainable. To take just one example, according to the U.S. Department of Agriculture, the per hectare yield for soybean farms in China’s Heilongjiang province is a third lower than in the American Midwest, while the cost of producing a metric ton of soybeans in China is more than twice that in the U.S. Given that U.S. soybeans alone account for roughly 11% of China’s overall food imports, replacing them with domestic supplies would be prohibitively expensive.

Caught in an open-ended rivalry with the U.S., Chinese leaders have limited options for addressing their economic vulnerabilities. Trading economic efficiency for security is unlikely to pay off, while seeking a rapprochement with the U.S. is impossible amid intense and growing mutual hostility. Ultimately, China is going to have to live with some degree of risk — and do all it can to prevent tensions with the West from spiraling out of control.

Author: Minxin Pei, Bloomberg