Talking Trade blog
US-China decoupling: Implications for Asia
Published 28 October 2020
Steadily escalating economic tensions between the United States and China have given rise to a new term: “decoupling.” A range of decisions by both countries has pointed to an economic future that is much more disconnected, particularly for products in the technology space.
As the splits between the two sides becomes more entrenched, it is likely to become increasingly challenging for companies to operate using existing footprints. A reshuffling of supply chains, especially, presents a host of new risks and opportunities for companies operating in Asia.
Much of the early focus on decoupling has focused attention on adjustments in semiconductors and other specific products, has been based on arguments about what firms based inside the US or China might do, and has largely ignored companies located in neither country that are bound to be caught in escalating tensions in the future.
What does decoupling mean for other types of products? How are firms actually responding to changing economic conditions? What are firms based in what might be called “third countries” like Singapore or Vietnam likely to do in response to increasing pressures from the US or China?
It seems clear already that companies will continue to adjust supply chains in the near term, although it is important to note that such reshuffling may not be as complete or speedy as many might expect.
These are still relatively early days of decoupling, with significant uncertainty likely about specific policy directions in both the US and China and confusion around what firms can realistically accomplish in a radically disrupted economic environment.
While the COVID-19 pandemic exposed new vulnerabilities in the production and supply strategies of firms conducting business in China, some research suggests that the actual number of companies fleeing China is relatively small and that this shift predates the pandemic.
A “China + 1” strategy has long been seen as an alternative way to diversify supply chain risks while continuing to tap into China’s market opportunities. Rising costs in China have driven many existing supply chain adjustments which have accelerated under the US-China trade war and pandemic stresses.
While firms have shifted some production already out of China, it is economically risky for companies to completely ignore the unique advantages that China offers including its quality infrastructure and sizable domestic market, which serve as strong incentives for firms to stay put.
Most companies that believe they may be exposed to an ongoing set of trade tensions between the US and China have engaged in internal reviews and scenario planning. COVID-19 has both put a hold on and, paradoxically, accelerated some of this thinking. While the pandemic has made it difficult for many companies to focus on strategy not directly related to immediate survival and management of a series of supply chain disruptions caused by market shutdowns, it has also amplified the risks of potential exposure to new challenges.
Every company has begun talking about building more resilience into their systems. What, exactly, such resilience will mean is less clear.
For some, it means holding more inventory. For others, it means identifying key chokepoints in the supply chain and looking for additional sources of supply to lower risks in these specific aspects of the chain. For others, it means shifting production closer to final markets to reduce disruptive effects caused by border closings and other specific obstacles.
At this point, however, most firms have already instituted supply chain reshuffling between internal locations, if such options are available. For example, companies that have overlapping capabilities in multiple locations have ramped up production in some markets while lowering production elsewhere. Internal swings to mitigate risks have already been put in place wherever possible.
One key bottleneck mentioned by multiple firms in interviews has been the availability of staff and the right sorts of talent in different markets. The pandemic has made changing supply chain locations more challenging, as it is harder than ever to get key personnel into place to manage supply chain adjustments. This could include, as an example, adding or shifting equipment to plants, sourcing additional warehousing or suppliers or distributors, or managing a flexible workforce on the ground.
The net result is that most firms seem to have thought about supply chain reshuffling, but many have not yet made the decision to implement specific recommendations beyond internal adjustments that are often easier and faster to apply.
Firm-level interviews suggest that companies remain uncertain about the impact of operations in such markets. Some firms appear bullish on the opportunities for growth in non-US, non-Chinese locations. This is not just for the domestic or regional markets, but even for the supply of goods and services back into the US or China. By locating in third markets like Singapore, Vietnam, Taiwan, Mexico or Eastern Europe, firms could successfully compete in a range of competitive markets with lowered risks of getting caught in decoupling policy shifts.
Some companies imagine a potentially “decoupled” world operating like a hybrid military/civilian or dual use manufacturing operation today. In extremely simplified form, a factory in Singapore could produce goods for the US market on one side of a building and for the Chinese market on the other. The management of such split operations has successfully taken place for dual-use goods, even for extremely complex and high-tech products already in a wide variety of locations around the globe.
This model, some firms noted, could be managed as long as the extent of decoupling remains manufacturing location based. It gets much trickier if the decoupling spreads deeper into systems such that the US and China are literally operating on different standards. If American standards for data are not compatible with Chinese standards, as an example, there may be less and less scope for managing an overlapping production facility as firms would effectively be manufacturing two entirely different types of goods.
The twin shocks of the US-China trade war followed by a global pandemic have placed severe stresses on supply chain operations. Effectively managing these risks will require firms to rethink location decisions and decide whether or not existing footprints are still “fit for purpose.” The continuing pressures emanating from a US-China decoupling will accelerate these conversations for many firms in Asia.
While most supply chain adjustments have remained at the planning stages during the pandemic, companies say they are ready to pull the trigger to activate new scenarios in the near term. Responding to decoupling and the pandemic is likely to lead many firms to make changes in 2021 and beyond.
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