The illusion of decoupling from China: Costly trade barriers vs engagement

China joined the World Trade Organization in 2001. In 1990, countries across the world sourced 2.1 per cent of their total imports from China. By 2000, this share had more than tripled to 6.6 per cent. A decade after China’s accession to the WTO, its share of global imports had entered double digits, reaching 13.5 per cent in 2011. By 2019, just before the pandemic, the world relied on China for 16.3 per cent of its total imports.

 

The G7 economies have continued to run massive trade deficits with China, a key issue in US presidential elections. One response was President Donald Trump’s imposition of tariffs on Chinese steel and aluminium products in 2018, which led to Chinese retaliation and the US-China trade war. Now, Trump 2.0 has imposed an additional 10 per cent duty on all imports from China.

 

At the heart of these tariffs is the desire to decouple from China. And this decoupling is not just restricted to international trade. In May 2019, the US banned Huawei from participating in building its 5G network. It also pressurised other nations against doing business with China, especially in strategic sectors. For instance, following the US ban, Australia, Canada, Japan, New Zealand, and the UK also announced bans on Huawei equipment in their 5G networks. Similarly, the Dutch semiconductor chips giant ASML Holding cancelled shipments of high-tech microchip machinery to China after pressure from the US government.     

 

Is it really possible to decouple from China? And what would be the costs of such decoupling? A growing body of academic work suggests that even if countries like the US may be reducing their direct imports from China, their indirect imports from the country may be making up for this loss.

 

In essence, while the US may be trying to substitute China with other sources for its imports (like Mexico and Vietnam), the latter continue to rely on China for essential raw materials, parts and components (i.e., all kinds of intermediate inputs), which does not reduce the effective import dependence on China.

 

Chinese exports to Mexico and Vietnam have increased at the same time as US imports from these countries have increased, alluding to the indirect use of Chinese products (though US direct imports from China have fallen). Trump 2.0 has threatened to impose a 25 per cent tariff on both Canadian and Mexican exports to the US, possibly to also address this indirect trade. Anecdotal evidence suggests that China may also be investing more in countries like Mexico and Vietnam so that it can open up another route via which it can access the US market.

 

It is also true that China is deeply integrated into regional and global value chains (GVCs), so any effort to move away from it will come with significant costs, at least in the short to medium term. For one, supplier networks are driven by commercial considerations and despite rising wages, China continues to be a cost-effective supplier of most products. Two, across different price points, Chinese products are associated with a certain quality. Compromising on cost-effectiveness and quality for geopolitical reasons is unlikely to benefit domestic producers and consumers in any economy in the long run. At the very least, any China+1 diversification strategy will face tangible supply-side constraints.

 

Finally, given its leadership in sectors like critical minerals and EV-batteries, is it even feasible to decouple from China? For instance, the country produces around 60 per cent of the world’s rare earth metals, and is the origin of around 90 per cent of refined rare earths on the market. China’s market share in key EV battery components tops 80 per cent. So, even new industrial policy measures adopted by the US and the European Union are unlikely to significantly alter the global landscape in these sectors.

 

A more realistic strategy would be to engage with China constructively without compromising domestic interests. Moreover, global challenges like climate change cannot be tackled without multilateral cooperation. Decoupling from the world’s second-largest economy may, therefore, not be the most pragmatic approach.

 

The author is a professor in the faculty of finance & economics  at S P Jain Institute of Management  & Research, Mumbai, and a visiting fellow at the Centre for Social and Economic Progress, New Delhi. The views are personal