Understanding and Countering Beijing’s Strategy of Economic Decoupling on Chinese Terms

The Objectives of Chinese Economic Decoupling

Based on Donald Trump’s “America First” ideology and American demands for fair and reciprocal economic arrangements, it is widely assumed that America initiated a U.S.-China Economic decoupling, forcing China to respond in defense of its economy. However, China has pursued its own economic self-sufficiency and sought to limit its economic exposure and dependence on America since reforms under Deng Xiaoping, and Chinese economic policy plays a large role in China’s hopes for relative gains against America, and wider aims within the region.

China aims to not only maintain the viability of its current CCP-led political economy, but to expand this approach, and its related principles and procedures throughout the region. This would require a Sinocentric economic order, with significantly diminished U.S. power and influence, and the support and compliance of other regional states. Since coming into power, Xi Jinping has expressed through his policy his aims to expand China’s region of interest, dictate activity within the first island chain and counterbalance other countries’ naval activity beyond it, to increase China’s leverage over regional economies, and defend and promote the Chinese authoritarian institutional system abroad.

China has been attempting to simplify the strategic map in the region through strategic compliance, expand Chinese territory through gray zone tactics, dominate supply chains and prevent other states from extracting themselves, while using the promise of absolute gains to discourage non-Chinese economic competition from smaller states, and encourage these states to separate geo-economic issues from geo-strategic and geo-political ones. China is also trying to ensure that its capacity to escalate in military, economic and diplomatic matters is more credible than other states, normalizing coercive behavior in order to discourage resistance.

This is reinforced through the Chinese “Economic decoupling”, that is emerging through strategical economic policies such as the Belt and Road initiative (BRI) that on the surface may appear to simply aim to raise Chinese capital and enable mutually beneficial economic exchanges between China and other countries. These policies, however, are also designed to use Chinese state resources to develop a Sinocentric infrastructure in terms of services, resources and physical operations through which Chinese firms and entities would dominate and negotiations would operate on terms that are favorable to the interests of Beijing. This would reduce the capacity of American firms and authorities to impose their own commercial standards and significantly weaken the influence of western powers within the global market, allowing China to control the regional economy.

Another initiative, the Dual Circulation Policy (DCP) seeks to increase Chinese domestic production and create wealth, to increase domestic demand and promote Chinese economic self-sufficiency, thereby reducing the extent to which China is vulnerable to Western controls and sanctions. However, beyond ensuring China becomes an advanced and innovative economy, the policy aims to dominate the value creation and export of high-tech goods into global markets, allowing China to take control of these global supply chains. This aim is also made clear by the objectives of the Made in China 2025 initiative, which seeks to increase the production of high tech and high value goods domestically within China.

These policies go beyond Chinese economic development and aim to lock in enduring advantages for China and block opportunities for other advanced economies such as America. This economic decoupling is on China’s terms, and it is intended to isolate and decrease the relevance of America as a world power, and economically subjugate other Indo-Pacific nations such as Japan and Australia.

Suggested Countermeasures to the Chinese Economic Decoupling Strategy

In order to counter these economic practices, America and allied nations can take three main approaches. Firstly, it is important to counter China’s objective to acquire support states through economic and technological capture. Second, they should counter elements of China’s technological upgrade strategy to ensure China cannot surpass advanced democracies. Lastly, it is important to counter Chinese domination of high tech and high value global export markets. This would not require large amounts of investment into targets, but simply sufficient commercial competition in profitable economic zones such as the maritime economies of the Indo Pacific, especially Southeast Asia.

If America were to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), it would help to disentangle and diversify the regional supply chains in critical strategic sectors away from China, help agreement of common industry rules, standards and export controls for high value and high tech sectors, link common market access to legal, regulatory and human rights standards, and diversify external finance sources away from China and Chinese demands, giving America and allied nations the ability to reform or build institutions to resist Chinese economic practices.

It is also essential to prevent China from dominating sectors such as artificial intelligence, advanced robotics, new synthetic materials and next generation integrated circuits. As China is a net importer of such technologies, it is heavily reliant on joint ventures with foreign firms in these sectors, and therefore America has significant influence on the capital and know-how into China that could feed into its Made in China 2025 or DCP policies, and allies should consider scrutinizing or restricting some categories of investment from and into China, with the objective of preventing overdependency on the Chinese economy or Chinese technology within sectors such as computer systems design, biotechnology, life sciences and other critical or high value sectors.

Europe also has a critical role in addressing the economic challenge posed by China. While the BRI excluded America, it included Europe, indicating that European involvement is vital to the success of the initiative. While consumer markets in Southeast Asia and India are projected to grow quickly, Europe remains the second largest consumer market, and the most important destination for finished goods throughout the BRI. China also needs the technology transfers from joint ventures with foreign advanced economy firms and is moving away from funding large infrastructure projects in Europe to increasing the stakes of Chinese firms in European companies engaged in high value and high-tech sectors, with the majority of investment in Germany and the UK since 2016. Europe tends to be lenient towards Chinese economic practices in order to ensure its own economic prosperity, however it must also take into account the economic and security threats this may pose.

While China has been pursuing economic decoupling from America and allied economies for over a decade, with aims to dominate and decouple vast economic sectors, especially high tech and value sectors where competition is the most consequential, it is facing increasing obstacles, largely due to the Chinese political economy, and the west has the agency and leverage to ensure that the decoupling that does occur can occur on terms favorable to itself as opposed to China.

Comment

NISHIMURA Hiroyuki:
Many Japanese corporate executives, policymakers, and media representatives struggle to keep a clear outlook in terms of how and how far the U.S.-China decoupling will unfold, and this insight will help shape the narrative and the Japanese response.

A widespread assumption that economic decoupling is being primarily pursued by America creates expectations that the process may slow down and lose momentum. Meanwhile, the suggestion that decoupling is happening from both sides implies that the process is likely to gain traction, requiring nations and corporations to be prepared. However, the majority of Japanese companies have not held any serious discussion about the latter possibility, nor have they considered taking any steps in response. To what extent will decoupling deepen, and what effects will that have on corporate strategy? Will companies still be able to operate in or sell to China? Will the question of who can stay and who must leave depend on the technology level the companies possess, and what happens if a company does not comply?

While a U.S. return to the Trans-Pacific Partnership (TPP) would be an effective countermeasure against Chinese attempts to decouple Asian economies from the U.S., most policymakers and scholars in Japan consider such a scenario unrealistic. However, that should not be the case, given that Japan took a leading role in salvaging the TPP after the Trump administration withdrew from it in 2017. Now, some Japanese trade officials are trying to engage the EU in the TPP. An EU-TPP trade pact could be established to enhance the magnate of the TPP and to create a huge free trade zone, with the EU acting as a counterbalance against China in terms of liberal, democratic, political and economic standards. This would also provide impetus for the U.S. to return to the TPP. Is engaging the EU in this way a good idea, and how realistically can the U.S. be enticed to rejoin the TPP?

In September, negotiations were also launched for the U.S.-led Indo-Pacific Economic Framework (IPEF), a framework devised specifically to decouple China. While the new framework includes export controls of critical goods and technologies and measures to join forces to exclude China from important supply chains, it does not negotiate market access, an important element that drew Asian economies to the TPP. Would IPEF be an equivalent, if not a better method, than the TPP to counter China, considering the framework is already backed by the U.S.?

Finally, the macroeconomic and political consequences of an inevitable decoupling would need to be confronted. Economic efficiency is dependent on the security of supply as well as cost, and a decoupled economy would likely lead to higher inflation and lower growth, although economists hold differing opinions as to how severe the effects would be. Would democratic governments be able to sustain public support for decoupling if companies and the public began to see severe harm inflicted upon themselves? What can western governments do to minimize damage and keep companies and consumers in line?

John LEE:
In terms of whether we are putting too much pressure on corporations to engage in strategically useful or advisable choices: corporations cannot be expected to engage in geo-strategy, however they should identify risks for themselves and broaden that notion of risk. Corporations can go beyond looking only at economic and commercial risk and consider other risks such as political risk and sovereign risk. With regards to what is happening right now, there is a partial decoupling going on in terms of supply chains, and while companies servicing the Chinese market must continue to invest in China, as required by Chinese rules, many Japanese, Korean, American and even European firms are trying to diversify their supply chains out of China.

Other economies have become used to Chinese economic practices and have not considered them to be part of a decoupling strategy. Commercial firms will likely begin to make risk-based decisions if the narrative is corrected, however governments will need to pass legislation to encourage firms to take these decisions. A complete decoupling from China is impossible and undesirable, however China must not be given the access to foreign know-how and investment that would allow it to undercut competition and drive others out of the market as it did with the solar panel industry. The maritime economies in the Indo-Pacific are where the majority of economic and strategic power lies, and so they must not become too dependent on China. Governments have the ability to guide private companies via incentives, regulation and legislation.

While many consider it impossible for the U.S. to join the CPTPP, especially under Donald Trump or Joe Biden, this does not mean that the entire administration or cabinet is against the partnership. There are many key figures in Washington who are supportive of the CTPPP, and it shares many similarities with IPEF. The fundamental difference between the two is IPEF’s lack of American market access, which would be the strongest draw away from a Chinese economic ecosystem for many countries. The U.S. joining the CPTPP would not solve every problem, however it would make the CPTPP the platform by which issues are addressed.

Europe does not necessarily need to join the CPTPP, however there is a need for tech export controls and agreements with Europe, which will be difficult to implement if Europe continues to view America as the economic rival over China. This was especially apparent with Germany under Merkel. European perspectives are changing, especially with the Ukraine situation, and there is a growing appreciation for the importance of geo-politics and geo-strategics.

When it comes to the macroeconomic implications of decoupling, the aim is not for a hard decoupling or to block China from the global economy. That would be impossible. The key is to block China’s strategies, by preventing it from dominating some technologies, and the supply chains and services associated with those technologies, in the high technology sectors. This is not as extreme a situation as a hard decoupling. While these policy responses are unlikely to happen under to current circumstances, based on its current military strategy the prospect of China using force to some degree in Asia is increasing, and an act of force from China in Taiwan, the Senkaku islands or South China sea that kills foreign citizens would change the psychology of the nations in the region significantly, and partial decoupling policies would be a rational response for many countries.

Q&A

Q:
Should countries stay with U.S. centrism rather than Sinocentrism, and restrict economic activities with China? Although it is said that there is a decoupling between the U.S. and China, the amount of investment from the U.S. to China remains positive and has not turned negative. If the U.S. is not pulling out of China, then should Japan not pull out either?

John LEE:
It is not as stark a dichotomy as U.S centrism or Chinese centrism. From the Chinese perspective China wants to be central and it wants a Sinocentric economic and strategic order, but the U.S. side will depend on which direction the U.S. goes in. A more insular, truly “America First” direction would not be followed by Japan, Australia, or other countries as it would not serve their interests, so the Americans should be persuaded to create an ally-friendly economic ecosystem as opposed to an America based one.

It is correct that foreign investment into China from the U.S. is not declining, however it is only specific sectors where China is seeking to eventually absorb and dominate certain technologies and supply chains that are of concern. There is no need to restrict or lessen U.S. investment into China outside of these specific sectors. And in fact, these sectors are already starting to see less investment through regulations, executive orders and legislation.

Q:
How will Russia’s invasion of Ukraine affect the future of U.S.-China relations?

John LEE:
A few weeks before Russia invaded, Xi Jinping and Putin announced their “No Limits” pact, and this was a moment of crisis as U.S. intelligence correctly surmised that Russia would invade Ukraine, but incorrectly believed Ukraine would fall within a few days. The Russian invasion of Ukraine has highlighted several options to deter China from the use of force and has bought more time for the region. Provided China cannot achieve a quick victory, be it in Taiwan or elsewhere, the costs would be extremely high, and China and the Chinese Communist Party would be unable to endure the level of sanctions that Russia and Putin can. China has realized that an invasion is far less simple than it appears, and that western democracies have very powerful nonmilitary tools to devastate other economies, that they would be less hesitant to use them in the event of a war. The U.S. as well as Japan and Australia are now even more determined to ensure that China cannot achieve a quick victory in Taiwan, and the Russian invasion of Ukraine has emphasized the possibility of actual war to populations and governments. This will lead to a worsening geo-strategic relationship between America and China, with America more focused on China’s aims in Northeast Asia.

Q:
Is there anything that both Australia and Japan can jointly do to overcome the negative impact of decoupling?

John Lee:
The main thing would be to encourage the Americans to think of relocating supply chains to friendly countries rather than onshoring them based on the assumption that it could lead to an increase in American jobs or prosperity. America must move some supply chains out of China, but not necessarily back to America. There have already been some U.S. initiatives in specific sectors involving America, Australia and Japan. It is important that America is rational and concentrates on ensuring that China does not dominate the region in the Global economy, as opposed to forgetting the rest of the world.