Nevertheless, the lingering risks of a prolonged US-China trade war, as well as the COVID-19 pandemic, have prompted many countries and firms to consider moving their global supply, and value, chains away from China to diversify geopolitical and economic risks. For example, Japan has set up a US$536 million fund to assist Japanese firms in leaving China, and helping them move those operations to other South East Asian countries or regions. Though the amount is small, only 3.5% of total Japanese investment in China, the message is loud and clear.
Despite President Trump’s threat and pressing desire to decouple from China, and bring supply chains back home, this would be a long-term US foreign policy initiative in our view. In spite of the ongoing trade tensions, if there is one thing that many Western and Asia-Pacific countries agree on, is that they all want to check the rise of China, with any form of decoupling from the Asian superpower essentially being a means to that end. In fact, many well-known US firms such as Microsoft, Google, and Apple have recently moved production capabilities to other Asian countries such as Thailand and Vietnam, with some considering further pivots towards Mexico and India.
“Because Breaking Up is Hard to Do” – Decoupling from China is Much Harder Than You Think
Despite increased tensions between the US and China, as well as greater calls by global politicians to decouple from China, the tense relationship between China and the West is much more interconnected than people like to admit. Any move by the West to decouple from China in any capacity will be much harder than you think.
2020 has been a very rough year for China. Beijing has been trying to juggle between fighting a trade war with the US, managing the health consequences of being the epicenter of the global COVID-19 pandemic, and dealing with the global backlash over the country’s initial response to the virus, all while simultaneously trying to maintain China as the top destination for foreign direct investment (“FDI”). For now, China has refrained from retaliating against the US over their trade war tactics, while simultaneously managing the continuation of FDI inflows into the country. Further, the country has also been able to navigate the geopolitical landscape in terms of the global retaliation over their response to the COVID-19 pandemic. Given these developments, it appears that this balancing act seems to be working – for now.
Foreign Investment Leaving China? Not So Fast
The latest balance of payments (“BoP”) data from China shows continued inflows into the country, but foreign investment has slowed in recent months. In our view this slow down in foreign investment likely stems from foreign firms restructuring their supply chains in response to:
Further, FDI utilisation data (defined as BoP minus foreign companies’ undistributed and unremitted profits) shows the same trend. However, the narrowing gap between the BoP and the FDI utilisation data suggests foreign firms have been repatriating earnings rather than reinvesting their profits, or diverting investment, away from China.
Financial Ties Have Deepened
Despite the ongoing tariff skirmishes between the US and China, as well as investment restrictions placed on China, US-China financial integration has strengthened, rather than reversed. This has been caused by China accelerating its financial liberalization, prompted in part by Western pressure. Prior to these developments, foreign financial firms operating in China were only allowed to operate joint ventures with minority ownership stakes with Chinese based firms. Since 2019 however, the financial market liberalization reforms has led to a sharp rise in the number of majority or wholly foreign-owned financial institutions operating in Mainland China. These include large US firms such as Goldman Sachs, S&P Global, PayPal, JP Morgan, American Express, and Fitch Ratings.
Meanwhile, China has been further integrated into the global capital markets in recent decades. Foreign portfolio inflows into onshore Chinese equities and fixed income assets have risen sharply in recent years. Despite the ongoing idiosyncratic risks such as the COVID-19 pandemic and the trade war, foreign portfolio inflows have not slowed, and in fact continue to remain steady in our view. In fact, we do see Chinese assets growing to become an even larger part of the global financial markets, as Chinese equities and bonds continue to be added to global benchmarks, prompting global investors to increase the weighting of Chinese assets in their investment portfolios.
Time to Look Elsewhere? Incentives for Foreign Supply Chains to Decouple
Nevertheless, the lingering risks of a prolonged US-China trade war, as well as the COVID-19 pandemic, have prompted many countries and firms to consider moving their global supply, and value, chains away from China to diversify geopolitical and economic risks. For example, Japan has set up a US$536 million fund to assist Japanese firms in leaving China, and helping them move those operations to other South East Asian countries or regions. Though the amount is small, only 3.5% of total Japanese investment in China, the message is loud and clear.
Despite President Trump’s threat and pressing desire to decouple from China, and bring supply chains back home, this would be a long-term US foreign policy initiative in our view. In spite of the ongoing trade tensions, if there is one thing that many Western and Asia-Pacific countries agree on, is that they all want to check the rise of China, with any form of decoupling from the Asian superpower essentially being a means to that end. In fact, many well-known US firms such as Microsoft, Google, and Apple have recently moved production capabilities to other Asian countries such as Thailand and Vietnam, with some considering further pivots towards Mexico and India.
The Ties That Bind
Despite this rhetoric over efforts to decouple from China, many global supply and value chains are still centred in the country, with much of the FDI targeting China’s burgeoning domestic market. According to a 2019 survey by the US-China Business Council, 95% of US companies invested in China for its domestic market, with 87% of them having no intention of leaving, despite the ongoing tensions. In addition, according to a 2020 Japanese survey by Tokyo Shoko Research, only 4% of Japanese companies invested in China were considering an exit from the country, with many focused on the Chinese local market as well.
Although views may change over time, decoupling is not an overnight process, as the experiences of some Asian countries have shown. Asian peers such as Taiwan, South Korea, and Japan have all tried to reduce their respective investment in China, and allocate their capital towards other Southeast Asian countries. Despite their intentions, their level of investment in China remains high. Furthermore, Southeast Asia is deeply integrated into the global supply and value chains that run through China, so relocating production capabilities elsewhere through the region does not lead to much in terms of diversification. In fact, China’s lockdown measures during the onset of the COVID-19 outbreak hit Asian production lines hard, both directly and indirectly, as these very same supply chains rely heavily on Chinese inputs for production – essentially creating an economic feedback loop.
Clash of the Titans?
The process of global supply and value chains restructuring and decoupling away from China may very well continue, but it will be a process that will occur slowly. In our view, if this trend continues, in the long run, it may lead to the emergence of two competing commerce blocs, with one led by the West and the other led by the China. In a scenario such as this, we believe that this would have implications in reshaping the global commerce environment, with far reaching foreign investment implications in terms of the financial markets, economic development, and political power.
Related Commentary
Hong Kong: The Long-Term Impact of Losing Special Economic Status from the US
Call of the Wild: Australian Dollar Continues to Rally – Trade Ideas
Related Portfolio Solutions
Economics Global Alexandria Emerging Markets All Access Portfolio™
© 2020 Economics Global Inc.
Content Disclaimer
Any views expressed here are those of Economics Global Inc. as of the date of this publication, are based on available information, and are subject to change without notice. This document does not constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.