Demystifying decoupling: what’s really at stake in the US-China relationship

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Alexis Crow, Partner; Global Head, Geopolitical Investing, PwC, Sir Robin Niblett, Distinguished Fellow, Chatham House

• The technological decoupling between the US and China does not necessarily mean deglobalization is happening; elements of global trade – including green and digital trade – remain robust.
• One development of Beijing and Washington’s evolving relationship is the reduction of the presence of US financial institutions in mainland China, which contributes to an already complex commercial environment for other countries.
• Despite clear areas of strategic competition, there is ample space for cooperation between the US and China.

In a world marked once again by armed conflict, geostrategic rivalry between the world’s two largest economies and military powers, and rising polarization within societies, it is little wonder that some business leaders and commentators have declared the end of globalization. It is true that new supply chain bottlenecks and a host of new restrictions on the global trade in goods have led to a marked slowdown in world merchandise trade, prompting some to declare a trade recession in the short to medium term.

Nevertheless, trade in services activity remains robust. In fact, in 2022, the value of digitally delivered services rose and now represents 12% of overall global trade, bolstered by the emergence of a data-driven global economy and the growth of generative AI.

Moreover, as executives, policymakers and investors work to decarbonize and deliver their net zero goals, this is contributing to growth in the trade of goods and materials central to fueling the clean energy revolution, such as rare earth minerals, hydrogen and ammonia; as well as finished products, such as batteries and electric vehicles. The flow of goods between the US and the EU is also expanding, amidst the energy crisis in Europe and green transition in the US, as it is within Europe itself, as energy imports from Norway have grown to replace Russian oil and gas. Growing demand for clean tech may also catalyze new exchanges of human capital and R&D and technology to support projects and investments within the energy transition.

The return of national industrial policies in this sector – and spurts of climate protectionism – have not tolled the death knell of the cross-border movements of inputs and know-how needed to advance the energy transition. And, as governments and companies focus on their green and digital priorities, global value chains are being transformed, benefiting the ‘latecomer’ emerging market developing economies (EMDEs).

Additionally, in looking at signs of possible fragmentation in the global financial system, even though the role of the US dollar in trade finance has been called into question (given the expansive use of US sanctions), we see markedly little challenge to the US dollar as the world’s reserve currency. The predominance of the greenback has not – thus far – been thrown off course by geopolitics.

DISCOVER

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Decoupling, deglobalization or de-emphasizing?

So what is happening, and what should investors, executives and policymakers do about it? First, we should avoid conflating the terms decoupling and deglobalization. A discernible decoupling in elements of the tech ecosystem is well underway between the US and China and is unlikely to be rolled back. It is rooted in a fundamental concern about the convergence between technology and national security in Beijing and Washington.

But, the hawkish stance of ministries of foreign affairs and national security towards China across G7 countries, and not only in the US, stands in contrast to the view of many business leaders from the same countries, some of whom enjoy a large profit base in China. Indeed, despite the technology decoupling, many leading companies from North America, the EU, the UK and US allies in Asia, representing sectors including industrial and automotive; retail and consumer; commercial and investment banking; and wealth management, are maintaining a strong presence within mainland China, hoping still to tap into the predicted rise in future consumer spending. By one measure of money, China holds the largest supply of M2 on a global basis – indicating that there is enough cash in the financial system within the mainland to weather any short to medium-term potential storm.

At the same time, with a shrewd eye on the future of growth and profit, some companies and investors are continuing to globalize as they ‘de-emphasize’ China. In purely economic terms, structural forces (such as the shift from manufacturing to services-oriented growth) and secular headwinds (such as aging populations and declining fertility rates) have led to a material slowdown within mainland China.

The waning of the Chinese economic miracle – together with higher wages in the mainland – has prompted companies to scout opportunities within neighbouring geographies, including ASEAN and India. As we can see in the figure below, US foreign direct investment (FDI) into ASEAN is nearly treble that of flows into mainland China, a phenomenon that predated the trade tensions between Beijing and Washington, indicating that the prospect of lower wages in emerging Asia has been a principal driving force of the diversion of FDI activity out of mainland China. In turn, this dispersal of investment activity has benefited countries such as India, Singapore and Vietnam, which continue to post some of the fastest growth rates in the world.

A turning point

Underneath the ripples of the US-China technology decoupling, the fragmentation of supply chains and corollary goods trade diversification, one thread has continued to tether the two countries together: finance. Beijing ranks among one of Washington’s biggest creditors, owning some $902 billion worth of US government debt (although, in terms of foreign creditors, Japan remains the largest to the US). Moreover, in considering financial linkages, many of the leading US globally systemic important banks (GSIBs) and asset managers benefited from financial reforms initiated by Beijing, which supported increased foreign participation in domestic financial markets.

However, Russia’s invasion of Ukraine has the potential to upend this financial tethering between Beijing and Washington. War in Europe has conjured fears of armed conflict in the South China Sea and around Taiwan. And America’s and Europe’s robust use of sanctions against Russia, including far-reaching financial sanctions, has prompted executives to question whether their businesses might become trapped in the sanctions net, should bellicosity increase – or a mistake potentially unfold – between the US and China.

Accordingly, from mid-2022 to date, there has been a meaningful headcount reduction of some of the US GSIBs and non-bank financial institutions in mainland China; and a cessation of new investments by some of the largest US (and Canadian) funds. Whether or not such actions emanate from the reality of decoupling; from ‘de-emphasizing’ in pursuit of other markets; or from a ‘point charnière’ – a turning point triggered by the Ukraine war – is difficult to diagnose. However it is important to note that as some US financial entities reduce their exposure to mainland China, a meaningful facet of dialogue between the US and China is quietly being eroded, which may have negative repercussions for the wider relationship.

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How to truly de-risk

The serious efforts by the US and Chinese leadership at the APEC summit in San Francisco in mid-November to steady their increasingly fraught relationship served as a reminder that neither side believes it can afford to let their mutual political distrust lead to a widespread economic decoupling. They are also aware of the importance of maintaining open lines of communication on some of the greatest externalities humanity currently faces – such as climate change and the social implications of the rapid advance of AI and automation.

The world as a whole remains a dangerous place – even for countries that view each other as strategic rivals – and the stakes are too high to act in isolation. Recognizing this, perhaps, is a fundamental path to de-risking, while not decoupling.