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CHINA CENTER PUBLICATIONS

Market Bifurcation and Supply Chain Decoupling Will Accelerate in the Wake of COVID-19, but Market Drivers - not Policy Directives - Will Determine Outcomes in the Foreseeable Future

There is much concern in the foreign business community about whether and how COVID-19 accountability and liability disputes, and potential policy actions by the two sides, could affect the US-China trade relationship and the business environment for MNCs in China.

 

As we have argued, the US-China “trade war” reflects, at its core, the tensions of a “competition of systems” – specifically, the CCP’s state capitalist system versus the market economy system of ‘the West’.  Both systems have strengths and weaknesses; but because they embrace fundamentally different goals and values, they don’t play well together.

 

The respective COVID-19 responses of China and the US, and their contending public diplomacy narratives, reveal this competition-of-systems reality with unprecedented clarity. The increasing friction between the two systems is akin to two massive tectonic plates grinding against each other, inducing earthquakes and creating mountain ranges dividing the global landscape. How this competition will play out over the long-term is a key question that China Center researchers and members are working on illuminating. The current trade war, we assert, is one earthquake along the way and an early chapter in this evolving story.  

 

Looking forward, I foresee high potential for the following assumption set to manifest in the post COVID-19 business environment for MNCs:   

 

  • The dispute about China’s accountability for the COVID-19 crisis, and its liability for reparations, will be intense and long-lasting. It will harden US and EU rhetoric on technology supply and transfer and see national security-related trade policy positions extend to cover medical, healthcare, pharmaceutical products, and more. 

 

  • In parallel, the many global supply chain vulnerabilities exposed by the COVID-19 crisis will force decoupling as a commercial imperative for a wide swath of firms across numerous industries. But, given that most MNC goods producers have material interest in the China market, this decoupling does not mean exiting China as a production base. Instead, for most, it will mean building supply chain redundancy outside of China. 

 

  • Because of the economic harm it would inflict on their own companies, we do not think governments in the US or Europe will formally force their goods producers, even in sensitive tech sectors, to stop supplying or to exit China. Nor will China formally prohibit buying, despite its shrill calls for “secure and controllable” supply. It won’t be anytime soon that China can indigenize most world-class core technologies1 , and its firms will not readily regress to second-best solutions. 

 

  • Therefore, trade in these sensitive sectors, like ICT and semiconductors, will continue, but more regulatory hurdles will be involved on both sides, and these will add costs and inefficiencies to the trade. Under FIRRMA provisions, sensitive “US IP” will not be allowed to be produced in China in the form of new projects or ventures. Ultimately, these added costs and inefficiencies may compel firms to localize “In China/For China” businesses, including localized IP development that is effectively separate from the US portfolio. 

 

  • For non-sensitive sectors – e.g. auto, industrials, consumer products – market access and investment conditions will remain as they were, i.e. pre-trade war status quo. But, given the elevated anti-China sentiment in the US and many countries, western firms undertaking large-scale China investment may be vulnerable to, and more influenced by, the risks associated with negative home market media attention and public opinion related to their China activities.

 

  • Nevertheless, most MNCs will ultimately make their supply chain location decisions based on end market and ecosystem proximity factors. For most, China ranks highly, if not highest, on these two dimensions, and therefore will remain a focal location, assuming that China market demand doesn’t decline substantially and intractably in the wake of the COVID-19 crisis and its economic destruction. This calculus will differ by sector and firm.

 

  • Despite the bombastic diatribe now occurring between US and Chinese leaders and their respective media, and the growing acrimony globally regarding China’s causal role in the COVID-19 crisis, many foreign investors are reportedly experiencing exceptionally high hospitality from their Chinese interlocuters, especially at local government levels. History tells us that it is in times of economic need where foreign investors – as purveyors of quality investment, employment, tax payment, and CSR – have the strongest value proposition in China. This is such a time. 

 

  • In this sense, the current crisis may bear silver linings for many foreign investors in China. For strong foreign players, crisis induced consolidation of weak Chinese competitors should enable market share gains and competitive environment improvements that could even offset market shrinkage.

 

 

 1 The view of this author is that Chinese firms are unarguably very innovative at the application layer of the various technology stacks. A distorted incentive structure, lack of institutional safeguards, and counterproductive state intervention in technology development undermines sustainable Chinese innovation in core technologies. 
 

AUTHOR

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David Hoffman

Senior Vice President Asia and Managing Director of the China Center for Economics & Business
The Conference Board

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