[Analytics] Prepare for the US and China to decouple

Yuan (AFP/Getty). Sketched by the Pan Pacific Agency.

While Covid-19 has dominated news for much of the year — and understandably so, as people and businesses fight for their survival — a larger, longer-lasting problem has been unfolding in the background, which many businesses will soon need to contend with: As de-globalization accelerates, two hostile economic blocs are emerging, one centered around China and the other around the United States. Michael A. Witt specially for the Harward Business Review.

Arguably, we’ve been headed towards this moment for a long while. De-globalization has been under way for more than a decade: At best, international trade was stagnating before the pandemic hit, and foreign direct investment had fallen by 70 percent in 2018 from its peak in 2007. Never easy, Sino-U.S. relations have taken a more confrontational turn under Xi Jinping. By 2018 we were already witnessing the opening skirmishes of a new Cold War.

Covid-19 has accelerated the process by providing a justification for re-shoring production of strategic goods. Japan, for instance, has just set aside $2.2 billion to facilitate re-shoring from China. Directly and indirectly, the pandemic has also added major points of contention to the already very long list of friction points between China and the United States, from the question of responsibility for the pandemic to Beijing’s decision to in all probability put an end to “one country, two systems” in Hong Kong.

Sources at political risk consultancies have indicated to me that U.S. businesses have pinned their hopes on a possible end of the Trump presidency following the November 2020 elections. They will be disappointed. First, it is far from a foregone conclusion that Trump will lose. Second, and more importantly, if there is one thing Democrats and Republicans agree on these days, it is that the rise of China needs to be checked.

In late 2018, I conducted a survey of 109 board members of international companies, laying out a Cold War scenario with two exclusive economic spheres of influence and asking them for their strategic response. They offered two major options: deeply localize your business so it would, on either side of the divide, be seen as local; or withdraw to one sphere.

At the time, pulling off a localization strategy successfully would have been a strategic masterstroke. Firms that have succeeded should congratulate themselves. But as tensions rise and connections weaken, deep localization becomes ever more difficult. This puts a premium on preparedness for further decoupling. In practical terms this means that U.S. firms and those operating in U.S.-linked markets should be ready to:

1. Reduce their presence in Hong Kong

Beijing has made clear its intentions to impose a national security law on Hong Kong. While the contents of the law are still unclear, the move represents a clear break with Hong Kong’s status as internally self-governing. China’s open intervention raises questions about the ability of Hong Kong to maintain the rule of law, a feature weakly developed in mainland China. It also implies a risk that other countries, especially the United States, will cease to extend privileged treatment to Hong Kong. Firms should therefore be readying contingency plans for relocating their sensitive activities elsewhere. Strikingly, U.S. firms — who are directly affected by Sino-U.S. rivalry — seem unprepared, even as they’re aware of the danger: A June 2020 survey of the American Chamber of Commerce in Hong Kong indicates that more than half of respondents are “very concerned” about the national security law, and 60% believe that it will harm their business. Almost half are pessimistic about the medium to long-term future of Hong Kong. But two thirds have not made any contingency plans in response to the law and escalating tensions.

2. Relocate supply chains to politically safer countries

Recent efforts to move manufacturing operations to countries neighboring China — such as moves by Apple, Google, and Microsoft to ramp up production in Vietnam and Thailand — may not suffice. If history is any guide, proximity is one key parameter in predicting which countries become members of which economic blocs, even against their will. Few Eastern European countries would have voluntarily joined the Warsaw Pact, for instance. Companies need at least to consider the possibility that large parts of the world may no longer be viable host countries for their supply chains. Firms instead need to consider building capacity further afield in (from a geopolitical perspective) “safe” countries. For instance, Apple’s manufacturing partners are increasingly looking not only at East Asia, but also at India and Mexico.

3. Reevaluate relationships with Chinese companies and universities

The pitfalls of these relationships are obvious when considering areas of advanced technology with potential military applications. However, if the relationship between China and the United States is increasingly understood as a zero-sum game — one side’s gain is the other side’s loss — other, seemingly innocuous relationships will also be affected, too. A growing number of firms will likely find themselves (fairly or not) on the U.S. “entity list” or China’s “unreliable entity list,” and entire sectors or individual executives may be affected. For instance, China last year moved to punish Canada for the arrest of Chinese executive Meng Wanzhou by arresting two Canadian citizens (sentencing one of them to death) and restricting imports of Canadian canola oil. Similar punishment over disputes has been meted out to Norway (salmon) and Australia (beef). Your industry, company, or executives could be next.

4. Factor in the geopolitical investment risk

Investments by a company reliant on U.S.-linked markets in the other bloc may become increasingly difficult to justify — including the commitment of fresh funds to maintain existing operations. Investors will have to explain why, through their investments, they are contributing to economic growth and thus power of an adversary. The argument that economic development brings democratization and thus peace (“democratic peace”) has become untenable in the context of China, where chances of democratic governance have receded under Xi Jinping. The proposition that economic interdependence makes conflict less likely (“commercial peace”) may seem credible, but the reality is that the economic price China or the U.S. would pay from losing economic interdependence is very small relative to their GDPs. For instance, the size of U.S. GDP ($21.5 trillion in 2018, the latest available figure) is such that it could replace the entire value of U.S. direct investments ($117 billion in 2018) in China in half a week. In short, companies need to start factoring in geopolitical conflict when drawing up investment plans.

The current dire predictions about the future of Sino-U.S. relations may prove wrong, and it is possible that we will once again enjoy the fruits of globalization and international cooperation. I sincerely hope that this will be the case. But hope is not a strategy, and it’s always better to be prepared.

Michael A. Witt teaches and researches international business at INSEAD in Singapore and is an Associate in Research at Harvard University’s Reischauer Institute.

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