US-China decoupling myth busted



Talk of decoupling — a profound and lasting split in the world order — entered public debate in 2019, an alarming manifestation of the mounting conflict between the United States and China. Escalating tit-for-tat tariffs are only the tip of the iceberg. Geostrategic security concerns, early skirmishes in a “tech war”, the related fear of two parallel internets, a nationalistic US president with an overt distaste for “globalism”, and a history of military clashes between rising and incumbent powers raise the spectre of a new Iron Curtain reminiscent of the Cold War.

Historians point out that the tensions between the US and China lack the ideological component that was the defining characteristic of the first Cold War. That may be true, but so what? The possibility of a protracted conflict between the world’s two largest economies, whatever its cause, should not be taken lightly.

Nevertheless, even if there is a permanent fracture between the US and China, the $87-trillion global economy is unlikely to split into two blocs. The reason is simple: bilateral action cannot divide a tightly linked multilateral trade system.

Despite a protracted slowdown of world trade growth in the aftermath of the 2008-2009 global financial crisis, trade still stands at about 28% of world gross domestic product (GDP). That’s double the 13.5% average share from 1947 to 1991, during the Cold War. The tighter that trade is woven into the fabric of global commerce, the tougher it will be to disentangle those linkages.

Moreover, the nature of today’s trade linkages makes global decoupling all the more unlikely. Traditional exports and imports of finished goods that were fully produced in individual countries have been increasingly supplanted by fragmented trade in components and parts that are both produced and assembled in a vast network of multi-country global value chains (GVCs). According to a recent International Monetary Fund study, the expansion of GVCs accounted for 73% of the fivefold growth in global trade between 1993 and 2013. This diffusion of bilateral trade through multi-country supply chains would dampen the effects of a bilateral decoupling of any two economies.

US politicians like to argue that their country’s trade problem is a China problem. After all, they say, over the past six years (2013 to 2018), China accounted for 47% of a gaping US merchandise trade deficit. What American politicians don’t admit (or understand) is that the overall trade deficit is an outgrowth of the US’s chronically low net domestic saving rate of just 2.4% of GDP in 2018 — well below the 6.3% average in the final three decades of the 20th century.

Lacking in saving and wanting to invest and grow, the US must import surplus saving from abroad, running a chronic current-account deficit to attract foreign capital. This macroeconomic imbalance puts China in good company as just one component of the US’s multilateral deficit in merchandise trade with 102 countries (as of 2018).

Politicians would be the last to admit that they are the root of the problem, responsible as they are for the large budget deficits that account for the bulk of the US’s protracted shortfall of domestic saving. Unfortunately, that key feature of the US’s trade position is likely to be further compounded by the US federal budget outlook, which is going from bad to worse.

The saving shortfall underpinning the US’s persistent macro imbalances implies that a trade war with China needs to be seen in a different light, and that the decoupling debate should be reframed accordingly. Without addressing the US saving shortfall, raising tariffs and other barriers on China will simply divert trade away from Chinese sourcing toward the US’s other trading partners. Bilateral decoupling does not mean global decoupling; it means trade diversion.

That diversion will be compounded by GVCs. Based on trade-in-value-added data from the Organisation for Economic Co-operation and Development and the World Trade Organisation (WTO), it turns out that about 20% of the outsize US-China merchandise trade deficit is not made in China; instead, it reflects inputs from other countries that participate in China-centric supply chains. This suggests that official measures of the US-China bilateral trade deficit are exaggerated, further compromising the rationale for a Chinese solution to the US’s multilateral trade deficit.

The shift in the structure of trade, from traditional exchange of finished goods made in individual countries to GVC-driven trade from multiple production platforms, reflects a fundamental realignment of an increasingly integrated pan-Asian factory.

Research reported in the 2019 Global Value Chain Development Report found that the widening of the US-China merchandise trade deficit since China’s accession to the WTO in 2001 stems mainly from offshoring to China by other developed countries (especially Japan and Asia’s newly industrialised economies such as South Korea and Taiwan). This is very different from the China blame game of which most US politicians are enamoured.

As a result, increased GVC connectivity means that tariffs imposed on shipments of finished goods from China to the US will be felt not only by Chinese exporters, but also by third-party countries linked to China-centric supply chains. Little wonder, then, that US tariffs are having an effect on other trade-sensitive economies in East Asia. Supply-chain linkages have spread the so-called China fix throughout the region.

None of this implies that there can’t be a decoupling of the US-China relationship — both in real terms through trade flows and in financial terms through capital flows.

With China reliant on the US consumer as a major source of external support for its export-led growth model, and the US dependent on China as its third-largest and fastest-growing export market (as well as the largest foreign buyer of treasury securities), both countries needed and welcomed the other’s support. But conflict arises when one co-dependent partner changes the terms of the relationship, as China has done by shifting from export-led to consumer-led growth. The current trade war is a classic example of the conflict phase of co-dependency.

There is a striking irony to a tariff war being instigated by the US, the world’s largest deficit saver. In light of its ominous fiscal trajectory, the US will be even more prone to large trade deficits in the years ahead. Closing off the China option through a bilateral decoupling will do nothing to reduce the overall size of the US trade gap. It will merely force a rearrangement of the pieces of the US’s multilateral trade deficit with its other trading partners.

That poses an even thornier political problem. The trade diversion arising from bilateral decoupling would mean that US sourcing would migrate from low-cost Chinese production platforms to a broad constellation of foreign producers.

Whether that pushes trade to other Asian platforms or even “re-shores” it back to the US, as President Donald Trump has long insisted would happen, the bottom line is a likely shift to higher-cost production platforms. Ironically, that would be the functional equivalent of a tax hike on US companies, workers and households.

In the end, that underscores the potential for the most contentious decoupling of all in the years ahead — between the US’s politicians and its long-beleaguered middle class. — © Project Syndicate

Stephen S Roach, a faculty member at Yale University, is the author of Unbalanced: The Codependency of America and China

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Stephen S Roach
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