US-China decoupling has been playing out in trade, financial markets, and in technology. The latter has by far the largest consequences for European companies.
The 2020 headlines on US-China decoupling were focussed on trade disputes and tariffs, access to financial markets and, to a large extent, the availability (or not) of semiconductors. It was expected that some foreign companies would eventually be forced to beat a retreat back to the «safety» of their home markets, thereby starving China of the investment and technology that it so badly needs.
As the year ended, European companies reported on what they were actually experiencing as a result of the decoupling dynamics: forget the trade war and forget the financial war, it is a tech war that is really reshaping global trade and investment.
The trade war failed to fulfil the Trump Administration’s goals, because bilateral tariffs are futile in a world that relies on global supply chains.
The limitations of a financial war, meanwhile, lie in the fact that the US dollar’s status as a global reserve currency and its abundance in international financial markets means it would still be readily available even to companies that are sanctioned or delisted in the US.
Escalation on both trade and financial fronts is of course still an option, but only if the US is willing to accept massive damage to its own interests in its efforts to inflict harm on China. This «nuclear option» seems highly unlikely unless a major geopolitical red line is crossed.
The deepening quagmire created by the forced separation of the US’ and China’s technology ecosystems is where the real horror lies. European companies are now caught between two diametrically opposed forces: China’s reinvigorated campaign for technological self-reliance on one side, and America’s need to maintain dominance in and control of certain strategic high-tech sectors, along with its rapidly expanding definition of «national security», on the other.
Eager to build a self-sustainable technology ecosystem, China’s leaders have poured billions into state aid to close the gap in critical inputs like semiconductors and software, and are pulling on the entire country to achieve this. The key priority from China’s economic planning session in December 2021 is to build scientific and technological strength, through a «new type of whole-of-nation system».
One of the symptoms of this push for self-reliance is an increasing scepticism towards all foreign technology in China, especially in the digital sphere. Explicit market access restrictions, like those on value-added telecoms services, and flexible policies demanding «autonomous and controllable» technology, are leaving many European companies locked out of much of the market to leave room for local champions that are viewed as more reliable.
Meanwhile, US distrust of Chinese technology has extended beyond the cases of Huawei, ZTE, TikTok and WeChat. While restrictions have been tightened on Chinese products and services within its own borders, America has also gone on the offensive with technology export controls.
This is already impacting European companies that have for years gladly integrated the best technology and digital solutions into their products, regardless of origin. Now, technology stacks that combine US and Chinese inputs have become a liability in either market.
As the US’ and China’s technology ecosystems are pulled further apart, the greater the number of components and inputs that will be affected.
This dynamic is pressurising companies to contemplate either building a «dual system» or adopting «flexible architecture».
In a dual system, two separate R&D operations and supply chains need to be created, with one to serve China and the other for the rest of the world. The flexible architecture model would entail companies building solutions that are «neutral» to the greatest extent possible, with crucial, affected components capable of being swapped out. Either option comes at enormous cost.
More traditional industries further upstream in supply chains will be less affected by technology decoupling. A chemical plant, for example, would have to invest in localising equipment, but not components.
Cutting edge sectors at the end of supply chains will be the worst hit. Automotive manufacturers, for example, have scores of affected components that use highly specialised technology and programs derived from diverse sources.
The net result of increased technology decoupling will be greatly diminished economies of scale, and massive hikes in R&D expenditure. Further down the road, governments can look forward to their citizens experiencing higher costs and having fewer jobs.
There is no going back to the «good old days», nor should we – they were demonstrably unsustainable. However, there are alternatives to the self-destructive path currently being pursued.
Such a course correction cannot be unilateral. President-elect Biden must be prepared to reverse the Trump Administration’s tendency to make everything China into a national security threat. At the same time, the onus is as much on the Chinese side to produce results and similarly step back from its campaign for self-reliance at all costs.