Executive Summary
Global trade in goods, services, and capital has recovered to pre-pandemic levels, but investment increasingly flows between geopolitical allies rather than geographically close countries.
“Decoupling” has so far been concentrated on advanced rather than regular products, though US sanctions against China have begun to reshape entire segments of the global economy, most notably the semiconductor industry.
Europe, still mostly reliant on open markets, is caught between an increasingly protectionist Washington and a Beijing that is becoming more assertive in its own practices.
Implications for International Business
The “friend-shoring” trend is expected to be costly, but the push for increased economic integration between partners also brings business opportunities with new trade agreements and government support to develop new supply chains.
As the United States adopts new sanctions and export controls, firms need to allocate more resources to ensure compliance, to beaware of continued disruption risks in China and hence to explore alternatives in emerging markets.
State of Play Open markets under pressure
Globalization is proving surprisingly resilient. Despite a pandemic, a war in Ukraine, and a looming recession, the global exchange of goods, services, and capital has recovered to pre-pandemic levels. For instance, by mid-2022, the global volume of trade in goods had increased by 10 percent compared to the end of 2019. Foreign direct investment, meanwhile, rose to $1.58 trillion in 2021, an increase by 64 percent relative to the low levels of 2020, the first year of Covid-19. Forecasts suggest that international flows will continue to grow, albeit at a slow pace. At the same time, the escalating rivalry between the United States and China is starting to pose real challenges to the openness of the global economy. In recent years, the world’s two biggest economies have become locked in a battle to dominate global politics, which entails the use of far-reaching sanctions, trade restrictions, and efforts to try to win over countries in Europe and elsewhere to their side.
If implemented at grand scale, the “decoupling” of the American and Chinese economies may divide certain segments of the world market into geopolitical blocs. An IMF study showed that foreign direct investment increasingly flows between countries that are allies rather than those that are geographically close, even if trade does not appear to follow the pattern. Western sanctions in response to the war in Ukraine have contributed to the trend by strengthening ties between democracies and pushing China and Russia closer together. However, most countries, including regional powers like Brazil, South Africa, and Saudi Arabia, are unwilling to position themselves firmly on either side.
Key Issues The US-China rivalry is contagious
The United States uses powerful sanctions to contain China’s rise to superpower status. In October 2022, Washington unveiled expansive new export controls to restrict Chinese access to advanced computing chips and chipmaking tools. More such measures are expected to follow soon in areas such as quantum computing, artificial intelligence, and biotechnology, as US policymakers now openly declare that they want to “maintain as large of a lead as possible” in critical technologies. China, meanwhile, is trying to find new ways to access the most advanced chips, including by investing in domestic industries. It also seeks to expand its circle of friends in Africa and Latin America through large loans and infrastructure projects and elevated its trade with Russia in terms of technological and military equipment.
To varying degrees, major powers in Europe and East Asia share America’s concern about China’s global ambitions. To protect themselves from supply disruptions, technology transfers, and spying, they have begun scrutinizing trade, investment, and procurement rules as well as launching initiatives to increase their self-sufficiency and diversify their supply chains. The Netherlands and Japan, for instance, recently introduced export controls to prevent China from buying the machines needed to manufacture the most advanced chips. Also, the US-led Chip 4 Alliance with Japan, South Korea, and Taiwan aims to create a “democratic semiconductor supply chain” .
At the same time, American protectionism makes it hard for the EU and its member states to fully side with Washington. The Inflation Reduction Act is a major sticking point, as its extensive subsidies for green technology and its domestic manufacturing requirements lure European companies to relocate significant operations to the United States. China, meanwhile, has in recent months advertised a more welcoming business environment for tech companies and foreign investors. During French President Emmanuel Macron’s trip to Beijing earlier this month, companies like Airbus, Alstom, and CMA CGM concluded major deals with Chinese counterparts. However, China’s state-directed economy is unlikely to open up anytime soon, as self-sufficiency remains one of the government’s major goals.
Against this backdrop, the EU is committed to “de-risking” rather than “decoupling” its relations with China – a more-than-semantic variance that will likely appear also in Germany’s upcoming China strategy. This means to diversify supply chains through initiatives like the Critical Raw Materials Act that the European Commission proposed in March and is currently in the EU’s legislative process. Another important and soon-to-be-adopted tool to safeguard Europe’s economic security is the Anti-coercion Instrument to deter Chinese punitive tariffs against EU countries. These measures underline the importance of the EU-US Trade and Technology Council as the main body to coordinate such initiatives. As Washington insists on wider restrictions, the Europeans may ultimately find it to be in their interest to join US efforts to curb China’s access to highly advanced technology. That said, the EU would do well to insist that the latter are balanced by increased transatlantic openness, not protectionism.
Decoupling carries risks for businesses
So far, economic security initiatives such as export controls and investment screening have largely focused on cutting-edge technology, critical infrastructure, and scarce raw materials needed for the green transition. US export controls on semiconductors, for instance, only target the top percent of the most advanced chips in the nanometer range. Over time, however, trade in less advanced goods may be drawn in too. For example, China has used extensive restrictions on a range of regular products, including wine, beef, timber, and coal, to punish countries like Australia and Lithuania for opposing Beijing on specific issues. Chinese consumer boycotts have targeted American and European companies in the apparel, automotive, and food and beverages sectors. While China’s economic coercion is alarming, the United States remains the dominant geoeconomic power, be it through advanced technological products and services, or via financial transactions through the dollar-based system. US sanctions are therefore often very costly for targeted companies and countries, and global firms concerned about decoupling have to keep up with US legislation. This includes monitoring Foreign Direct Product Rules, which prohibit certain exports of products containing American technology, software, or equipment, such as tools for chipmaking or the development of supercomputers.
As trade between adversaries becomes more restricted, many countries’ eagerness to enhance their economic security may also mean more exchanges between allies. The deterioration of EU-China relations seems to have accelerated European efforts to conclude free-trade agreements with Asian countries such as Indonesia, India, and Australia and to reinvigorate talks with Mercosur, opening up new markets for businesses. Meanwhile, the EU’s raw materials and global infrastructure initiatives are expected to strengthen ties with third countries, including in the mining industry. As governments strive to develop “safer” supply chains, projects in emerging markets that previously seemed too inefficient, costly, or distant may become attractive business opportunities. Savvy companies should be able to profit.