ANALYTICS

07.08.2023 | The Wests De-Risking Strategy towards China Will Fail
by Chris Miller - The Economist

Amid high tensions with China and the steep cost of confrontation, Western leaders have adopted a buzzword to describe their strategy: de-risking. This involves continuing to roll out tech and investment restrictions on China, but coupling them with high-level summitry and calls to keep trade flowing. The aim is to limit the risk of escalation in both the political and economic spheres. It is unlikely to work.

The West shifted away from the tougher decoupling rhetoric and towards de-risking and economic security for two reasons. First, hawks in Japan and America needed softer language to keep on board wobbly European allies, who call China a systemic rival but prefer that other countries pay the price of restraining it. De-risking sounds safe and low-cost. Second, President Joe Bidens administration hopes that the pressure imposed by Americas years-long effort to contain China has made Beijing more pliable. With Chinas economy wobbling, Mr Biden hopes it will lose some of its appetite for economic conflict.

There are three reasons why a low-cost de-risking will fail. First, Chinas government believes it can overcome the Wests tech restrictions. Second, foreign multinationals are already taking costly steps to shift production away from China, making acceptance of the status quo worse for Chinas economy than Western rhetoric implies. And third, Beijing is pursuing its own agenda of reducing its reliance on Western manufacturing technology, while continuing its effort to make the West more dependent on Chinese products, from low-end chips to electric vehicles. This will drive a new round of tech and trade tension.

Start with Chinas confidence that it can overcome the restrictions. It is true that China now faces an organised coalition aiming to contain its technological and military advances. On the tech side, Beijing has been locked out of advanced semiconductor technology and venture-capital flows into China have collapsed. On the military side, Japan is doubling defence spending as a share of GDP, and buying missiles that can strike deep into China; AUKUSa pact that will see America and Britain supply Australia with nuclear-propelled submarinesis binding those three countries more closely together; and the Philippines and Papua New Guinea are providing America with new military access.

Now that this containment coalition is broadly in place, Western leaders want talks to stabilise the economic relationship and limit Chinas retaliation. In April, Americas treasury secretary, Janet Yellen, bluntly explained in a high-profile speech that she believes Chinas long-run growth rate seems likely to decline, making this an opportune time for talks. Ursula von der Leyen, the president of the European Commission, called on the West to de-risk rather than de-couple, while Britains foreign secretary, James Cleverly, emphasised the importance of a positive trade and investment relationship, whilst avoiding dependencies in critical supply chains. Even some hawkish former Trump administration officials speak of refashioning the economic relationship with China with a scalpel, not a sledgehammer.

The West wants to wall off security concerns related to high-tech goods from the broader economic relationship, such as trade in toys and textiles. Chinas leaders, however, realise that de-risking is a strategy to slow Chinas technological advances while minimising the cost of trade disruptions to the West. Chinas Global Times newspaper has explained that de-risking is just decoupling in disguise. China believes it can respond by out-innovating the West.

The second problem with de-risking is that Western firms are not listening to politicians rhetoricinstead they are taking costly steps to restructure their relationship with China. Foreign investment into China has slumped, partly because of the countrys slowing economy and opaque regulation, but also because companies from HP to Apple are shifting tech and electronics production to South-East Asia, India and Mexico.

Companies arent trying to be political; they are simply responding to new regulatory reality. Many firms have concluded that they must operate separate tech stacks: one for China, the other for the rest of the world. Some are hiving off Chinese manufacturing operations from their rest-of-world supply chains. Corporate decisions are driving a broader bifurcation than de-risking implies.

The third reason a narrow de-risking wont work is that it ignores Chinas own strategy: decoupling with Chinese characteristics. Chinas decades-long effort to cut its reliance on Western manufactured goods continues. Brad Setser of the Council on Foreign Relations, a think-tank, has noted that Chinas trade surplus in manufactured goods keeps surging higher.

China is successfully applying this strategy to green energy, where it simultaneously hopes to cut reliance on oil imports and make the rest of the world dependent on Chinese solar-panel and battery supply chains. The surge in Chinese electric-vehicle exports to Europe is the latest stage in this effort.

In the tech sector, meanwhile, China is subsidising construction of massive production capacity in low-end chips, which it will sell at discount prices to threaten Western chipmakers market share. China hopes these chips will be integrated into a wide array of manufactured goods, creating new dependencies on Chinese components that counteract Chinas own reliance on imported high-end tech.

Western leaders will inevitably respond with new restrictions, making it even more difficult to isolate economic relations from deteriorating political ties. The Wests strategy of talking while tightening controls is not unreasonable, but it would be naive to put much hope in it. Power struggleswhether diplomatic or economicare only resolved when one side gives in. China believes it still has plenty of cards to play as the impact of confrontation rips through the trade relationship. Containment wont come on the cheap.


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