Derek Scissors
A weakening economy. COVID-related lockdowns. Reciprocal trade sanctions. Possible conflict over Taiwan. There are many reasons for companies to curb China operations. Each situation is different, but corporate decisions can be grouped by the nature of their activity in the People’s Republic of China (PRC). These categories also have implications for US policy: For one, full supply chains will not move on their own.
Group 1: Financial investors
This is the newest group. The correct amount of US portfolio investment in China was $368 billion through the end of 2016. The increment just from 2017 through 2020 was another $781 billion. (No 2021 number yet because the Department of the Treasury pretends the Caymans receives the most funds and publishes accurate figures only annually.)
This group was drawn by Chinese incentives (the PRC needs money) and the lure of exploiting underdeveloped financial markets. But fundamentals not mattering or being impossible to determine cap investor interest. Further, it’s much easier and faster for portfolio capital to exit than for physical operations, except for those who overcommitted financially and are begging for other people’s money to offset their mistake.
The incentives facing companies with different China activities have policy implications. The gross amount of US portfolio investment supporting a cult-of-personality dictator for life is . . . gross, but it can quickly self-correct. American policy should focus on controlling investment that assists the PRC in vital areas, such as advanced dual-use technology.
Group 2: Producing for export
Many companies directly invest and use China primarily as a production base to sell to others. In 2019 (pre-COVID), foreign-funded enterprises accounted for 40 percent of the PRC’s trade, more than $1.8 trillion. This was China’s original lure and has been lucrative for more than two decades, but it can be unwound.
Political tensions with the US, from the small inconvenience of tariffs to gigantic costs in a Taiwan conflict are one shot across the bow. Zero-COVID is another. Wages will rise indefinitely as the labor force shrinks. Some high-margin producers are being solicited by rich countries. Low-margin producers have options from India and Indonesia to Mexico and Vietnam, though they still face logistics and scale challenges outside the PRC.
Firms exporting from China are already shifting operations on a small scale—Xi’s aggressiveness overseas and insistence on near-absolute control make commercial risk too high to ignore. Washington should promote a stable business environment at home and publish detailed, regular assessments of Chinese behavior to keep companies informed, but these companies are unlikely to move to the US.
Group 3: Selling to/in China
The ways to tap a foreign market are exporting and making locally. Exporters to China have long faced barriers such as protection of state enterprises from competition. Xi Jinping’s desire for less dependence plus global tensions could see barriers rise further. Producing in the PRC for the local market is similar to producing for export, with the twist that the endlessly hyped Chinese consumer still saves relentlessly and may never be rich.
Despite incentives to seek customers elsewhere, flaws in other markets will make firms wary. India will outgrow China indefinitely in GDP terms. But India is much poorer, with less than 20 percent of the wealth. Vietnam, Indonesia, and the Philippines have high growth potential and intriguing consumer markets but their combined population is barely one-third China’s and their long-term policy records are decidedly mixed.
Effectively influencing firms selling to the PRC is a challenge. The appeal of countries’ domestic markets, China and others, is determined primarily by their own policy choices. The US could use comprehensive, high-quality trade agreements to boost global interest in countries such as Indonesia, but there is very little on the horizon.
Group 4: Supply chains
The final group may have seemingly small exposure in terms of investment, revenue, or jobs, but the PRC can still be vital, because materials, components, or assembly are sourced there. Natural competitiveness plus aggressive government intervention mean the advantage of partial sourcing in China can be very large or at least profitable for extended periods.
Moving parts of supply chains out can occur but pushing the PRC entirely out of key chains will require intense measures. Beijing can retain leverage over production by heavily subsidizing participation in just one stage of the chain where Chinese firms are already established. Vicious lobbying by American businesses against restrictions on locating supply chains in China highlights their dependence.
There is scope to encourage supply chains to leave China, but half-measures won’t work. Moving parts of chains can reduce revenue dependence but has no strategic benefit if the chain must still run through China to function. Incentives to shift every stage of supply chains would be far too expensive. Where the US wants full chains to move, it must ban Chinese participation.
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