COVID-19, Catalyst for US-China Decoupling

Preface 

The COVID-19 coronavirus outbreak has not only caused serious impacts on the global economy but also shattered trust between two largest economies of the world arena, the US and China. In point of fact, the trade war between them before the COVID-19 crisis had revealed how breakable their mutual trust was. Despite the phase one deal was eventually signed by the US President Donald Trump and Chinese Vice Premier Liu He on January 15, 2020, the US-China relationship is likely to deteriorate further. Further decoupling could be unavoidable. 

At the first quarter of 2020 when the outbreak was limited mainly in China and soon spread to the region of East Asiathe fear of a potential disruption in global supply value chains (GVC) was particularly highBecause of outsourcing from advanced countries for the past 40 years, China has been a hub of supplying raw material processing products and an assembling and packaging center of finished goods. And East Asia has been the major part of GVC or global production networks mostly manufacturing and trading in intermediate goods. However, the US and other western countries firmly believed that the COVID-19 epidemic took place in China before the year of 2020. It became a more serious pandemic due to China’s misconduct of trying to conceal the outburst. 

Starting from the late first quarter, the COVID-19 was spread further and caused more serious impacts on the economy of US and Europe, major market demand for finished goods. At this phase, China claimed that its domestic virus infections were mostly under control and grounded to a near halt because of its strict lockdown policyConsequently, the impacts have been shifted from the world’s supply side to the demand side. China has been denying the accusation of not being transparent in information sharing and insisting of providing enough time for the western society to adopt necessary measures in response. There’s still no consensus between China and the western society so far, and tensions have been ascending. 

The COVID-19 crisis has been causing obvious damages on the global economy through channels of globalization, whereas impacted countries are all supposed to be stakeholders. Currently, many stakeholders especially the US has lost the confidence in China and considered it an undependable economic partner. “De-globalization” would then arise in forms of factories relocation, shifting in GVC, and mostly, further decoupling from China. 

 

Decoupling by the US-China Trade War 

When Donald Trump ran for the US presidential election in 2015-2016, his policy proposals of jobs and economy clearly targeted at the US’s biggest trade deficit’s origin, China. Issues related to China include the followings: a) bring China to the bargaining table by immediately declaring it a currency manipulator, b) force China to uphold intellectual property laws, c) put an end to China’s illegal export subsidies and lax labor and environmental standards, d) place a 45% tariff on Chinese exports to the US, e) instruct the US trade representative (USTR) to bring trade cases against China, and f) use every lawful presidential power to remedy trade disputes if China does not stop its illegal activities. 

On August 14, 2017, the Trump administration instructed the USTR to proceed an investigation on China by applying Section 301 of the 1974 US Trade Act. The purpose was to investigate China’s regulations, practices, and conducts that might be hurting intellectual property rights, innovation, and technology development of the US. The USTR investigation report concluded that China used foreign ownership restrictions to require technology transferimposed substantial intervenes in US firms’ investments and activities, and conducted unauthorized intrusions and theft from the computer networks of US companies. The investigation report was signed by the US President on March 22, 2018, and the trade war started since then. 

Table 1. Top Trading Partners of US in 2018 and 2019. 

2018 

Top trading countries 

Percentage of total trade 

  1. China 

15.7% 

  1. Canada 

14.7% 

  1. Mexico 

14.5% 

  1. Japan 

5.2% 

  1. Germany 

4.4% 

  1. Korea 

3.1% 

  1. UK 

3.0% 

  1. France 

2.1% 

  1. India 

2.1% 

  1. Italy 

1.9% 

2018 

Top trading countries 

Percentage of total trade 

  1. Mexico

14.8%

  1. Canada 

14.8% 

  1. China

13.5% 

  1. Japan 

5.3% 

  1. Germany 

4.5% 

  1. Korea 

3.2% 

  1. UK 

3.2% 

  1. France 

2.3% 

  1. India 

2.2% 

  1. Taiwan

2.1% 

Source: United States Census Bureau. 

Before the phase one deal on January 15, 2020the US-China trade war had been extended to shouting wartechnology war and currency war in addition to the tit-for-tat tariff war. The trade war did alter the relationship between the US and China. China used to be the largest trading partner of the US before the year of 2019; however, became the third largest in 2019, since exports and imports between them shrank significantly. Trade between the US and China was 15.7% of US’s total trade in 2018; the percentage dropped to 13.5% in 2019. The US imported US$ 452,243.4 million worth of Chinese goods in 2019 or 16.2% less than the total imports of goods from China in 2018. The US exported goods in total value of US$ 106,528.8 to China in 2019 or 11.25 less compared with the value of goods exported to China in the previous year. 

If the imported goods are irreplaceable, tariff hike will add further cost to the imported countries’ consumers through imported inflation. In case so, China as an export-oriented country would have prevailed during the tariff trade war. However, if the imported goods are easy to be replaced, then the inflation will remain calm in the imported country. The US inflation rate on average stood at 1.8% in 2019 that was even lower than 2.4% in 2018. From this perspective, the major pressure of tariff war was on China but the US, since the US inflation remained mild and China did lose its market share in the US market because of the trade tensions. 

Table 2. Additional US Exports to China on Top of 2017 Baseline. 

Unit: US$ Billion 

2020 

2021 

Total 

Manufacturing Goods 

32.9 

44.8 

77.7 

Agriculture 

12.5 

19.5 

32.0 

Energy 

18.5 

33.9 

52.4 

Services 

12.8 

25.1 

37.9 

Total 

76.7 

123.3 

200.0 

Source: The US and China “Phase One Deal” on January 15, 2020. 

The US-China decoupling did take place before the phase one deal, and the deal was reached so as to relieve the tensions and ease the decoupling process. The deal halved tariffs from 15% to 7.5% on US$ 120 billion of imported products, ended threatened tariffs on another US$ 155 billion worth of items, but kept in place the 25% tariffs on US$ 250 billion worth of goods imported from China. In return, China agreed to import extra US$ 76.7 billion and US$ 123.3 billion of US goods and services in 2020 and 2021 respectively on top of 2017 baseline. The concession from Beijing also indicated that the trade war caused more damages and pressure on China’s economy. 

 

Economic Impacts of COVID-19 

Before the COVID-19 spread to the US and Europe, economists considered the relevant impacts would be like the outburst of severe acute respiratory syndrome (SARS) in 2003 in general only occurred in certain area of Asia. If the outbreak and damages of COVID-19 is similar to that of SARS in 2003, then a “V” shape recovery for 2020 can be expected. For example, Taiwan’s economic growth rate in the second quarter of 2003 declined by 1.15%, and the growth of fixed investmentprivate consumptionand exports in goods and services all slowed downed notably in the second quarter. However, the GDP grew strongly by 5.41% and 7.26% for the third and fourth quarter on year-on-year basis thereafter with economic activities mostly resumed after the full containment of SARS in Taiwan. 

Nevertheless, the SARS did not trigger outbreak and cause economic impacts on the US and Europe. By comparison, The COVID-19 has caused unprecedented and substantial impacts on the western countries. World major forecasting institutes including the International Monetary Fund (IMF), IHS Markit, and Economist Intelligence Unit (EIU) all revised downward their forecasts in April 2020. They simultaneously predicted that the global growth in 2020 would decline significantly from 2.5% to 3.0%. Industrial and advanced economies such as the US, Euro zone, and Japan were all forecast to suffer negative GDP growths, whereas these institutes estimated that China’s economic growth rate would only stand from 1.0% to at most 2.0% in the year of 2020. Accordingly, there can be annually “V” shape recovery in the world as well as major economies; however, quarterly “V” shape is still uncertain for the time being. 

Table 3. International Forecasts. 

 

% 

IMF 

IHS Markit 

EIU 

2019 

2020 

2021 

2019 

2020 

2021 

2019 

2020 

2021 

Global 

2.9 

-3.0 

5.8 

2.6 

-3.0 

3.9 

2.2 

-2.5 

3.0 

USA 

2.3 

-5.9 

4.7 

2.3 

-5.4 

6.3 

2.3 

-2.9 

1.9 

Japan 

0.7 

-5.2 

3.0 

0.7 

-3.3 

1.3 

0.7 

-1.5 

0.7 

Euro 

1.2 

-7.5 

4.7 

1.2 

-4.6 

1.2 

1.2 

-6.0 

1.3 

China 

6.1 

1.2 

9.2 

6.1 

2.0 

6.3 

6.1 

1.0 

8.4 

Source: IMF, World Economic Outlook, April 14, 2020; IHS Markit, April 16, 2020; EIU, Country Forecast World, April 8, 2020.  

According to the forecasts for 2020 by IMF, IHS Markit, and EIU, it can be concluded that all international institutes trust that the economic impacts caused by COVID-19 are much more serious than the damages caused by the dot com bubble burst in 2001 and the global financial crisis in 2009. By comparison, the economic growth rate of the world stood at 2.46% in 2001 and negative 0.08% in 2009. Some even believed that the COVID-19 crisis would be similar to or worse than the world economic depression in the 1930s. Decoupling associated with protectionism did rise in the 1930s; decoupling would be reignited by the COVID-19 crisis after the phase one deal. 

 

COVID-19, Another Catalyst for US-China Decoupling 

Since the outbreak of COVID-19, many industrial and advanced countries including the US, Japan, and Korea have been trying or planning to move their manufacturing supply chains out of China. Furthermore, the US, UK, and European Union policy makers believed that the COVID-19 emerged in November, 2019; however, China purposely tried to cover up the potential outbreakConsequently, China’s alleged actions enabled the coronavirus spread, causing a global economic catastropheThe industrial and advanced countries led by the US have been trying to hold China legally responsible for the damages by demanding China to compensate reparations. 

As the forming of production networks or GVC is one important process of globalization, the contagion of COVID-19 besides the trade war can be a major catalyst for de-globalization, a transitional process of decoupling. The objectives of forming GVC in this first place were to fulfill better efficiency, pursue lower costs and meet the local demands. However, an emergent disruption like the COVID-19 outbreak would be capable of holding back all efforts and hindering the networks from functioning properly. Before the outbreak of COVID-19 and the trade warChina recognized as the “world factory” had been the major assembly economy importing intermediate goods from other East Asian countries and exporting finished goods to the US and European markets. 

As the US-China trade war caused more harm on the Chinese economy, Beijing realized that China had to pick up its domestic demand and reduce its heavy dependence on external markets under the supply-side economic reform. In other words, China has been striving to transform itself from the world factory to a world market. The US on the other hand has been trying to bring jobs back from foreign lands especially China. The White House realized that every country in the world wants a share of the US market, the biggest market demand of the world. If the Trump administration can attract overseas US companies to move their factories home and supply the US demand with tax incentives or foreign policies in extreme, not only Trump’s goal of a 3.5% GDP growth on average, one of Trump’s presidential election campaign proposals, can be fulfilled, but also create millions of American jobs. In a nutshell, the US hopes to transform itself from the world market to a world factory. Before the coronavirus pandemic, the US and China had had conflicts of agendas by pursuing the opposite goals. The COVID-19 outbreak has further triggered the inevitable collision of these two largest economies of the world. 

The Trump administration has been planning to come up with an initiative designed to remove global industrial supply chains from ChinaOn the one hand, more tariffs could be imposed on imported Chinese products in order to punish China for its behavior causing the coronavirus pandemic and outbreak. On the other hand, the US Commerce Department has been looking for feasible ways to bring outbound businesses to move both sourcing and manufacturing from China, and back to the US soil or its economic allies with tax incentives or reshoring subsidies. The idea was recommended by Larry Kudlow, the US National Economic Council director on April 9, 2020. 

Mike Pompeo, the US Secretary of State, further announced on April 29, 2020 that the US government was working with Australia, India, Japan, Korea, New Zealand, and Vietnam to jointly move the global economy forward. Accordingly, the US is working on creating an alliance of “trusted partners” with respect to the “Economic Prosperity Network,” which would include the private and public sectors focus on important national development agenda. This is a vivid evidence that the US is preparing for further decoupling from China and also practicing international leadership again. 

In theory and practice, the regional economic integration (REI) processes such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and the Regional Comprehensive Economic Partnership (RCEP) are designed to promote vertical specialization-based trade meaning that free trade agreements evolving beyond duty free and includes many important issuessuch as rules of origins, technological standards and IPR regulations can help strengthen supply chains. Therefore, the need for multilateral economic integration processes to continue the economic momentum would be essential. However, for removing supply chains from China, it is also critical to launch another REI process that excludes China. 

The Economic Prosperity Network consists of key members from CPTPP and RCEP: Japan and Korea can be the US’s GVC partners of information and communication technology; Australia and New Zealand are both strong in agriculture and rich in natural resources; India is the forefront of software engineering; and Vietnam recognized by many as the “next world factory” can replace China as a hub of assembling and packaging. The network perception is in keeping with the Indo-Pacific Strategy Report issued by the US Department of Defense on June 1, 2019 identifying China as a revisionist power vis-à-vis the American security sooner or later. Therefore, the US must turbocharge the concept and form a new REI to back up new GVC in the post-COVID-19 era. 

 

Challenges and Opportunities of Taiwan 

The Economic Prosperity Network with the US trusted partners can be the economic and trade cooperation mechanism to accomplish the goals of Indo-Pacific Strategy. At first, new GVC without China will operate to meet the new demand, markets of the US and its allies. Secondly, a new REI process led by the US that may incorporate with the existential CPTPP must be formed to consolidate the GVC. After all, GVC supported by REI would be the best means for the optimal allocation of regional resources. The optimization can thus maximize consumers’ and producers’ surpluses, economic welfare of all stakeholders. 

The US-China decoupling means that these two countries will not be as connected or integrated in economic and trade relations as before. The process of decoupling may not go all the way; completely excluding China out of the supply and demand of US businesses seems unlikely. In spite of everything, China is still the third largest trading partner of US. However, decoupling process would certainly be furthered by the COVID-19 pandemic subsequent to the trade war. The US reliance on China would be reduced and dependence on trusted partners enhanced. 

There will be several challenges facing Taiwan. Taiwan is certainly interested in taking part in the REI process as well as the Indo-Pacific Strategy; however, building domestic consensus to be ready for market opening is not easy and may take time and end up missing the best timing. The US led process must possess standards at least as high as the CPTPP, and Taiwan’s more vulnerable industries will need to cope with serious foreign competitions once becoming a signatory member. 

Of course, there can be golden opportunities for Taiwan, too. The stimulation of bringing-in competition from the REI membership will help Taiwan’s industries move up supply value chains and generate more added values, whereas Taiwan can better leverage its strengths of innovation. In addition, with tariffs and barriers eventually removed, Taiwan’s businesses can finally compete with businesses from others on an equal basis.

 

By  Darson Chiu 

Research Fellow, Taiwan Institute of Economic Research 

 

 

Conclusions and recommendations of Taiwan Perspective articles are solely those of their authors, and do not reflect the views of INPR.

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