As the global economy is torn apart, European companies need action plans

When many think about ‘decoupling’, they think of the deteriorating US-China relationship, in particular the bilateral tariffs that have threatened free and open trade. Yet companies have long operated under the assumption that China is becoming increasingly independent with the world, since its opening up four decades ago, China has in fact been a nation conditionally coupled with the world economy, benefitting from global interconnectedness in some sectors while shielding others from foreign participation in order to build up domestic champions. Geopolitical tensions have only driven this strategy forward, with the Chinese government recently declaring that its dual strategies for the coming year are to build scientific and technological strength, and to develop greater autonomy and control in industrial supply-chains.

In its new report published in partnership with MERICS, the European Chamber analyses how European companies are navigating the new reality of this ‘patchwork globalisation’. The report finds that one major concern for European business is an emerging ‘technology ecosystem quagmire’. China is reliant on semiconductors produced abroad as a critical input for many of the competitive goods it produces. Blocking access to these inputs, as the US has sought to do through export controls on American semiconductors to Huawei, for example, creates a major supply chain bottleneck. China has met this threat with aggressive industrial policy that aim to both boost self-reliance for critical technologies and to tighten the dependence of global supply chains around China so that they may withhold important technologies as a deterrence. The recent Export Control Law and Unreliable Entity List mean that China could block rare earth exports to retaliate against US or European companies, similar to the US stratege.

European companies have so far faced limited impact in this realm because they usually do not meet the 25 per cent threshold of US-origin content for blocking exports to China; but that US regulators can lower this de minimus threshold at will for individual companies and countries is deeply troublesome. COVID-19 also offers a preview of the disastrous effects decoupling may have on critical input supply chains. The pandemic majorly stemmed the export of European semiconductors to China in late 2020, causing many China-based automakers to shut down production. Suppliers estimate that it may take six to nine months to catchup with demand, underscoring the disruptions that come from production shortages, not to mention a purposeful blockage by the US.

Digital decoupling is also a major concern across all industries. The US ‘Clean Network’ campaign moves it towards a world in which Chinese technology is purged from supply chains servicing Americans, even pressuring companies in regards to the nationality or physical location of programmers. On the Chinese side, the creation of a self-reliant tech ecosystem and pushes for ‘autonomous and controllable’ technology, alongside market barriers in digital industries, fuel protectionism and force foreign companies to integrate with the local system.

Faced with massive exposure, European companies will have to choose one of two approaches. The first is a dual systems approach in which they create one supply chain and R&D system to exclusively serve China, and one to provide for the rest of the world. While this can secure companies’ position in China, it is very expensive and unfeasible for many, particularly small and medium-sized enterprises with neither the resources nor production volume to offset costs. The second option is a flexible architecture approach in which everything that can be supplied in a ‘neutral’ manner in either market is developed and built for both systems, with other parts being developed separately for each market with the capability of being ‘swapped out’. The latter option, though cheaper than the former, comes at the risk of having to reconfigure entire supply chains if either China or the US decide to ban imports of a certain technology. Both approaches therefore carry high costs, but must be closely considered lest companies are pushed out of the China market entirely.

Even though this technological decoupling is inevitable and, in many ways, already underway, landmark deals like the Comprehensive Agreement on Investment (CAI) offer an opportunity for the EU to cautiously couple with China. As we await the final text of the agreement, the European Chamber hopes that the CAI is sufficiently comprehensive to deal with the uncertainty of decoupling trends. The Regional Comprehensive Economic Partnership also brings confidence in trade liberalisation, aiming to strengthen regional cross-border supply chains and boost opportunities for investment in the region.

The impending change of administration in the US is unlikely to bring a swift end to decoupling. As a bipartisan consensus grows in the US that China is a strategic competitor, there is no easy revert to that way the relationship was four years ago. European companies must therefore buckle down and prepare for the reality of this ‘patchwork’ system, perhaps by developing corporate task forces to track emerging developments, mapping potential vulnerabilities, and preparing strategies for a variety of potential scenarios, particularly how to manage the technology quagmire. Caught in the middle of geopolitical tensions, European companies will be increasingly exposed to a gradually bifurcating world economy. The best way forward into the unknown is to prepare for the worst.