Decoupling from China? Not so fast
by Avery Shenfeld
The US election cycle is in full swing, and if we ever get around to discussing policies rather than scandals and court rulings, trade and protectionism could be a key area of focus. Trump favours further hikes to tariffs against a broader range of trading partners, but both he and Biden are closer aligned in having a protectionist bent when it comes to China. That includes restricting Chinese access to American technologies with potential military applications, and a desire to use both carrots (subsidies for goods with US or NAFTA content) and sticks, with Biden having retained Trump’s tariffs, and Trump pledging further ones, to reduce imports from China.
The hazard is that the progress we’ve made on restoring supply chains and bringing down goods inflation could be put in jeopardy if the US moves too quickly on a path to decoupling from China. As a case in point, at a recent CIBC event for the renewable energy sector, we heard concerns among US players that elevated tariffs on key components imported from the Middle Kingdom would be a material cost headwind, even with the IRA encouraging the expansion of the domestic green-power manufacturing sector.
They aren’t alone. While everyone understands that China is still an important manufacturing player and supplier to the US economy, even we were stunned by a recent report that documented the degree of its global dominance. The economist Richard Baldwin and his coauthors found that China now accounts for roughly 40% of the world’s gross manufacturing output, and has surpassed the share of the next ten largest players combined (Chart). The US industrial sector is three times more reliant on Chinese inputs than China is on American suppliers.
Industrial policies like the IRA and the CHIPS Act, as well as NAFTA provisions that favour Mexico and Canada over others, could alter that landscape over time. So too could political uncertainties over China-US relations, as American businesses fearing future disruptions seek to rejig supply chains and source products from countries with fewer perceived political risks.
The experience during the height of the COVID pandemic convinced many companies that a more diversified supplier base, alongside holding more inventories of parts and finished goods, might be worth the additional cost in terms of being less exposed to disruptions in one particular country. We wouldn’t be surprised to see Mexico and other emerging markets pick up share under any likely US post-election policy stance.
But trying to force a quick divorce from China’s manufacturing sector through a sharp increase in trade barriers would likely prove costly for the US economy, particularly at a time when sustaining low inflation in the goods sector will be key to an easing in monetary policy. Where substitutes from the US or other trading partners simply aren’t available at a sufficient scale to replace Chinese goods, a heavier tariff on the latter would simply be passed on to American buyers, whether they are retailers or industrial companies using Chinese inputs.
Outright import bans would be even worse, snarling supply chains for a longer period. So before rushing into a quick divorce, American policymakers need to assess just how quickly its own suppliers or other trading partners could fill in the gap.
