Amid escalating geopolitical tensions, the United States has grappled with the challenge of “de-risking” its trade relations with China over the past three years. This involves reducing dependence on China’s predominant role in global supply chains through measures such as tariffs, sanctions, and the exclusion of tax credits. The objective is to incentivize manufacturers to relocate their operations to countries in closer proximity to the United States, or those aligned with its interests. U.S. policymakers are optimistic that these actions will not only secure resilient supply chains for American interests but also hinder China’s advancements in high-end industrialization.
The disruption in trade relations between China and the United States appears to validate the success of this approach. From January to November 2023, China’s exports to the U.S. decreased by 20 percent year-on-year, slipping to second place behind Mexico for the first time in 17 years. Moreover, greenfield foreign direct investment from the U.S. to China, an indicator of establishing supply chains abroad, has plummeted by 90 percent from its peak. On the flip side, nations reaping the rewards of supply chain diversification have experienced a noteworthy upswing in both exports to the U.S. and heightened investments for setting up new factories.
De-risking has resulted in noticeable changes, particularly reflected in the decline of China’s exports to the United States. However, standard trade data doesn’t capture the full story of how de-risking is actually playing out. In a recent analysis, Fitch Ratings pointed out that the overall scale of supply-chain diversification has been modest thus far and won’t undermine China’s position as the world’s largest manufacturing hub in the medium term.
Supporting this assessment, China’s share of Global Manufacturing Value-added (GMV) has consistently grown, reaching approximately 30 percent in 2022. This trend persists despite ongoing efforts to diversify the supply chain. GMV, a crucial metric, gauges the net contribution to global manufacturing by deducting the cost of intermediate inputs from gross output. This measurement offers insights into China’s manufacturing strength, considering intermediate goods as a significant factor.
The strategic importance of intermediate goods is often overlooked when assessing China’s continued prominence in global manufacturing. In a recent article, Wei Jianguo, a former Chinese vice minister of commerce, highlighted this aspect and emphasized the crucial role of intermediate goods in China’s ongoing pursuit to establish itself as a “global trading powerhouse.”
Intermediate goods are industrial inputs utilized in the production of other goods and services, typically associated with high-value-added activities. This is crucial, as global supply chains fundamentally revolve around intermediate goods. In the era of globalization, global value chains have transformed the manufacturing landscape by breaking down production tasks into independently designed and manufactured modules that contribute to the creation of finished products. Consequently, the nature of global trade has shifted from a simple exchange of finished goods to a more intricate trade relationship involving intermediate goods.
To grasp this shifting dynamic, the introduction of intermediate goods as a metric becomes crucial. This approach helps elucidate why China’s dominance in global supply chains will not be undermined by de-risking, contrary to how the media has framed it. Additionally, it brings to light the formidable challenges associated with constructing a supply chain independent of China – challenges that are even more substantial than they may initially appear.
Over the past two decades, intermediate goods have emerged as China’s primary merchandise exports, contributing nearly 60 percent to the growth of its foreign trade. What’s even more noteworthy is that China has maintained its position as the world’s largest exporter of intermediate goods for 12 consecutive years. Its dominance in the production of intermediate manufactured goods is even more significant than in production of final goods, solidifying its role as the epicenter of global manufacturing.
A bit of historical context is essential here. China embarked on its industrialization with the initiation of open-market reforms, initially focusing on low-value-added assembly manufacturing that heavily relied on imported intermediate goods from developed countries. Since 1995, global manufacturing increasingly gravitated toward China with the advent of offshoring-oriented globalization.
Over the following two decades, China’s value-added contribution to global manufacturing quadrupled. The country expanded its industrial base by domestically producing many inputs that were previously imported. Domestic manufacturing of intermediate goods fosters industrial concentration, expanding from primary suppliers to secondary and tertiary suppliers, with robust support from foreign investments and government backing. This, in turn, established China as a global leader in the production of intermediate goods.
The surge of intermediate goods made in China was particularly notable after its accession to the World Trade Organization (WTO) in 2001. By the 2010s, China surpassed 25 percent of the world’s total production of intermediate goods, a proportion nearly double that of the next significant supplier, namely, the United States. In 2018, China’s manufacturing sector produced a greater value of intermediate goods than all developed countries combined. The concentrated production of intermediate goods has earned China the status of the “OPEC of industrial inputs,” reflecting its extensive integration into global value chains and robust domestic supply chains.
China’s dominance in the production of intermediate goods grants it significant leverage in managing supply chain diversification. According to Fitch Ratings, the impact of production relocation on China’s trade value is expected to be relatively modest in the medium term. This is attributed to the substantial surge in demand for intermediate goods from China, which acts as a buffer, offsetting potential losses from the decline in finished goods exports.
In sectoral terms, the trend of relocation from China generally involves low-skilled assembly and mass production, impacting finished product exports. However, there has been a notable increase in overseas demand for China-made inputs. This is evident in the rapid growth of China’s intermediate goods exports in some sectors with long-supply chains, such as electronics and machinery components surpassing finished goods since 2018. Additionally, the annual growth rate of China’s textile product exports (6.4 percent) outpaced apparel exports (2.1 percent) from 2018 to 2022.
Ironically, diversification can drive increased demand from nations using Chinese inputs to make goods exported to the United States. China has notably increased its exports of intermediate goods to countries involved in production relocation, such as Vietnam. Despite Vietnam’s total exports reaching 10.36 percent of China’s in 2022, its value-added exports (gross export value minus imported intermediate goods) were only 1.28 percent of China’s. This underscores Vietnam’s significant dependence on China for crucial industrial inputs. Similar situations exist in other emerging contenders to the Chinese supply chains, like Mexico. Their reliance on Chinese intermediate goods renders the de-risking strategy less impactful.
Being the primary supplier of intermediate goods not only helps China offset export losses but also provides it with a more significant, albeit less visible, advantage. This advantage enables China to be more resilient than the United States amid supply chain diversification. New research by Richard Baldwin, a professor of international economics at IMD Business School, unveiled the asymmetric supply chain reliance between China and the United States.
By scrutinizing Chinese inputs in goods acquired by American manufacturers from third-party suppliers, Baldwin uncovered a surprising revelation: The actual exposure of U.S. manufacturing to Chinese production is nearly four times greater than initially apparent. China is the top supplier of industrial inputs for the United States in all sectors except pharmaceuticals. What’s more notable is that the U.S. manufacturing sector is significantly more reliant on Chinese supply than the reverse scenario.
This substantial and asymmetrical dependence means that any attempts to de-risk by reducing ties with China would be more disruptive to U.S. manufacturing than to China itself. This trend is even more pronounced when considering other G-7 countries, emphasizing the broader dependence of the Western nations on China in the realm of manufacturing.
The inherent imbalance in dependence hasn’t been rectified yet, as current efforts to de-risk only result in more convoluted supply chains, introducing heightened risks and uncertainties. Western media often assert that these de-risking efforts are causing a substantial decoupling of China from the United States. While there’s some validity to this claim, the reality doesn’t fit this narrative exactly. In fact, the so-called decoupling is more evident in China’s reduced import dependence on the United States, as more intermediate goods are now produced domestically – but the same trend doesn’t apply in the reverse direction.
Despite its inherent flaws, the United States is doubling down on its efforts to de-risk economic ties with China. However, a crucial question arises: Can the U.S. reverse China’s dominance, which currently accounts for a third of global manufacturing? China certainly displays no intention of ceding its dominance to the United States. As China continues to advance its supremacy, the U.S. attempts to reverse this trend could prove even more challenging.
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