By Nicholas Larsen, International Banker
First, it was “friendshoring”. Next came China Plus One (C+1). “Decoupling” followed. And finally, it seems that policymakers have settled on “de-risking”. With such frequent shifts in official policy positions, the West—particularly the United States (US) and the European Union (EU)—has seemingly put considerable effort into determining its preferred economic stance towards China. The recent softening of language from decoupling to de-risking suggests a less hostile approach to its rival may be in the offing. But it still begs the question: Will de-risking differ from the West’s previously discarded policies?
Such levels of antagonism did not always exist. Companies worldwide sought to ride the tsunami of Chinese growth unleashed in the mid-2000s, particularly when its growing manufacturing prowess and deep well of affordable labour earned the country the reputation of “the world’s factory”. But as the West’s posture towards China became increasingly belligerent (first through the Obama-era [US President Barack Obama] “pivot to Asia” and then the all-out trade war waged against Beijing by the administration of former US President Donald Trump during the late 2010s), with China’s rapid economic expansion continuing to erode the West’s global economic dominance into the 2020s, a series of policy positions were formulated by Washington et al. to lower the purported risks of being commercially exposed to China.
After the US realised that a full decoupling of ties would be too impactful on its own economy, de-risking became the phrase du jour to describe the current approach, which envisions minimising the risks of doing business with China without initiating a decisive separation. “The Chinese economy is too big for decoupling to be a realistic prospect. China is the world’s largest manufacturer of goods, with an output equivalent to that of all US, German, and Japanese factories combined,” Agathe Demarais, senior policy fellow at the European Council on Foreign Relations (ECFR), explained in an August 23 article for Foreign Policy. “Under a decoupling scenario, goods shortages would be likely, and inflation would spike as US firms struggle to source products.” Demarais also noted that with China’s leading position in producing “dishwashers, computers, or toys” not materially threatening US interests, decoupling across such non-critical sectors is not needed.
The EU has since followed in the Americans’ footsteps. “The EU will continue to reduce critical dependencies and vulnerabilities, including the supply chain and will de-risk and diversify where necessary and appropriate,” the European Commission (EC) stated following a summit in Brussels in late June, having concluded that key supply chains were too vulnerable should relations with Beijing be fully severed. “The EU does not intend to decouple or to turn inwards.” According to Ursula von der Leyen, the EC’s president, “diplomatic de-risking” is core to the bloc’s China policy, which will allow it to be tough over such geopolitical issues as China’s support of Russia but also permit open channels for trade and dialogue on such issues as climate change. “Diplomatic de-risking is also important because we want to keep open communication lines with China on issues where we agree,” the European Commission’s chief explained.
Is de-risking working? Perhaps to some degree. China recently recorded its first-ever quarterly deficit in foreign direct investment (FDI), with its State Administration of Foreign Exchange (SAFE) publishing an $11.8-billion deficit during the July-September period for direct-investment liabilities—an FDI measure that includes foreign companies’ retained earnings in China. Western news outlets have been quick to suggest that these capital outflows could make attracting overseas companies a serious challenge for Beijing, with many suggesting that de-risking by Western governments has played a role in triggering the deficit.
Goldman Sachs attributed some of the weakness in China’s FDI to the widening interest-rate differential between China and much of the world, prompting multinational companies to repatriate their earnings. “With interest rates in China ‘lower for longer’ while interest rates outside of China ‘higher for longer’, capital outflow pressures are likely to persist,” the US bank noted.
United Kingdom-based Capital Economics suggested that the sizeable interest-rate gap has led firms to remit their retained earnings out of the country. Speaking to Reuters on November 6, the research firm’s head of China economics, Julian Evans-Pritchard, did confirm, however, that while he has observed little to suggest a significant exodus from China, over the medium term at least, it is likely that “increasing geopolitical tensions will hamper China’s ability to attract FDI and instead favour emerging markets that are more friendly to the West”.
Such “geopolitical tensions” could significantly harm the global economic outlook, particularly as international trade becomes increasingly disjointed. According to the International Monetary Fund (IMF), de-risking strategies by the United States and other OECD (Organisation for Economic Co-operation and Development) countries that aim to reshore production domestically or friendshore away from one another “can result in a significant drag on growth around the world even assuming no new trade restrictions with third countries—especially in Asia”. An October 17 blog post from the Fund also urged that for systemic economies around the world, “there is an urgent need for constructive dialogue to resolve underlying sources of tensions and resist costly fragmentation outcomes”.
From Beijing’s perspective, meanwhile, de-risking is largely perceived as “the same old same old”. A commentary published in state-owned Xinhua, for instance, underscored the scepticism regarding the West’s intentions towards China. “A few developed countries led by the United States replaced ‘decoupling’ with ‘de-risking’ to target China, but it is just old wine in a new bottle, and there is little difference in what they intend to do,” the June 10 article stated, adding that an objective analysis would prove that the de-risking proposition is illogical and unfeasible.
So, why adopt such a belligerent approach? According to a report from the India-based think tank Observer Research Foundation (ORF), de-risking is the US’ attempt to stall its rival’s move “up the ‘smiling curve’ into more lucrative areas such as product design, branding, or even research and development”—the smiling curve being a reference to an IT (information technology) manufacturing concept graphically depicting how the two ends of the value chain in an industry add more value than the middle stages.
“The pushback against de-risking has also led China to penetrate new markets,” the report added. “There is greater diversification of investments under the Belt and Road Initiative. Russia, Turkey, Poland, Kenya and 22 other nations did not get any BRI investment between January and June 2023, while countries in sub-Saharan Africa witnessed the largest growth, with Namibia, Eritrea, and Tanzania recording increases of 457 percent, 359 percent, and 347 percent, respectively.” Indeed, growing anti-Chinese sentiment in the West may expedite Beijing’s efforts to broaden and diversify its global market exposures, shielding it from sustained damage inflicted by a long-term de-risking policy.
China’s ambassador to the European Union, Fu Cong, also warned that the bloc’s “mind-boggling” values-based approach to foreign policy towards China is a decidedly risky one, as evidenced by the broad diversity of value-based responses to Israel’s ongoing war in Gaza from around the world. “Some will argue that China does not share EU values. If this logic follows, then the EU will have a lot of rivals,” Fu Cong recently stated. “Because from the Middle East to Africa, from Asia to Latin America, there are many countries who obviously do not see eye to eye with Europe when it comes to values. We can clearly tell from the divergence of responses to the ongoing Gaza crisis in the Middle East.”
Despite the political rhetoric surrounding de-risking, much of the Western corporate class is not necessarily on board with the policy, which could ultimately prove decisive in further de-escalation in the coming years. “US restaurant brand Subway announced this week it has entered into a new master franchise agreement with a Shanghai-based company to significantly expand its presence in China,” the Xinhua commentary also observed. “A report issued by the EU Chamber of Commerce in China indicates close to 60 percent of the companies surveyed said they would increase R&D expenditure in China in the coming five years. An AmCham China survey shows 66 percent of US companies in China will maintain or increase investment in China in the coming two years.”
But despite the West’s adversarial approach, much of China continues to hold out hope that relations will improve. Indeed, a China Chamber of Commerce to the EU (CCCEU) report found that cooperation remains the defining feature of economic and trade relations between China and the EU, with 83 percent of the 180 Chinese enterprises surveyed still showing faith in the EU market by continuing to expand their presences. And that is despite a hefty 76 percent of respondents reporting that the EU’s de-risking strategy has negatively impacted them.