Accelerating Decoupling of Global Supply Chains from China

The decoupling of global supply chains from China is a complex and multifaceted phenomenon driven by a combination of economic and geopolitical factors.

While a complete severing of ties remains unlikely, the reconfiguration of supply chains away from excessive reliance on China is accelerating across various industries.

Related Statistics

• Over the past 10 years, the number of foreign companies with manufacturing operations in China has declined by over 25%.
• In the past 18 months, Western companies have pulled over $150 billion out of China, shifting resources to other countries to reduce exposure.
• Many US retailers are heavily reliant on Chinese imports - Walmart sources around 25% of its supplies from China, Target's exposure is about 33%, and Mattel sources about two-thirds of its toys from China.
• US companies are embracing a "China + 1" sourcing strategy, seeking new suppliers in countries like Vietnam, Indonesia, and Mexico, and finding out in the process many are to varying degrees affiliated with Chinese companies.
• China's share of global exports has declined from a peak of 13.8% in 2015 to 11.7% in 2022, indicating a shift in global supply chains away from China.
• The average allocation of global equity funds to Chinese assets peaked at 3.13% in April 2015 but declined to 1.75% by September 2023 as investors reduced China exposure.
• The value of US dollar foreign direct investment (FDI) in China fell to $8 billion in 2022, returning to 2004 levels amid rising geopolitical tensions.
• Chinese firms raised $529 million from US stock offerings in the year to mid-October 2023, far below the $29 billion peak in 2014 when Alibaba listed shares in New York.

Drivers of Supply Chain Shifts

Economic Factors

• Rising labor costs in China have made alternative production hubs like Vietnam, Bangladesh, and Mexico more cost-competitive for labor-intensive industries like textiles.
• The need for supply chain resilience and risk mitigation, amplified by disruptions from the COVID-19 pandemic, has prompted companies to diversify their supplier base to increase resilience.

Geopolitical Tensions

• U.S. tariffs on Chinese exports, imposed since 2018, have significantly increased the costs of sourcing from China, accelerating the shift to other countries.
• Growing concerns over potential conflicts, such as tensions around Taiwan, have catalyzed the imperative for companies to adopt a "China + 1" strategy.
• Increasing protectionism and restrictions on foreign direct investment in certain industries have limited companies' ability to operate in China.

Challenges in Shifting Supply Chains

• For industries like consumer electronics, where China accounts for around 75% of global export capacity, rapidly decoupling supply chains is extremely difficult.
• China remains a crucial supplier of key components like lithium-ion batteries used in electronics and electric vehicles, where Chinese companies have an estimated 30% cost advantage.
• Companies like Apple and Nike rely heavily on China's ability to supply massive temporary workforces needed to optimize their complex supply chains.
• Diversifying suppliers away from China may result in higher costs and potential quality issues during the transition period until new supply chains are fully bedded-in and well established.

Emerging Alternative Supply Hubs

• Vietnam's share of U.S. imports increased by 1.9 percentage points between 2017-2022, the largest gain as companies diversify away from China. (Further reading Chatham House, "Vietnam’s political turmoil reveals a turn towards China – and away from the West").
• Other countries gaining market share in U.S. imports include Taiwan, Canada, Mexico, India, and South Korea as more and more firms worldwide adopt a "China + 1" sourcing strategy.
• Although, many alternative suppliers are still affiliated with or have exposure to Chinese companies, limiting the extent of what could be defined as a full-blown "true" decoupling.

The Nature of Reconfiguration

While supply chains are shifting away from excessive reliance on China, this does not signify a wholesale displacement or direct "decoupling." Instead, a reconfiguration of global supply chains is taking place, enabled by growing volumes of Chinese exports and investment.

Chinese businesses are adapting by relocating and optimizing their operations, reducing costs in the process. For example, since 2018, China's inland provinces have increased their global exports at a faster rate than coastal regions.

The reconfiguration is driven by a complex interplay of economic considerations and geopolitical tensions, offering companies diverse options to optimize their supply chains while maintaining a presence in the vast Chinese market.

Escalating Taiwan Tensions

A major geopolitical factor driving the decoupling from China is the escalating tensions over Taiwan. China's stated intention to take control of Taiwan by force if necessary has raised serious concerns among Western nations and companies.

The potential for military conflict in the Taiwan Strait poses significant risks to supply chain disruptions and economic turmoil. As a result, many companies are accelerating efforts to reduce their dependence on China and diversify their supply chains to mitigate these risks.

The Taiwan issue has become a flashpoint in the broader U.S.-China strategic competition, further fueling the momentum towards economic decoupling as a means of reducing vulnerabilities and preserving national security interests.

The Unfolding Scenario

The decoupling of global supply chains from China is an intricate process that presents a range of potential scenarios and outcomes over the coming years. As we look ahead to the late 2020s and early 2030s, supply chain managers must be prepared for various eventualities, including the possibility of military conflict in the region.

Escalating Taiwan Tensions

One of the most significant geopolitical risks driving the decoupling momentum is the escalating tensions between China and the West over Taiwan. China's stated intention to take control of Taiwan, is prompting many to accelerate efforts to reduce their dependence on supply chains coming out of China.

If these tensions were to escalate into outright military conflict in the Taiwan Strait, the consequences for global supply chains could be catastrophic. A regional war in the Asia-Pacific could plunge the entire Southeast Asian region into turmoil, disrupting vital shipping lanes, production hubs, and trade flows enormously.

In such a worst-case scenario, companies heavily reliant on Chinese and regional supply chains could face severe shortages, skyrocketing costs, and prolonged disruptions, never mind any consumer backlash. The ripple effects would reverberate across industries, from consumer electronics and automotive to pharmaceuticals and energy across the entire globe.

Peaceful Coexistence & Gradual Reconfiguration

If China were to abandon its desire to take over Taiwan militarily and pursue a path of peaceful coexistence, the decoupling process could unfold more gradually and with less disruption. In this scenario, the reconfiguration of supply chains would continue at a measured pace, driven primarily by economic considerations and the need for resilience and risk mitigation.

Companies would have more time and flexibility to diversify their supplier networks, cultivating alternative supply hubs in regions like Southeast Asia, Mexico, or India, while maintaining a calibrated presence in China to leverage its vast market and production capabilities.

Even in this more stable environment, the decoupling momentum is unlikely to be reversed entirely. The geopolitical tensions and strategic competition between the U.S. and China will likely persist, prompting companies to continue reducing their over-reliance on Chinese supply chains and fostering greater supply chain agility.

Navigating the Unfolding Landscape

Regardless of the specific scenario that unfolds, one thing is clear, the decoupling of global supply chains from China is an irreversible process that is already well underway. Supply chain managers, key stakeholders and leaders must be prepared to navigate this unfolding landscape with strategic foresight, adaptability, and a long-term perspective. Either way there are two inescapable fundamental choices, be proactive or reactive, the latter fraught with inherent danger and almighty risk.

Effective navigation requires a deep understanding of geopolitical developments, regulatory shifts, and the evolving competitive landscape. Collaboration with industry peers, policymakers, and stakeholders across the value chain is essential to mitigate risks, seize opportunities, and foster supply chain agility in an increasingly complex and tumultuous global environment.

While a wholesale abandonment of Chinese supply chains is unlikely and in many cases impractical, a strategic reconfiguration and diversification of supply networks is an urgent imperative. A "wait-and-see", or "lets hope it doesn't happen", approach or mindset is likely to prove catastrophic.

This may involve adopting a "China+1" or even a "China plus multiple" strategy, cultivating alternative supply hubs while maintaining a calibrated presence in China to leverage its vast market and production capabilities.

Ultimately, the decoupling from China is not an abrupt severance but a gradual recalibration, a delicate balancing act that demands agility, resilience, and a nuanced approach from supply chain leaders worldwide.

Preparing for the worst-case scenario of regional conflict, while striving for a more stable and peaceful coexistence, will be crucial in navigating the unfolding decoupling landscape over the next decade and beyond.

Further Reading

• "Implementing the 'China+1' Strategy for Supply Chain Regionalization" by Mark Vernall LinkedIn article (December 2023)
• “Improving Supply Chain Resilience by Decoupling” by Mark Vernall, LinkedIn article (January 2024)
• “Supply Chain Fallout: China vs. Taiwan” by Mark Vernall, LinkedIn article (January 2024)
• "Supply Chain Decoupling: Geopolitical Debates and Economic Dynamism in East Asia" by Ando Mitsuyo, Hayakawa Kazunobu, and Kimura Fukunari (August 2023)
• "The Deglobalization Myth: Summing up Asia’s Supply Chain Changes" by Hinrich Foundation (March 2024)
• "Supply-Chain Decoupling From China Gets Sharper Teeth" by Wall Street Journal (September 2022)
• "US & China Decoupling pt2: Reshaping Global Supply Chains" by The Global Treasurer (April 2024)
• "Decoupling proceeding amid lingering U.S.-China tensions" by Research Institute of Economy, Trade and Industry (RIETI) (May 2023)
• "The Great Uncoupling: One Company's Decision to Move Part of Its Supply Chain Out of China" by Harvard Business Review (November 2022)
• "Reshoring, Friend-Shoring, and Diversification in the Wake of COVID-19" by UNCTAD (November 2022)
• "The Decoupling of the U.S. and Chinese Economies" by Congressional Research Service (March 2023)
• "Decoupling from China: Diversified Supply Chains and Opportunities for ASEAN" by ISEAS-Yusof Ishak Institute (June 2023)
• "The Great Supply Chain Pivot: Mapping the Decoupling of China and the World" by Nikkei Asia (January 2024)