Anticipating The Catastrophic Economic Impact of Decoupling

China and the US have been connected increasingly tightly up until recently. As the relations between the two countries degrade and restrictions on technology transfers are put in place and coupled with COVID-19 pandemic concerns, companies that were once tightly partnered will begin to decouple. This decoupling introduces inefficiencies into the supply chain, makes supplies even less reliable, and—given they are driven by tactical thinking—may eventually have to be rebuilt.

Let’s talk about how we got here and why there needs to be a strategic approach to the underlying problem.

Tactical Solution to A Strategic Problem

The current spat between the US and China appeared to start when the then-current US administration wanted to balance what was becoming a significant trade deficit but lacked the leverage to get China to agree. The US imposed tariffs without seeming to understand how tariffs worked, and how they artificially raise prices for the country’s citizens implementing them. And, without investing the money being received from those tariffs to address the underlying manufacturing problems, blocking China from US technology became an escalation of tactical tools that were, alone, inadequate to correct the trade deficit.

Huawei was targeted individually. The US administration even went after the founder’s daughter—setting her up on a questionable charge of breaking the Iran Embargo using US currency. This move had the unintended effect of again motivating China to remove the US Dollar as the world currency standard, which, if victorious, would do unfortunate things to the US economy.

To date, the charges against Huawei have not been proven; their CFO remains at risk in Canada, and the tech industry is experiencing increasing parts shortages while the US attempts to ramp up domestic manufacturing and switch to suppliers, not in China. At the same time, the US Trade Deficit declined by 18% between 2019 and 2020, but at $393.6B, it is still anything but trivial.

This problem required a strategic approach where the two countries collaborated to solve the problem definitively. Instead, it became a tactical trade war, and because the sustaining capability—manufacturing—is in China, which enjoys a labor cost advantage, the US is likely to be hurt more than China if this continues.

Breaking An Ecosystem – Collateral Damage

Ecosystems are set up over decades and have many interwoven parts making them problematic to break up. Set up gradually with initial trials and then refined over time, a supply chain has many interdependent components that assure its reliability and security. Quality and security checks, staffing requirements to meet regulatory requirements, trusted relationships that assure positive outcomes, and the knowledge gained over time across the ecosystem reduces misunderstandings and assures a predictable result.

These all break when a single vendor is changed out, but with geographic decoupling, you aren’t changing out just one vendor. You may be changing out an entire manufacturing ecosystem. While most anticipate cost escalations, we often take the rest of the elements for granted, and the result is generally missed commitments, recalls due to quality failures, fines for failing to adhere to staffing requirements and other forgotten regulations, and a host of new relationships many of which won’t initially work out.

And those cost disadvantages may not be recoverable because the existing relationship likely was because the supplier not being decoupled was the lowest cost quality supplier identified by initial competitive bidding.

Pandemic

One of the new risks to moving manufacturing out of China and severing ties to Chinese companies is that other countries like Vietnam and India, which could pick up the slack, are experiencing COVID-19 pandemic spikes and aren’t as well protected as the US and China are currently. Even Japan appears to be experiencing a spike, increasing failure risk for alternative vendors while the Chinese suppliers and US companies have been mainly restored to total capacity.

This pandemic problem is putting additional risk on US companies now increasingly dependent on suppliers in these COVID-19 ravaged countries, making it likely there will be severe supply shortages in the second half of the year—exceeding what we are now experiencing.

Wrapping Up

The trade war between the US and China has resulted in massive decoupling, which, in turn, has introduced costs and inefficiencies into US supply chains. Because of the lack of vaccines in countries being selected as China alternatives, it is increasingly likely that the shortages we see today will be eclipsed by more massive shortages resulting from the spread of the COVID-19 pandemic and continued hostilities between the US and China.

In the end, what is required is a strategic approach. If other countries are to be used to replace China, they need to be protected by the US to assure this changing supply chain. Either that, or the relationship between the US and China must be again solidified under a treaty, and then supply chains can revert to what they once were.

Until either one of these is done, supply chains are likely to be operating sub-optimally and at continued risk of outright failure.