Is US–China decoupling heading in a dangerous direction?

Bilateral trade between the United States and China continues to expand despite the trade-war tariffs and escalating tech restrictions that the United States has imposed on China. But bilateral trade expansion is slowing and is growing at only one-fifth the pace of the overall US trade expansion. The share of US imports coming from China has declined, while China has shifted some imports of foreign goods away from the United States. The composition of US–China bilateral trade has also shifted away from goods with the highest tariffs.

Data on bilateral trade alone does not show the full picture of US–China commercial ties. Since the tariff war began, China’s direct investment in Southeast Asia has skyrocketed— reaching US$128 billion in 2020. US imports from Southeast Asia are also expanding rapidly.

The survey also shows that though most US firms operating in China plan to stay, a rising share are considering shifting supply chains out of China— including Apple and Google.

Prospects of US investment in China are clouded by potential US restrictions on outbound investment to China. The Biden administration is concerned that US investors may be helping to advance Chinese technology in critical sectors and is developing a mechanism to constrain the flow of US investment into China. But because US firms constitute a relatively small portion of total foreign direct investment, such a screening scheme will only be effective if other states are involved. The difficulties of convincing others to develop similar programs may be causing the delay in the launch of a US outbound investment screening scheme.

In March 2023, 665 Chinese companies on the US Entity List were subject to restrictions on the flows of certain technology and goods from the United States. China responded with its own Unreliable Entity List in September 2020. So far only two US aerospace and defence companies are listed and prohibited from trading with or investing in China.

US–China technological decoupling escalated in September 2022 when US National Security Advisor Jake Sullivan announced a profound shift in US economic policy on China. Rather than designing export restrictions to keep China’s critical technologies a generation behind that of the United States, the US objective is now to freeze China’s current level of technological development. As the US tech frontier continues to expand, the gap between the two countries would widen, causing China to fall further behind.

Given the stated US goal in maintaining ‘as large of a lead as possible’ in semiconductors, quantum computing, artificial intelligence and other critical sectors, it is not surprising that China’s President Xi Jinping has stated that the United States attempts to contain, encircle and suppress China. China is now pouring hundreds of billions of dollars into cutting-edge technologies to achieve self-sufficiency. The West’s economic sanctions following Russia’s aggression against Ukraine worry Chinese leaders who fear similar sanctions could be applied to China if it pursues reunification with Taiwan.

Technological decoupling raises serious concerns about global growth in the short and long term. A 2021 IMF study identifies three direct channels where technological decoupling can affect global growth—reduced global trade flows, misallocation of resources and less cross-border knowledge diffusion.

Together with trade fragmentation and ‘friend-shoring’, technological decoupling can lead to significant economic losses globally. The drive for self-sufficiency is costly and success is not guaranteed. Reining in technonationalism is in the United States and China’s interests, but the political reality in both capitals is making rational policy formulation extremely difficult.