China - What Next?

When England China Business Forum (ECBF) was established in early 2013, David Cameron visited China later in December, and Xi Xing Ping returned the favour in 2015. We had a period of a golden era relationship with China, and we were scrambling to understand how to enter the market in China, build business relationships and protect our interests.

The situation began to change, when Donald Trump imposed tariffs on imported solar cells and certain washing machines in 2018. Joe Biden continued the policy of constraining China and trade barriers are now expanded to include a large variety of goods and, more significantly, the tech sector. The US, UK, NATO and the G7 increasingly see China not just as a systemic competitor but also as a security threat. There is escalating talk by Western politicians from all parties of decoupling for both economic resilience and security reasons, as well as upping military forces around China.

So, what's next? I would like to address two issues from the perspective of the impact on UK businesses trading with China.

First, how realistic is decoupling in the short and medium term? Second, will there be a war over Taiwan?

Let's look at some trade figures.

• In 2021, China was the UK's largest import partner and sixth-largest export partner for goods. Our trade deficit in 2021 was £44.8 billion in goods, partially offset by a £5.7 billion surplus in services[1]. The figures for 2022 is slightly lower but is expected to rebound in 2023.
• Foreign direct investment into China in 2022 rose 8% from a year earlier to USD 189.13 billion. Increases in FDI from the UK was 40.7% and the EU 92.2%. FDI into China was 46% into manufacturing and 28% into high-tech industries[2].
• For the full year of 2022, China's global exports rose 7% to USD 3.6 trillion[3]and China's trade surplus grew to a record $877.6 billion[4] despite weakening U.S. and European demand and Zero-Covid controls that shut down various industrial cities in China.

It does not appear from the trade statistics that economic decoupling is going to happen anytime soon. Why? Western countries have generally taken two strategic approaches to decoupling from China.

The first approach is to become less reliant on China, especially with advanced chip technology. The US Chips and Science Act will invest USD52.7 billion to develop America's semiconductor industry. The EU will also be investing more than €43 billion to support its Chips Act until 2030. The US has gone further, blocking Chinese firms from acquiring advanced chip technology and prohibits American citizens and companies from assisting China's semiconductor industry.

According to some views "Washington is now purposely and openly working to hold back Chinese economic progress."[5]

Allied countries such as the EU, Japan and South Korea, under tremendous pressure from the US, have agreed to impose export restrictions on lithography machines. However, draconian trade protection policies will not only impact China but will have unintended consequences. Industry leaders such as ASML, a key supplier of lithography equipment, warns that sanctions will accelerate the development of Chinese competitors.

"If they cannot get those machines, they will develop them themselves. That will take time, but ultimately they will get there … The more you put them under pressure, the more likely it is that they will double up their efforts."[6]

There is also a strong possibility of a boomerang effect, as the supply chain that provides the raw material for semiconductors are primarily located outside the US and EU. China alone manufactures 79% of the global supply of the quality of silicon needed for chip manufacturing[7].

For us in the UK, even if we have a cohesive industry strategy on how to decouple, it will require considerable resources over several years. The UK has been working on a semi-conductor strategy for the last 2 years. It appears that the UK wants to increase semi-conductor production using existing programmes[8], possibly £1bn over several years[9], which is plainly insufficient if the UK wants to be a global player. It is very doubtful whether our current politics and economic system are able and willing to sustain the cost and investment needed.

A House of Commons Committee report stated that it is not clear "that the support or attention currently offered by Government is at anything like the scale which is needed to secure our supply of semiconductors and to deliver the future prosperity of the semiconductor industry."[10]

The second strategic approach to decoupling from China is for western companies to relocate to other emerging economies, such as Mexico, India and Southeast Asia. There are however significant constraints. For example, Vietnam with a population of just under 100 million will only be able to absorb so much industrial capacity. India and Indonesia with much larger populations will need many years to build up its industrial and transport infrastructure before they can be manufacturing powerhouses.

"China's rise wasn't all about cheap labour … modern infrastructure was a big factor in drawing global companies to use the country as a manufacturing hub."[11]

One interesting thing about China's trade figures is Southeast Asia. As a bloc, ASEAN has the 3rd largest population in the world with a median age of 30.3 years. In 2019, ASEAN overtook the European Union to become China's largest trading partner. In 2020, about 25% of ASEAN's foreign trade is with China and ASEAN accounted for 14.7% of China's total trade. With the launch of RCEP (the Regional Comprehensive Economic Partnership) in 2022, Southeast Asian economies are expected to grow substantially in coming years.

The point being made here is that for many countries in the Global South, China has become the more important trading partner. This is a highly significant change in global trade that UK businesses ought to take note of.

It does not appear that Western attempts to decouple, sanction and constrain China will have significant impact on China's economy. So, what can derail this somewhat rosy picture for trade with China? There is one major uncertainty. The issue of how US politicians will play the 'bad China' card during the US presidential elections in 2024 and whether the US will cross China's red line by declaring Taiwan as an independent country.

The current signs do not appear good. The US (and NATO) is increasing their military assets in an arc from Japan to Philippines. Japan is being encouraged to militarise. The frequent scare mongering news of 'bad China' is conditioning people in the US, and perhaps to a lesser degree in Europe to a potential hot war with a 'hated' enemy. For examples, a US Air Force general sending out a memo saying his guts tell him there will be a war with China in 2025[12], the warnings of smart light bulbs spying for China and the furore over a balloon from China flying over the US.

One key factor would be how quickly the US can remove its dependence on Taiwan for advanced semi-conductors. TSMC first fab in Arizona will be completed in 2024 and a second fab in 2026[13], with a total investment of USD40 billion. When completed, the 2 plants are expected to meet the US demand for 600,000 wafers annually[14]. Will the US be more likely to start a war then?

According to a WSJ op-ed "Washington looks to be playing for time - not time to rearm and prepare for a fight, but to reduce Taiwan's importance to the U.S."[15] for semi-conductors.

Even is the WSJ op-ed is true, there is always a risk of mishaps and/or miscalculations. However, a war between the US/NATO and China will lead to the closing of the South China Sea, East China Sea and Sea of Japan. The result will be disastrous for the global economy, as the closing of shipping lanes will seriously disrupt supply chains between East and West.

To conclude, an open war between the US and China over Taiwan is very unlikely in the short term and medium term as the disruption to the global economy will hit every country hard.

Still, the propaganda and political rhetoric from both sides will get worse, and there is always the risk of a mishap. However, past experiences from the Cold War with the Soviet Union, as well as incidences between the US and China over the years, indicate that nuclear powers have means to defuse and walk back from critical situations.

British businesses must therefore continue, even increase their trade with China. There is a strong expectation that after lifting the restrictions of Zero-Covid, there will an increase in consumer demand. IMF forecasted that China's economy will grow by 5.2% in 2023, but will settle below 4% in the medium term[16].

According to Andrew Seaton, Chief Executive of CBBC,[17] "There is a broad expectation of a strong revival in business and economic activity, particularly from Q2 onwards. As The Economist recently said about the new policy: 'This year's biggest economic event is already underway'."

Of course, in trading with China, we ought to be clear-eyed, as with any business relationships in any country. The UK government could also be clearer about its economic, industrial and security strategies, based on medium and long term level headed assessments rather than short term political gains.

The Head of CBI has warned that "Global investors are shunning Britain because the Government has no coherent economic plan and is failing to keep up with volcanic policy changes in the US and Europe"[18].

Finally, as UK businesses, we should be striving to reduce the trade imbalances by strengthening the promotion of our services and becoming better in manufacturing. Overall, although I have some concerns, I remain optimistic that trade between the UK and China will continue to grow.

[1] UK trade with China: 2021 - Office for National Statistics (ons.gov.uk)

[2] China Foreign Direct Investment - December 2022 Data - 1997-2021 Historical (tradingeconomics.com)

[3] China Exports - December 2022 Data - 1981-2021 Historical - January Forecast (tradingeconomics.com)

[4] China's trade surplus swells to $877.6B as exports grow | The Independent

[5] America is turning towards protectionist trade policies and it's going to affect you (msn.com)

[6] Sanctions move China to replace chips supply chain - Asia Times

[7] US Chip Sanctions on China: Analysis and Implications - China Briefing News (china-briefing.com)

[8] UK government set to subsidise chip manufacturing in bid to cut overseas reliance | IT PRO

[9] Britain to challenge China with £1bn subsidies for computer chip makers (msn.com)

[10] The semiconductor industry in the UK - Business, Energy and Industrial Strategy Committee (parliament.uk)

[11] Global Trade Is Shifting, Not Reversing - WSJ

[12] U.S. four-star general warns of war with China in 2025 | Reuters

[13] TSMC Announces Updates for TSMC Arizona

[14] TSMC to up Arizona investment to $40 billion with second semiconductor chip plant (cnbc.com)

[15] Will the U.S. Really Defend Taiwan? - WSJ

[16] IMF lifts 2023 growth forecast on China reopening, strength in U.S., Europe | Reuters

[17] What China's reopening means for British business - Focus - China Britain Business Council (cbbc.org)

[18] The world is giving up on Britain, warns CBI chief (msn.com)