No decoupling, but West and China drift apart

Mark John, Reuters

China’s unexpectedly poor export performance as revealed on Tuesday is still largely down to wider economic headwinds. But underlying trade and investment trends point to an unmistakable long-term drift in commercial ties with the West. Official data showed a 14.5% drop in July exports amid weak consumer demand in the world markets served by China — the fastest decline since the pandemic hit in 2020. Lower imports meanwhile highlighted the lacklustre domestic Chinese picture. For now, such cyclical factors outweigh any impact of calls by Western governments for companies to “de-risk” supply chains as a new era of distrust prompts the United States and Europe to cut trade reliance in strategic sectors with China.

But the longer-term direction of travel emerges more clearly as you pan out from the monthly trade headline. Take foreign direct investment — the more forward-looking clue as to where commercial ties between countries are heading. Foreign investment into China fell to around 0.4% of output by the end of June compared to an average of 1.6% for the five years before the pandemic — a 67% real decline over the period to the lowest level since records began 25 years ago. “We would expect that to recover with the reopening but that really hasn’t been the case,” said Louise Loo, senior economist with Oxford Economics. “That is more of a geopolitical story because of the regulatory environment, because of what is happening on the supply chain side,” she added of regulatory crackdowns on some sectors that have unnerved potential investors.

Some, meanwhile, point to the fact that US-China trade — exports and imports of goods combined — hit a record $690 billion last year as evidence that the reality does not match the frosty political rhetoric. But Stephen Roach, senior fellow at Yale Law School’s Paul Tsai China Center, noted that such tallies were expressed in dollars unadjusted for surging inflation and came at a time when overall output was dragging many indicators higher.

In fact, he calculated, US-China bilateral trade in goods and services in real terms fell to 3% of US output in 2022 from a peak of 3.7% in 2014 — a decline of about a fifth. “While this is a far cry from full decoupling ... it certainly qualifies as a meaningful step in that direction,” he wrote in a column last month. The picture in Europe is more mixed but clearly visible in the trade data of Germany, which under former chancellor Angela Merkel nurtured strong commercial ties with China that helped turbo-charge its economy through the 2000s and beyond. According to official data accessed by Reuters last week, exports to China made up just 6.2% of total German exports in the first half of the year — the lowest share since 2016.

The fact that China is no longer the market it was for German exporters has less to do with de-risking and is more likely a consequence of China increasingly able to produce goods it previously had to buy from Germany, analysts noted. Last month’s China strategy document unveiled by Chancellor Olaf Scholz’s three-way coalition left open exactly how far Berlin would ultimately go in reining in commercial ties. Mark Leonard of the European Council on Foreign Relations said the German stance was critical given that four German firms — Mercedes-Benz, BMW, Volkswagen, and BASF — accounted for a third of all European investment in China between 2018 and 2021. “The stakes are high, because where Germany goes, the rest of Europe often follows,” he wrote in a July 28 commentary.

The trade environment could be about to get frostier. US President Joe Biden is expected in coming days to issue his long-awaited executive order to screen outbound investments in sensitive technologies to China, according to people familiar with the matter. As campaigning for elections next year in United States and Taiwan gets going, US foreign policy could turn more hawkish, Oxford Economics’ Loo noted of a further development that could weigh further on China’s trading outlook. “Our conviction around a near-term possibility of a more predictable and transparent framework for US-China relations remains low,” she said.