The Cost of Decoupling

It is not, however, only China that is turning inward. The COVID-19 pandemic accelerated trends of moving away from globalization that were in place prior to the outbreak. In January 2019, The Economist adopted a term coined by a Dutch writer to introduce the concept of “slowbalisation” – or the movement away from the golden age of globalization and its envisaged flat world to “a new era of sluggishness.” Globalization’s losing steam started around the 2008-2009 financial crisis, and continued to slow for a decade as the costs of moving goods stopped falling, multinational firms faced increasing local competition, trade in goods yielded to services that are harder to transport, and Chinese manufacturing became more self-reliant. The dramatic trade disputes prompted by erratic actions from Washington under Trump and the global disruptions to supply chains and trade due to COVID-19 have caused a rise in economic nationalism and fueled concerns about the future of globalization.

It was also in the aftermath of the 2008-2009 financial crisis that it became increasingly clear that China’s alignment with liberal market economic norms would remain selective. From China’s Indigenous Innovation initiatives in 2009, to ‘Made in China 2025’ in 2015, the ‘dual circulation’ imperative of 2020, to the push for self-sufficiency in key technologies and energy and the 14^th five-year plan in 2021, to a new generation of state controls on data and regulatory actions shaping the future of technological innovation – Beijing has deployed a mix of market access limits, industrial policies, and regulatory restrictions to support the competitive position of domestic companies and reduce dependence on foreign technology and expertise. Most advanced economies choose to cushion the effects of market liberalism for political or security reasons, but the scope and intensity of China’s departure from those norms have been notably far-reaching.

The intensifying systemic rivalry between the US and China has also prompted a focus on the potential for ‘decoupling,’ whether between the US and China, or more broadly. The concept of decoupling is, in a sense, a structured slowbalisation. However, it is also not entirely new: China has long managed its interdependence with the world economy in a highly strategic and limited manner – selective coupling where it needed foreign technology or competition and remaining uncoupled in sectors reserved for China’s, often state-owned, national champions, or where the risks of liberalization were perceived as too great (e.g., internalization of the RMB). The volatility introduced during the Trump years and the continuing US-China tech confrontation now poses an existential challenge to the international trade world order, especially as China’s push for self-sufficiency continues and as it leads in global economic recovery from COVID-19.

The push for self-sufficiency is not new, nor is it unique to China – especially in the wake of the COVID-19 pandemic. Any hopes that the Biden administration would reset the trade relationship with China are waning. The continued tech rivalry and a potential technological decoupling could require international companies to have bifurcated businesses – supply chains, tech systems, data, R&D – and adapt to two or more different operating systems. The continuing trade tensions around technology are rooted in national security concerns, but further decoupling will not only hurt American and Chinese businesses. No one wants to be caught in the crossfire between the US and China – this is true for European multinational corporations eager to do business in both nations, for Southeast Asian countries dependant on China for prosperity and the US for security, and for others. A world with two competing business or technological landscapes would create global inefficiencies.

The Costs of Anything Approaching Full Decoupling are Uncomfortably High

But how high will the costs of decoupling actually be? A recent report by my colleagues at The Economist Intelligence Unit sought to answer that question and to highlight the potential economic losses resulting from ‘de-globalizing’ the world economy, focusing on international trade. Using a Computable General Equilibrium model, they examined the potential impact to trade over the coming decade of three different scenarios. The most dramatic impact on the global economy was the ‘full decoupling’ scenario, defined as follows: “Rising geopolitical tensions culminate in deliberate trade decoupling of China and the Five Eyes countries (Australia, Canada, New Zealand, the UK, and the US). Tariffs of 100% are applied on all goods and services, except in strategically important sectors (pharmaceuticals; ferrous metals; metal products; computer, electronic and optical products; utilities; and communications) where the countries institute embargos.”

This scenario envisions an extreme bifurcation; one that political and business leaders who value economic openness understand is best avoided. But as the stop-start nature of the pandemic recovery continues, nationalist politics rise, fears of shortages spur efforts to bolster supply-chain security and rising protectionism, and geopolitical tensions and inflamed rhetoric increase, it is illuminating to examine just how much we stand to lose. Operationalising the ‘full decoupling’ scenario yielded stark results:

A trade rift between China and the US (and its Five Eyes allies) would create a significant drag on global economic growth over the next decade. The stakes in this scenario are high, owing to the sheer volume of trade that exists between the world’s two largest economies – trade that would be virtually wiped out in this scenario. The cumulative loss to global GDP relative to the baseline forecast in 2021-30 amounts to USD 52.8 trillion in 2020 prices. This is equivalent to losing an economy the size of Japan every year for the next decade.

Although China suffers the most in this scenario, with 2021-30 aggregate GDP 16.5% lower than in the baseline forecast, the economic damage would reverberate across the global economy. Five Eyes countries with high export dependence on China (Australia and Canada) stand to bear the next greatest losses. But even non-parties to the ongoing trade confrontation, including South Korea and Germany, would sustain collateral damage from the disruption to global demand and supply chains.

Clearly, there are no winners in a fully decoupled world. While globalization may never recover to the intense enthusiasm of the 1990s, a globalized, rules-based international system has underpinned stability and growth for the better part of a century. It is sobering to contemplate that system being irreparably broken by complex contemporary economic and political tensions.

In January 2021, Xi Jinping delivered an online address to the World Economic Forum, focusing on multilateralism and sustainable development. Mr. Xi cautioned that creating small circles, decoupling, and sanctions would result in division and confrontation. He called for world leaders to accept diversity and not force one’s own history, culture, and social system upon others, while warning against ‘cold war’ and ‘zero-sum’ mentalities.

Although arguably pointed, his admonishments are prudent. In the wake of the economic devastation wrought by COVID-19, the world cannot afford to turn further inward. While there may no longer be red banners flying in any nation’s capital calling for global alignment, there is too much at stake to completely decouple.

The report, The Cost of De-globalising World Trade: Economic Scenarios for the World’s Turn Inward, is available at https://eiuperspectives.economist.com/

Mattie Bekink is responsible for the Economist Corporate Network’s China strategy, including program development and client engagement across China. She also provides support to all Economist Corporate Network programs worldwide with a China component.

Ms. Bekink has extensive experience in the public, private and policy sectors. Prior to joining The Economist Group, she was the Executive Director of the Fulbright Commission in the Netherlands. She also ran an eponymous consulting business, advising senior executives from businesses, universities and non-profit organizations on China policy, strategy, public affairs, and corporate social responsibility. Ms. Bekink practiced law at Skadden, Arps, Slate, Meagher & Flom LLP, has worked with the US-Asia Law Initiative at NYU Law School and the American Bar Association Rule of Law Initiative China Program, and served in the legal department at General Motors China. She has a BA in International Relations from Stanford University and a JD from the Georgetown University Law Center.