Breaking Up Is Hard to Do

The Biden administration is on a campaign to fundamentally alter the supply chains that feed America’s vast appetite for foreign-made goods. This effort is driven in part by the public’s demand for protection against the sorts of shortages that made everything from butter to SUVs scarce during the Covid-19 pandemic. Real enthusiasm for reordering supply chains, however, is stoked by perceived military and economic threats to the U.S. from a more assertive China.

On her first visit to India last November, Treasury Secretary Yellen called for “like-minded countries” to work together to reduce the world’s dependence on “risky countries,” taking clear aim at China. Such statements play well on Capitol Hill, where members of Congress outcompete each other to show who is most disgusted by China. But they pose problems for many of America’s trade partners who do not share America’s desires to decouple.

Tangled Webs

The Biden administration inherited Trumpera policies intended to force China to clean up its predatory treatment of American intellectual property — patents, trade secrets and the like. The tariffs, which remain on two thirds of U.S. imports from China, were justified by the Trump administration not only by claims that American companies were forced to share technology as a condition of doing business there, but also as a means of reducing U.S. dependence on China for natural resources and some industrial products, and as payback for past unfair trade practices.

America’s list of China’s economic threats is long, but concern that it will dominate future “chokepoints” — supply nodes that can be used to restrict access to critical materials — drives current policy. And recent Chinese actions have only reinforced fears of economic coercion. Over the past few years, China has used its economic leverage to retaliate against perceived slights from more than a dozen countries, slapping on tariffs and negating long-standing trade relations. Last October, the Biden administration deployed chokepoints of its own to forestall Chinese hightech development, banning exports of advanced semiconductors and the equipment needed to make them.

Although it features prominently in the press, America’s “tech war” with China is only part of the wider effort to reshape U.S.-Sino trade relations. The White House is determined to reduce future dependence on China through “reshoring” and “friend-shoring” of the activities that supply American markets. The goal of moving supply chains away from China now guides U.S. trade and investment policies, its economic relationships with allies, and its refusal to restore the World Trade Organization’s authority to act as an effective arbiter of trade disputes.

As the world’s most innovative economy and its largest importer — American merchandise imports exceeded $3 trillion in 2022 — the United States has many levers to move global supply chains. A review of these tools shows, however, that while some can be used effectively at least in the near term, none comes without substantial economic costs. There are also profound consequences of this campaign for U.S. global leadership.

America’s efforts to restructure global supply chains reflect a fundamental rethinking of how the global trading system should work. No longer willing to abide by WTO treaty norms, especially non-discrimination against other members, the U.S. is leading the formation of exclusive trade and investment networks. Other countries also seek to reduce dependence on China and are eager to capture market share it loses. But they still resist U.S. efforts to force them to decouple from China.

The Usefulness of Trump’s Trade-War Tariffs

The Biden administration has left untouched the Trump-era tariffs levied in 2018 and 2019. This failure to reform Trump’s tariff policies, which represented an about-face from decades of U.S. commitment to rules-based open global trade, surprised many who followed the Biden campaign’s cogent criticism of the former president’s approach. However, since rearranging supply chains and making them less vulnerable to geopolitical tides is a priority for the Biden White House, retaining the Section 301 tariffs gives the administration broad discretion in responding to perceived injuries and provides a ready-made tool for altering U.S. trade patterns. Tariffs on China, which still average 19 percent, have helped to reduce its share of U.S. goods imports from 22 percent at the start of the trade war to only 17 percent by the end of 2022.

This reduction in China’s share of the U.S. market has caused considerable economic harm to U.S. interests — costs that now seem to have been forgotten in the rush to remake U.S.-China economic relations. To date, U.S. Customs has collected $167 billion in duties on imports from China subject to Section 301 tariffs, which amounts to a hefty tax on U.S. businesses and consumers, as shown by several detailed studies of U.S. import prices. This sum, it’s worth noting, dwarfs revenue collected under Trump-era scattershot trade actions that also hit targets ranging from Canada to Turkey to the EU as well as China. And, incredibly, Americans continue to pay these import taxes while 2022 U.S. imports from China will exceed the value purchased in 2018, when the trade war began.

Because the largest share of U.S. imports from China are “intermediate goods” — goods, like engine parts, used to make other goods — these tariffs make U.S. businesses that rely on inputs from China less competitive against their foreign rivals at home and abroad. An analysis by Kyle Handley (Michigan), Fariha Kamal (U.S. Census) and Ryan Monarch (Federal Reserve), using detailed information on the activities of American manufacturers, found that Trump-era tariffs lowered export growth for those exposed to them, with an effect equivalent to a 2 percent to 4 percent tariff levied on their foreign sales. And there’s no reason to believe these tariffs are currently less damaging.

While hurting U.S. exports, tariffs do not often result in “reshoring” — that is, returning production (and jobs) to the United States. A recent study by the Peterson Institute for International Economics found that trade subject to the Trump tariffs was diverted away from China toward Mexico and other parts of East Asia, not to Detroit or Seattle or Dallas.

Mr. Biden has made the notion of “democracies versus autocracies” an organizing principle of his foreign policy. Unfortunately, in a world with low barriers to trade, blocking an autocracy from participation in one’s supply chains does not imply that democratically governed economies will take its place. Indeed, one of the ironies of the U.S.-China trade war is the bonus it has provided to Vietnam, an economy guided by the country’s communist party. Vietnam’s share of exports to the U.S. increased markedly after the levy of tariffs on Chinese goods including footwear and apparel. Adding to the irony, the shift was less than what it appears: these Vietnamese- labeled goods undoubtedly contain Chinese content, and some are made in Chinese- owned factories.

Most striking is Vietnam’s emergence as a site for multinational electronics manufacturing. Following the start of the U.S.-China trade war, China’s share of U.S. imports of electronics fell rapidly, losing 10 percentage points in four years (see figure below). Over the same interval, Vietnam’s share of the U.S. electronics import market rose by six points.

The shift of manufacturers to Vietnam is even more dramatic in specific products. Before the trade war, China provided 51 percent of U.S. imports of broadcasting equipment, almost 19 times the share imported from Vietnam. By 2020, China’s share had fallen to 39 percent, while Vietnam’s share had ballooned to 11 percent. An important reason for Vietnam’s success in raising its U.S. presence is its ongoing market reforms and opening to foreign investment. Perhaps the U.S. would do well to focus on whether traded products are made under competitive market conditions rather than under systems of government other than our own.

Strikingly, not one U.S. trade partner joined the American effort to change China’s ways by blanketing China with tariffs. While China’s share of U.S. imports fell, the rest of the world maintained normal trade relations with the export giant. China’s share of world manufacturing exports actually rose, reaching 19 percent in 2020, up from 18 percent in 2017. Clearly, the trade war failed to move the needle on global supplies.

Redirecting Semiconductor Supply Chains

Semiconductors are the poster child for economic chokepoints. The geographic concentration of fabrication plants, or “fabs,” has been identified as a threat to long-term U.S. access to chips. Because about 70 percent are manufactured in Asia — including almost all of the most advanced chips — many fear that conflict in the region would prevent Western access to the semiconductors that have become critical to modern life. Finding this situation untenable, the U.S. passed the CHIPS and Science Act in August 2022 with the aim of increasing investment in domestic semiconductor manufacturing capacity. The bill includes over $50 billion in subsidies for construction of new onshore fabrication facilities, with Micron and Intel among those announcing plans for new U.S. fabs.

While working to reduce U.S. reliance on Asian manufacturing, the U.S. has also made use of its own chokepoints in the semiconductor industry. In October 2022, the Biden administration announced unprecedented controls on sales to China of high-end chips used in artificial intelligence and supercomputing along with chip design software and semiconductor manufacturing equipment. These controls represent a far-reaching effort to alter not only today’s shipments of advanced semiconductors, but to ensure that China is cut off from advanced industrial supply chains for years to come.

There’s no free lunch here, though. Efforts to reduce reliance on Asian chip fabs and to deny China access to American-made chips and equipment come with costs and risks. In addition to the money spent on direct government subsidies to new fabs, the U.S. may pay permanently higher prices for semiconductors made domestically or by non-Asian suppliers. Executives from Taiwan Semiconductor Manufacturing Corporation, which is now tooling a $12 billion semiconductor plant in Arizona, have been clear that the higher cost of building and operating the plant in the U.S. will filter into future chip prices. The Taiwanese market leader is now planning its next Arizona plant, which will produce 3-nanometer chips — the advanced chips export controls now seek to restrict — at an estimated cost of $28 billion.

Not surprisingly, not everyone is eager for initiatives that drive up the costs of advanced computing. America’s unilateral export controls have provoked pushback from allies, some of whom are being blocked in efforts to sell chip-design technology and manufacturing equipment to Chinese customers. The Biden administration continues to persuade the Dutch and the Japanese, makers of key elements in the semiconductor supply chain, to join the control regime, but to date the U.S. must rely on extraterritorial enforcement through sanctions to prevent sales to China.

Europe appears set to oppose the aggressive approach to technology decoupling taken by the United States. At the January 2023 World Economic Forum’s Annual Meeting in Davos, French Minster for the Economy and Finances Bruno Le Maire pushed back, arguing that “China cannot be out, China must be in.”

U.S. semiconductor subsidies and its new export controls work together to form a “herebut- not-there” strategy for chip manufacturing. In a world of dizzyingly complex supply chains, it’s difficult to see how such a strategy can be successfully applied to more than advanced chips. Major technology-producing countries rely on each other for different stages of production and for different varieties of the same type of good. The United States currently exports high-value chips and imports low-value chips, so removing China from supply chains would require the U.S. to prioritize basic chip production at the same time it is ramping up advanced chip production.

In short, subsidizing new fab plants at home and blocking exports of advanced chips to China will alter America’s semiconductor supply chain — but export controls offer an incomplete template for reordering the lion’s share of global flows of these globally produced commodities. In time, global players that don’t share the Biden administration’s priorities will find a way to work around U.S. technology and markets.

Friend-Shoring: Creating a Future with Exclusive Trading Clubs

Although it is unwilling to negotiate new trade deals, the Biden administration sees economic agreements focused on labor, environment and governance standards as a tool for shaping the future of global supply chains. The newly launched Indo-Pacific Economic Framework is the clearest expression of this strategy, as it aims to build a circle of “friends” who commit to American values on labor and the environment and share American aspirations for greener and fairer economic outcomes.

For the United States, IPEF is a second chance to achieve some of what was lost when Donald Trump pulled the plug on the Trans-Pacific Partnership, a Pacific-rim economic alliance whose downside seems to have been the fact that it was an initiative of the Obama administration. The Biden administration wants to bolster American military presence in the region with deeper economic ties. But IPEF has a second utility: it’s a mechanism for an end-run around China’s manufacturing capabilities. Using commitments to high standards for how goods are designed and new rules for how they are produced, the U.S. hopes to build an alternative to the TPP that China will never be allowed to join.

With much of its domestic coalition opposed to new international economic agreements, the Biden Administration hopes that transfer of its domestic priorities to IPEF negotiations will appease those who see anything that smacks of globalization as a loss for the United States. The White House has designed an effort that is free of new market opening, binding commitments, or even a whiff of U.S. concessions. Unfortunately, the lack of any meaningful U.S. concessions makes the IPEF a hard sell in developing Asia.

South and Southeast Asian nations are eager for deeper economic engagement with America. However, without some tangible reward for meeting U.S. demands and no obvious cost of failing to do so, leaders in these countries have little leverage to overcome their own domestic opposition to the “high standards” envisioned for IPEF that are certain to increase production costs. Equally important, U.S. rhetoric and demands for friend-shoring threaten to upset the delicate balance the region has achieved between reliance on the American security umbrella and trade/investment ties to China.

China is the first or second most important trade partner for all IPEF countries, as seen in the figure at right. Indeed, 11 of the 13 countries joining IPEF negotiations with the United States are already members of the ASEAN-led Regional Comprehensive Economic Partnership (RCEP), which features a platform for economic cooperation as part of its mandate. Through RCEP, almost all IPEF partners are members of a free-trade agreement with China. Generous rules of origin contained in RCEP encourage development of value chains among its members.

A key question for IPEF, then, is whether the agreement will constrain the partners to source inputs only from other IPEF “friends.” By eliminating China as a source of intermediate goods, participants in IPEF would risk degrading their export competitiveness. If the U.S. were offering preferential market access to those who friend-shore, taking on new obligations that raise production costs to serve U.S. buyers might make economic sense. And the U.S. may ultimately feel obliged to make concessions of this sort — probably not through preferential tariffs but through rules that restrict the products that can be brought into the U.S. market, or through price mechanisms, such as carbon border taxes, that reward “friendly” green producers.

Reordering the Global Order

The rules-based international trade system as we know it is on the endangered list. With China seen as willing to subsize its industries, block imports and steal technology, playing by WTO rules looks like a sucker’s game to many Americans. U.S. diplomats still pay lip service to the importance of the system, but the Biden administration continues to block the appointment of new WTO appellate judges needed to enforce WTO rules — as did Presidents Obama and Trump. The negative U.S. response to the recent WTO ruling on former President Trump’s steel and aluminum tariffs — in which national security was found to be inadequate, in this instance, as a basis for trade restrictions — makes clear that America no longer intends to abide by WTO rules that interfere with its geopolitical objectives.

In its place, the U.S. is building an economic system designed to satisfy its goal of restricting trade with China. Trump-era trade-war tariffs continue to tax U.S. imports. U.S. semiconductor-related exports are now subject to powerful controls, with the promise of additional controls on advanced tech sales to come. And the U.S. has turned to Asia, the region most deeply intertwined with the Chinese economy, to create a future network of “like-minded” friends.

The costs of this pivot away from a multinational trading system built on nondiscrimination have yet to be tallied. For some, China’s authoritarianism at home and bellicose behavior abroad demand that the U.S. develop a new, exclusionary framework. In this view, the price of inaction is too high, so the demise of the WTO should be seen as unavoidable collateral damage. The path forward is thus clear: reduce economic exchange with China as quickly as possible.

The problem here is that even if the U.S. succeeds in dropping China from its supply chains, the latter will almost certainly remain the world’s largest exporter and second largest importer. Without the support of allies and partners, the U.S. cannot be successful in doing more than isolating its own market.

U.S. allies and partners are not prepared to decouple from China under current conditions. Chinese intermediate goods will be built into the products they sell, their exporters will seek to profit from the Chinese market, and their multinationals will continue to invest in China. U.S. production will be burdened by its isolation from least-cost suppliers and thereby hindered in its ability to remain competitive in foreign markets.

The U.S. urgently needs to clarify the extent to which it intends to remove Chinesemade goods from its supply chains (including those that funnel Chinese inputs through the factories of our trading partners). And if the goal is containing an aggressive China, clarification won’t be easy.

For much of what the world buys from China has little connection to high-tech competition and is made in privately owned factories with little connection to the Chinese state. Indeed, a healthy private sector may prove the only effective buffer against increasing authoritarianism from Beijing. Is the U.S. truly better off if it alone turns to higher-cost suppliers for these products?

So far, the Biden administration seems set on its path — trade with trusted partners! — but not how far down the road it wants to go in excluding China. The White House has said that the U.S. does not want to truly decouple economically from China, yet U.S. actions on 5G telecommunications equipment and now semiconductors send a different signal. The result is heightened uncertainty for international businesses as they plan where and how much to invest.

President Biden has made consultation with allies a hallmark of his foreign policy. Such consultation is imperative when the U.S. needs the support of partners who see economic relations with China in a different light.

The U.S. and EU have created the Trade and Technology Council (TTC), a coordinating platform that proved useful in crafting a collective response to Russia’s invasion of Ukraine. But the TTC is also a natural venue for the U.S. to coordinate beyond sanctions and export controls. It could be used as a platform for clarifying where dependence on trade with China puts our economies at risk. The EU and the U.S. could also use the TTC to coordinate the search for alternative suppliers. And if new sources need to be created, the TTC could help the U.S. and the EU avoid a subsidy war with each reaching to grab whatever jobs China-proofing their economies will create.

Lastly, the U.S. would be wise to reconsider the role of standards as a mechanism for keeping China out of new trade arrangements. China will be able to meet many labor and environmental standards, including the “decarbonization” of production, sooner than many developing countries that the U.S. would like to include in its exclusive trade clubs. Better to declare up front that China is not welcome than to pretend that they’re ineligible because they can never measure up to our standards.

By the same token, positioning high standards as an aspirational goal for U.S. supply chains rather than the price of admission would create a setting more welcoming to poorer countries that do not currently meet them. Although developing countries may desire the fair working conditions, clean environments and digitally enabled trade being promoted by the U.S. in its IPEF initiative, they differ in how far and how fast they will be able (or want) to commit to American standards. If the IPEF is to bear fruit, the U.S. must aim at building a trading network that does not yet exist rather than asking potential partners to meet standards that do not fit their current circumstances.

As the multilateral trading system frays, the United States has begun to build a new system that suits its current priorities. At the top of this list is reducing China’s role in U.S. supply chains. But current rules codified by the WTO hinder the creation of a network reserved for the “like-minded.” And so far, the U.S. is not carrying its friends along on the journey. Unless Washington tempers ambitions for isolating China, the U.S. risks isolating itself instead. This would represent a failure of leadership that would weaken American competitiveness and leave our friends and allies more — not less — dependent on Chinese markets.