Poking China’s Achilles Heel by Withdrawing Foreign Capital

Against the backdrop of its strengthened national power, China is pursuing a hardline foreign policy.

By Ryoichi Hamamoto

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Against the backdrop of its strengthened national power, China is pursuing a hardline foreign policy. However, there is a word Xi Jinping’s leadership hates as much as the word “coronavirus.” It’s “decoupling ” or “tuo gou” in Chinese. It’s a word that the U.S. started using against China. On August 23, 2019, then President Trump, a champion of hostility toward China, called on American corporations to flat out withdraw from the Chinese market via his Twitter account.

“We don’t need China and, frankly, would be far better off without them. The vast amounts of money made and stolen by China from the United States, year after year, for decades, will and must STOP. Our great American companies are hereby ordered to immediately start looking for an alternative to China, including bringing your companies HOME and making your products in the USA,” he posted. He didn’t use the word “decoupling” but that is what he essentially meant.

At that time, the U.S. and China were in the middle of trade negotiations (from spring 2018 to January 2020), and Trump, frustrated by China’s attitude, used the threatening remark as a trump card. It was not a realistic concept to base policy on.

Later, on Labor Day in September 2020, Trump said at a press conference: “When you mention the word decouple, it’s an interesting word.” “We lose billions of dollars and if we didn’t do business with them we wouldn’t lose billions of dollars. It’s called decoupling, so you’ll start thinking about it,” But that was no more than rhetoric.

No Unified View within the U.S. Government

As is well known, it was Steve Bannon, the former White House chief of staff who was dismissed on August 17, and Peter Navarro, then top trade advisor to Trump, who suggested the decoupling theory against China. Navarro, an ultra-hawk, told Trump that China has skillfully launched an economic war with the U.S. by subsidizing exports while curbing U.S. imports. He argued that tariffs were the most effective way to force Beijing to change.

The idea came from his hardline stance that would not rule out decoupling from China. Trump liked and thought he could use this idea.

Meanwhile, then vice-president Mike Pence said in his second speech in the fall of 2019, “People sometimes ask whether the Trump Administration seeks to ‘decouple’ from China. The answer is a resounding, ‘No.’” As such, there was no agreement within the administration.

To begin with, decoupling theory is a broad concept. It raises the question of whether to disconnect from China in every aspect. This is obviously not realistic. So in which area could the country possibly decouple from China? The targeted area changes everything. In the end, the U.S. decided to shut out major Chinese companies such as Huawei in the high-tech field, which is important for the country’s IT strategy. It was a move that decided the fate of the IT hegemony that covered the 5th generation (5G) mobile communication system.

Ultimately, Trump and Pence were not reelected, and it seemed that the decoupling theory was going to die down.

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President Biden’s Sudden Change in Attitude

The Biden administration, which was launched in January this year and was supposedly against Trump policies, had fully succeeded the former administration’s stance against China. On February 24, Biden signed an executive order that included a 100-day review of the supply chain of four important items, including semiconductors and batteries for electric vehicles. Although it did not name China, it was an action taken out of the administration’s concerns over China.

The current administration is following suit in terms of the high tariff imposition measures and is not showing any intention of withdrawing them. The administration must have read that the hardline stance against China was a good card to use to repair the American society, which continues to be divided between Biden and Trump factions. Biden, whose son Hunter had been embroiled in a China money scandal, had switched his position like the veteran politician he is.

On the other hand, one cannot deny Biden’s lukewarm position as he also seeks cooperation with China on issues such as climate change. China sees weakness on the part of the administration and is resuming its aggression in the South China Sea with the Philippines in mind. The consequences of the Biden administration’s attitude toward China need to be followed closely.

Getting down to the bedrock of things, in response to the Biden administration’s stance toward China, China has stiffened its attitude toward the U.S. Although the new U.S. administration has not chanted decoupling loudly, it is building a siege against China on issues surrounding Hong Kong, Uygur, and Taiwan through collaboration with Japan and its European allies.

Just like money is vital for the economy, and energy for living things, the balance of power is imperative to international politics. China is desperate to resist the U.S.-led anti-China trend, as it is particularly sensitive to tactics and schemes that have been part of its traditions since ancient China.

Xi Jinping’s Repeated Resistance

On April 20, around the time when the world was suffering from the fallout of the new Covid -19 variant that emerged in India, Chinese Premier Xi Jinping made a video appearance at Boao Forum for Asia (BFA AC 2021) held in Hainan Island, China. In front of an audience made up of businesspeople from all over the world, he criticized the U.S. by saying: “In this age of economic globalization, openness and integration is an unstoppable historical trend. Attempts to “erect walls” or “decouple” run counter to the law of economics and market principles. They would hurt others’ interests without benefiting oneself.”

Presumably, by “others,” he meant the U.S., and by “oneself,” he meant China. It is the characteristics of Chinese culture to decide right and wrong ultimately by whether something is economically profitable.

Xi also gave an online speech at the Asia-Pacific Economic Cooperation Forum (APEC) leaders’ summit, saying: “China is already deeply integrated into the global economy and the international system. We will not reverse course or run against the historical trend by ‘decoupling’ or forming a small circle to keep others out.”

At the World Economic Forum in Davos, Switzerland on January 25, he said, “To willfully impose decoupling, supply disruptions, or sanctions, or to create isolation or estrangement, will only push the world into division and even confrontation.” He referred to decoupling for the second time by saying, “It serves no one’s interest to use the pandemic as an excuse to reverse globalization and go for seclusion and decoupling.”

These remarks reflect Xi’s strong desire to wipe out the idea of ​​decoupling that arose during the Trump administration. On May 23, 2020, a little over four months after the U.S. and China finally reached the Phase One trade deal, Xi spoke at the third National Political Cooperation Conference. He referred to domestic and international “dual circulation.”

The intention was to reduce the global economic dependence centered on the U.S. economy and set domestic demand (domestic consumption) as the pillar of economic development and combine foreign demand (trade and investment), to transition the country to a “dual-circulation” model. From his second year in office, Xi has called for deepening of reform and opening up, starting the country on a structural reform route and a shift to a domestic demand-led economy, so it was a reasonable change of course.

In addition, Xi pulled up a reference to the “endurance war” used by Mao Zedong in the Yan’An era to win the anti-Japanese war. By comparing the war with the trade pressure from the U.S., Xi had a motive to manipulate the public into supporting the “dual circulation” strategy. China’s strategy of keeping a distance from the U.S. will continue for the foreseeable future, as China guards against its conflict with the U.S. that is likely to continue under the Biden administration.

Like Xi, Premier Minister Li Keqiang raised decoupling in an online meeting with the CEOs of major U.S. companies on April 13. He said problems that occur in cooperation should be resolved through cooperation and insisted that “‘decoupling’ does no good to either side and will hurt the world.”

Foreign Minister Wang Yi who is a champion of China’s hardline “wolf warrior diplomacy,” has appealed for the elimination of the concept of decoupling in an online meeting with German Foreign Minister Maas on April 21. Wang brought up the fact that China has become Germany’s largest trading partner for five consecutive years.

He pointed out that China and Germany’s trading volume increased amidst the pandemic. The two countries should oppose the so-called “decoupling” together, and jointly keep the global industrial and supply chains smooth and stable, he said.

Xi Administration Cannot Do without Foreign Capital

It is apparent that Xi, Lee, and other members of the party’s highest class Politburo Standing Committee (PSC) in charge of foreign affairs are standing decisively against decoupling. Why do the highest leaders hate decoupling? This is because they recognize that capital and technologies from Europe, U.S., and Japan are indispensable for China’s economic development.

Even now, 43 years after the reform and opening-up of China that started in 1978, China cannot do without foreign capital and technologies. Although China should have already accumulated a considerable amount of technologies and know-how, they still need foreign companies in order to continue to promise economic development, which is the basis for the legitimacy of the Communist Party. The concept of “decoupling,” had brought to light the party’s distorted deep psychology.

If so, Western nations including Japan should urge China to correct its hardline wolf diplomacy and call for more active acceptance of scientific research into the origins of the coronavirus in Wuhan, China. Poking the Achilles heel a little bit should be a good policy.

In reality, however, the U.S. is far from decoupling. According to the latest data from China’s commerce ministry, the number of U.S. companies that entered China during the Trump era was 1,346 in 2017, 1,750 in 2018, and 1,733 in 2019, pointing to an upward trend. The numbers are large compared to the Obama era (1,500 to 1,100 companies).

Investment volume also increased by 2.65 billion in 2017, 2.69 billion in 2018, and the same amount in 2019. The volume of investment is not decreasing and many of the years recorded increases compared to the Obama era.

In other words, while the U.S. and China were loudly fighting a trade war on the surface, they were quietly deepening their mutual economic penetration. China, which has cheaper though rising labor costs and well-maintained infrastructure, remains an attractive market for many U.S. entrepreneurs, not just multinational corporations. Sino-U.S. relationship is unfolding in these two conflicting realities.

In February of this year, the U.S. Chamber of Commerce and Industry published the “US-China Decoupling Report,” summarizing measures that can be taken by the business community to respond to the U.S.-China conflict which has no prospect for improvement. It called for the U.S. to calculate the best level of economic involvement with China.

For example, if a U.S. company cuts its investment in China by half, and if the U.S. and China impose an additional 25% tariff on each other, the U.S. gross domestic product (GDP) will decrease by 190 billion in 2025. It will decrease by 250 billion in 30 years. The U.S. GDP would decline at a significant rate annually.

Just the U.S. semiconductor industry, which has the world’s largest sales profit and R & D., would lose 83 billion USD in profit and lose 124,000 jobs (There is a total of 250,000 jobs in the industry and 1 million jobs in related industries.) In addition, if we were to completely shut out Chinese travelers and students, the economy would lose 30 billion USD, according to the report.

The report points out the importance of such forecast data analysis and calls for policymakers to minimize damage from decoupling as it is expected to be enormous in scale. The U.S. Chamber of Commerce also exchanged views with the Japan Business Federation on March 23.

Japan-China Partial Decoupling

Next, let’s take a look at the status of Japanese companies expanding into China. In 2017, 590 Japanese companies entered the Chinese market, with 3.3 billion USD in invested capital (based on implementation). In 2018, the number was 828 companies and 3.8 billion USD in investment, and in 2019, it was 1,000 companies and 3.7 billion USD in investment.

Although the number of companies is less than that of the U.S., the investment amount is about 20% to 40% higher than that of the U.S. Japan seems to be affected by the fact that the investment cost in manufacturing is nearly three times that of the U.S. and it has many wholesale and retail sectors that do not exist in the U.S.

In any case, the deep relationship between Japan and China is not limited to economic fields such as investment and trade but is far deeper than that of the U.S. in terms of history, culture, and flow of people. According to the data from the Ministry of Commerce of China, the number of Japanese companies that have expanded into China is 52,834, and the number of U.S. companies is 71,914 (both cumulative as of 2019).

Since the pandemic started last year, the panic situation caused by the lack of masks and sanitizers throughout Japan had made the Japanese painfully aware of the danger of depending on China for life-saving medical supplies. Chinese authorities easily seized masks produced under commissioning contracts at their discretion and suspended their exports to Japan. To put it strongly, through the pandemic, the Japanese witnessed China yet again reveal its true nature.

Japan has achieved a remarkable change since then. The Abe administration at the time was forced to think about the concept of decoupling.

The Ministry of Economy, Trade, and Industry (METI) launched the “Program for Promoting Investment in Japan to Strengthen Supply Chains.” It received applications from May 22, 2020, through July 22, of the same year. Of these, 75 applicants were chosen for the advanced evaluation.

Under the program, which targets companies regardless of their size, the government provides grants to set up plants in Japan. The plan covered two categories: the building of a production base for goods crucial for people’s wellbeing, and the building of a production base to reduce the risk of supply disruptions of products and materials that have a high degree of concentration.

In the former category, the intended recipients of the grants included various masks such as non-woven, high-performance, and surgical ones, high-concentration alcohol for detoxification, Covid-19 test kits, medical face shields, acrylic partition plates, rubber gloves, X-ray equipment, and infection prevention equipment, which were all in short supply.

The latter category covered: turbine blades for aircraft engines, molds and plastic parts for automobiles, steel plate transmission parts, metal stamped products, IC trays for semiconductors, wafers for power devices, medical pharmaceutical ingredients, agricultural chemicals, dust collectors, down comforters, etc.

According to METI, the third-party committee chose companies from Hokkaido to Shikoku and included a range of small to large enterprises. A total of 75 companies received about 57.4 billion JPY. On average, a company received 765 million JPY, although grants depended on the size of the company. In some cases, companies have begun the construction of plants and would receive grants after completion.

METI Model Mechanism

The problem with the project is that there was no prerequisite for the targeted companies to have overseas operations. In other words, this was not a project intended to support the closures of factories in China and other countries and relocate them back to Japan. The project’s purpose was to support domestic supplies of products, parts, and materials necessary in times of emergencies. METI must have been aware that if it had promoted withdrawal of overseas operations, this could have caused diplomatic problems.

Initially, it was reported that the Chinese embassy in Japan and the Chinese Ministry of Foreign Affairs were concerned about the project. But it has not become an issue because it was purely a measure to support domestic production.

Indeed this method will promote Japan’s diversification and strengthening of supply chains through restructuring, and will ensure the country’s “strategic independence”(a proposal by LDP’s Policy Research Council and New International Order Creation Strategy Headquarters). The initial budget for this project was 247.8 billion JPY. It was flooded with applications from 1,670 companies, of which 146 were carefully selected.

Due to its popularity, METI opened a second call (total grant of 86.6 billion JPY). Considering the economic scales of Japan and China, METI may be open third and fourth calls.

This METI model may have the potential to evolve unexpectedly. Although diplomatic consideration was prioritized at the project’s inception, there may be a way to gradually narrow down candidates to companies with overseas operations. Alternatively, it may be possible to give priority to such companies.

If companies judged that it is not economically reasonable for them to manufacture the same products and parts both domestically and overseas, this may inevitably lead to a trend to withdraw from overseas operations and to return manufacturing to Japan.

There is an urgent need to restructure and establish supply chains that are resilient to risks for strategic high-tech fields such as semiconductor production. It is reasonable to have an idea to gradually revise the project with a medium-to-long-term perspective. However, this would not be run by METI but would be led by the economic team of the Japan National Security Agency (NSS), which plays a commanding role in economic security. Such a project would have a highly strategic importance that would lead to more stratified and complicated Japanese diplomacy.

This article is a translation of the Japanese article published in the July 2021 issue of Seiron magazine.

Ryuichi Hamamoto
Born and raised in Nagoya City. Graduated from Tokyo University of Foreign Studies and majored in Chinese and International Relations in 1976. Served as China bureau chief and editorial writer at Yomiuri Shimbun. Served as a part-time professor at UC Berkeley Graduate School of Journalism and professor at Akita International University. Become a freelance journalist in April 2020. Has been a contributor to Toa monthly magazine focusing on contemporary China, for over 13 years.

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