US-China Decoupling Negative for Emerging Markets – Not Necessarily So

In the ever-evolving landscape of global economics and geopolitics, the concept of US-China decoupling emerges as a multifaceted phenomenon. It's a narrative painted with both challenges and opportunities for emerging markets. As we delve into this intricate tale, we find that amidst the tensions, there's a nuanced perspective to consider.

Picture a vibrant night in Hangzhou, China, where the 19th Asian Games commenced with a dazzling ceremony, showcasing the city's technological prowess. Hangzhou, home to the tech giant Alibaba Group, hosted this remarkable event. It's a stark contrast to the sombre backdrop of the Beijing 2022 Winter Olympics, held under stringent COVID conditions, which lasted for nearly three years from January 2020 until late 2022. President Xi Jinping's intent is clear: to proclaim China's continued economic leadership and its readiness for global business, even as supply chains seek new directions.

For over a decade, economic factors like labour costs and demographics have driven supply chains to seek alternatives to China. However, recent geopolitical events like the US-China Trade War, the pandemic, Russia-Ukraine tensions, and Taiwan Strait disputes have accelerated this diversification. What we see beneath the surface is not just strategic competition and supply chain security; there's a push for supremacy through industrial policies.

The US, for instance, introduced the CHIPS Act to incentivize domestic semiconductor production, followed by the Inflation Reduction Act (IRA) promoting green manufacturing in the country. Europe is treading a similar path. Trade liberalization initiatives favour non-China Asian countries, and the US IRA extends subsidies to Free Trade Agreement partners such as Chile, Mexico, South Korea, etc.

Economic factors, too, play their part. Southeast Asia, Latin America, and India, with their favourable wages and demographics, are emerging as prime destinations for diversifying production.

On a country level, South Korea shines as a non-China alternative at the top end of the supply chain. Prominently, South Korea has emerged as a pivotal ally in America’s pursuit of an energy transition, with more than a third of all manufacturing investments under the IRA going to South Korean firms. This includes Samsung SDI, LG Energy Solutions, SK Battery, and Hanwha Q cells. Over and above that, the US is expected to indefinitely extend a waiver granted to South Korea’s chipmakers Samsung Electronics and SK Hynix on the need for licenses to bring US chip equipment into China, preventing them from being caught in the crossfire of the US-China chip war.

Comparatively, Taiwan, which manufactures over 60% of the world’s chips, much of its dominance attributed to Taiwan Semiconductor Manufacturing Co., has the US and EU rolling out incentives to support a reshoring of chip production.

At the medium-tech level, Malaysia already has an existing semiconductor packaging supply chain, and Thailand has well-built automobile facilities. In labour-intensive manufacturing, India has reduced import tariffs and is beefing up investment with tax cuts and subsidies, while Vietnam has decent infrastructure, incentives, and aggressive trade liberalization. Accompanied with cost advantage and positive demographic tailwinds, India and Vietnam are quickly becoming the “China + 1” locations. India, in particular, has demonstrated initial success with its “Make in India” initiative, be it on its moon landing; its development of a 4+ generation fighter aircraft; or the assembly of the latest Apple iPhones in India. This is driven by the global competitive advantage of its technical skill set, a large potential pool of tech talents, and improving physical infrastructure across ports and airports.

Another key phenomenon in this disengagement process is nearshoring, in which US manufacturing companies move production closer to their bases and consumers in the US. Along with its obvious geopolitical advantages, Mexico offers a large, low-cost workforce and free-trade agreements with the US and EU. Indeed, Mexico has replaced China as the largest trading partner of the US this year, even while China remains the main supply source or consumer market. Hence, nearshoring is expected to be a long and sustained race that could help build new ecosystems in Mexico’s existing manufacturing hubs.

On the commodity front, Indonesia dominates nickel production, with a worldwide market share of 48% in 2022, while Chile's critical materials, especially lithium, draw attention. Brazil, with its abundant natural resources and agricultural products, also finds a niche in the reordering of value chains.

As these trends lead to a desirable economic outcome in the long run, there can also be winners in sectors and corporates because of the more powerful policy-driven forces for change. The green, critical materials, and tech sectors hold promise for the Asia-Pacific and Latin America regions. A US-led chip ban may redirect production as long as global chip demand persists. These regions are poised to seize the opportunities.

Sometimes, crises drive nations to greater strength. For instance, Beijing’s continuation to pour money into its chip industry in a tech race amid the US-China decoupling, appears to work. Huawei’s latest 5G smartphone, the Mate 60 Pro, armed with a 7-nanometer processor fabricated in China by the country’s top chipmaker, Semiconductor Manufacturing International Corp., offers proof that China’s homegrown chip industry is advancing despite the US ban on chips and chipmaking technology. No doubt that China is 5 generations behind in chip manufacturing due to US sanctions, but it is becoming increasingly aggressive in technological competition, which would imminently lead the nation to leapfrog the US.

Likewise, China is already leading the challenge to global incumbent automakers. Amidst Apple, Dell, HP, and several major US-based technology companies making plans to shift productions out of China, Tesla is actually bucking the trend by boosting auto production as well as planning to build a new mega battery factory in Shanghai. As a matter of fact, China exported 2.34 million vehicles in the first half of this year, overtaking Japan as the world’s largest vehicle exporter for the first time. China would play a similar role like Japan and South Korea did in 1979-90 but in the realm of electric vehicles, rivalling global peers with improving affordability, variety, and quality. In fact, China’s share of global electric vehicle exports has ballooned eightfold over the past five years, with EV maker BYD being a major driving force behind this trend as well.

In the grand tapestry of geopolitics, industrial policies, and economic drivers, the diversification of supply chains is set to continue. It may bring increased costs and disruptions, but it will also unveil winners among emerging markets and sectors.

In the end, the story of US-China decoupling is not one-dimensional. It's a tale of complexity, where nations and markets adapt, evolve, and find new paths amid the ever-shifting currents of global economics and politics.