CHINA’S WEB

VIVEK Y. KELKAR, MUMBAI

China’s domination of the world’s supply chains lets it call the shots—and the launch of the Indo-Pacific Economic Framework isn’t going to change that.

In 2005, Thomas Friedman proposed the Dell theory of conflict prevention: “No two countries that are both parts of a major global supply chain, like Dell’s, will ever fight a war against each other as long as they are both a part of the same global supply chain.” It was a 21st century update to the Golden Arches theory of conflict prevention: “No two countries that both have a McDonald’s have ever fought a war against each other.”

The Golden Arches theory has been debunked. Perhaps it won’t be long before the Dell theory is discredited, too.

Friedman and other liberal theorists of international relations argued that a globalized web of entwined and offshored supply chains, spanning vast realms, would create cost efficiencies and bigger profits. The cost of war would be economically prohibitive for all concerned. A capitalist peace, and a stable world order undergirded by liberal institutions, would prevail.

Such thinking allowed China, Taiwan, and other countries in East and Southeast Asia to emerge as heavily specialized, technologically consolidated, and cost-efficient producers of global goods—from footwear, computing, and mobile phones to critical hi-tech engineering and cyber technologies.

Friedman was partly right. Countries have maximized their comparative economic advantages through participation in the world’s deeply entwined supply chains. For individual firms, offshoring, geographic consolidation, and specialization have lowered costs. But mutual economic dependency among countries has now become a strategic weapon that threatens global order instead of buttressing it.

Trade officials once thought of China and Southeast Asia as key links for enhancing firm- and industry-level economic efficiency. But these are now contested zones. Within the region, China is the top dog. It dominates critical supply chains. It’s central to global manufacturing. The rest of the world’s inability to produce what China can creates supply problems during times of crisis—whether the needed goods are low-tech products like masks, in a pandemic, or the relatively more complex goods such as laptops, mobiles, electronics, or hi-tech engineering. This gives Beijing, with its hegemonic ambitions in Asia and arguably the world, the wherewithal to promote its own version of world order, one quite at odds with the earlier liberal, institutions-based system. China can now construct a foreign policy based on economic power.

THE SUPPLY CHAIN DILEMMA

US President Joe Biden launched the Indo-Pacific Economic Framework in Tokyo on May 23. One of its stated aims is to build supply chain resilience, meaning that the US and its allies would no longer depend on products from China, or other consolidated supply chain countries, during a crisis. A key, unstated aim is to counterbalance China’s economic and political influence in the region—an influence that Beijing has increasingly used as a weapon.

But is the IPEF—matched with alliances like the Quad—too little, too late? Is Asia already so enmeshed with Beijing that the effort amounts to throwing a pebble in the ocean?

Today’s supply chains are complex. Two decades ago, perhaps, low labor costs were paramount in locating supply chains. But today’s complex, hi-tech products require a logistics infrastructure to move raw materials, components, and finished products from one destination to another, at the lowest possible cost, just in time. Reliable logistics networks ensure reliable delivery. Delivery reliability is now a critical component of quality, vital to price and profit.

Pools of skilled labor—people familiar with advanced manufacturing processes and technology, years of accumulated knowledge, and capable of adapting to rapid product innovation—have developed around manufacturing hubs in countries like China. This makes it difficult for firms to relocate to other countries.

These advantages are not easily recreated in other Southeast Asian or Latin American destinations, and they assume greater importance the further one goes up the technology complexity ladder. Manufacturers of advanced pharmaceuticals or innovative semiconductor-based products, for example, are deeply reliant on a labor force with the skill and knowledge required to develop and introduce new products. These ecosystems are key to the product’s total cost, and therefore firm profitability.

China’s manufacturing hub support ecosystem, with its local and global infrastructure links, got a head start nearly two decades ago. It’s where it is today thanks to massive government support and capital investment. To recreate this would take time, money, and the kind of investment only countries like the US can make. Firms don’t have an incentive to build this sort of infrastructure or develop the talent pools required to make shifts easy; they cost too much and disrupt firm-level economics.

CHINA’S REGIONAL NETWORK

China is investing in regional networks that will allow its own firms to build their own component and product chains and retain their clout. In recent years, China has augmented its influence in Asia not just by means of its economic heft but with its centrality to global manufacturing; supply chain links with countries such as Vietnam, Taiwan, and Indonesia; and trade pacts.

China’s homegrown firms like Luxshare are vital to manufacturers like Apple. But Luxshare has created its own supply chain, leveraging its links with Apple, by building plants to manufacture relatively simple products like Apple’s Airpods in neighboring Vietnam. It’s a cost-efficient mix that’s difficult to recreate.

Taiwan’s Foxconn is another example. Foxconn is the world’s largest manufacturer of electronic and technology components. It has no brand of its own, but it’s one of the most important suppliers to the world’s IT industry, and it has considerable R&D and engineering skills. Over the last decade, Foxconn has found it profitable to move some of its key manufacturing and process engineering knowledge to China, despite Beijing’s threat to Taiwan’s sovereignty. Foxconn is now firmly entwined within China’s global supply chain web.

If IPEF aims to enable its Southeast Asian signatories to develop as alternative hubs to China, it requires quite a different strategy. These Southeast Asian countries don’t have China’s technology-enabling infrastructure and talent pool, nor do they have the land, road, and sea links that China enjoys to global markets. The US has not invested as much in the region as China has. Washington is thus at a distinct disadvantage in the region.

CHINA’S INVESTMENT EDGE

China has steadily been making the kind of investments in the region that the US has been reluctant to make. The US favors Bretton Woods institutions such as the IMF and the World Bank. China has used its own banking system to finance infrastructure throughout Southeast Asia.

In the last decade alone, Beijing has invested nearly US$780 billion in the region, building infrastructure linked to the controversial Belt-and-Road Initiative. With the BRI, China has been offering Southeast Asia a carrot of essential low-cost regional road and rail connections, as well as a link to China and onward to Europe.

Trade needs efficient infrastructure, but it also needs low tariffs. When the US, led by Donald Trump, failed to ratify the Trans-Pacific Partnership in 2017, it missed a massive opportunity. The other countries involved in the TPP went ahead and signed the Comprehensive and Progressive Agreement for Trans-Pacific Partnership in December 2018, just a month after China had lured much of East and Southeast Asia into the Regional Comprehensive Economic Partnership.

These two trade agreements, along with the two-and-half decade-old Association of Southeast Asian Nations, comprehensively connect the countries of the region with pacts, linked to tariffs, throughout Southeast Asia and the key economic engines of the region—China, Japan, and South Korea.

China is not a part of either ASEAN or CPTPP, but Beijing has smartly tied much of the region into the RCEP, building a competitive advantage for itself anyway. RCEP came into force only in January this year, but data for the first quarter of the year shows that China’s trade with the RCEP member countries expanded 6.9 percent year on year to around US$448 billion.

The IPEF has broadly desirable aims: supply chain resilience, unified digital economy rules, clean energy, infrastructure, low taxation, and countering corruption.  The digital economy requires liberal, institutions-based leadership of the kind only the West can provide, lest it becomes a tool for the CCP. But as envisaged today, the IPEF offers few immediate economic incentives to Asia, without comprehensive trade pacts, tariff clarity, and access to US markets.

So, the IPEF’s launch might have been a PR victory for Biden and his team, but as it’s structured, it’s little more. The US requires Congressional ratification for trade pacts with tariff advantages, which is why Biden kept trade rules out of the agreement. US domestic politics render low trade tariffs with Southeast Asia a virtual non-starter, at least in the near term.

China is also very aware that emerging technologies such as advanced robotics, or additive manufacturing that combines 3D printers with computer-aided design and manufacturing, may diminish its supply chain power. These technologies, coupled with the Internet of Things, artificial intelligence, robotics, and 5G, offer such advantages as virtually on-site component fabrication. This will decrease the geographic spans of today’s supply chains, and eventually drive the reemergence of onshoring in advanced economies like the US, France, and Germany. Supply chains will be partly or fully repatriated to nations and regions. But these technologies don’t yet offer the cost-benefits or the investment efficiency ratios that firms demand. That could take the rest of this decade or more. China is now in a headlong race with the West to develop and own these technologies, but that’s another story.

Right now, as it stands, it’s Advantage China.

Covid19 prompted a great deal of rhetoric about resilience. But at the firm level, supply chain resilience requires a lot more. Resilience also means ecosystems that consistently deliver cost benefits. Covid caused disruptions to the China-based supply chains, but in 2021—before the 2022 Covid19 crisis hit Chinese cities—China displayed a remarkable ability to bounce back and rebuild manufacturing volumes, giving a great deal of confidence to the multinationals based there. Yes, this may be attributed to its authoritarian system, but that system has been a part of China’s success story all along—and it is why global supply chains moved there in the first place.

China’s web of globally linked supply chains is not going to be dismantled easily—not in this decade, at least. If the liberal world seeks to blunt Beijing’s accruing geoeconomic weapons, it will need quite a different approach. Halfhearted approaches like the IPEF won’t cut it.

Vivek Y. Kelkar is the co-founder and editor of the Cosmopolitan Globalist.

1 Comment on "CHINA’S WEB"

  1. Thank you, Vivek. I appreciate the analysis.

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