As the world economy starts to rebuild after the devastation of COVID-19, China continues to play an outsized role in the global recovery, although its relative dominance will likely subside as western economies begin their economic comeback. While China, like other economies that faced disruptions arising from the onset of the COVID-19 pandemic, experienced the shock of negative growth early in the outbreak as production and shipping were shut down, it quickly recovered. According to the World Bank, in 2020 China was the only major economy to record positive growth, expanding by 2.3 percent. That expansion continued through the first half of 2021, with Q1 2021 seeing China record the largest economic jump since records began, an 18.3 percent growth year on year. Of course, the first quarter of 2020 is precisely when COVID-19 first hit, with nationwide shutdowns. Actual 2021 growth quarter by quarter was much more modest, with Q1 registering just a 0.6 percent increase from Q4, 2020. However, at mid-year the World Bank remained bullish on China, estimating 2021 GDP growth at 8.5 percent, exceeding even China’s own projected growth rate of 6 percent.
This economic heft makes talk of an economic decoupling from China seem like a disconnect from reality. Not only has China’s growth been leading global economic recovery, but the rebound of North American and European economies has fueled a continued demand for Chinese imports. China continues to play a dominating role in global supply chains; and while there is much talk about diversifying sources of supply away from China, this is much easier said than done. It is true that supply chain disruptions arising from COVID have sparked a push for greater diversification of supply and a call for some reshoring, but businesses will still find it hard to replace China for many products. At the end of the day, business will go where supply is competitive and reliable.
A recent Canadian Government study noted that China is the dominant supplier for many goods traded globally, supplying the world with 1 in every 12 traded products at the HS-6 level (the broad classification system for goods used internationally). Almost fifty percent of Canada’s production inputs have some Chinese content. Losing any of those imports could cause significant damage to the Canadian economy and Canadian businesses. For example, 97 per cent of Canadian industries import electrical equipment and components, as well as computers, computer peripherals and parts from China. The study also showed how Chinese inputs have changed over time. Twenty years ago, China was an assembly point for supply chains owing to its low cost of semi-skilled labour along with relatively good infrastructure. At that time most of Canada’s imports from China were consumer goods. By 2019 the ratio of consumer goods had dropped significantly. China is no longer just a final assembly point but contributes more higher value-added input in the production process. If this pattern is true for Canada, it is surely similar for China’s other major developed country markets, particularly the United States.
Despite the dominance of China in a number of key areas, COVID-19 has taught importers important lessons. Reliance on a sole source for key commodities or components can lead to supply chain disruptions and expose weaknesses. This was driven home early in 2020 when Chinese factories were shut down because of COVID and couldn’t or wouldn’t deliver. A global scramble for N95 masks, pharmaceutical components, medical gowns and so on, led to the sudden realization of supply chain vulnerability. There are indications that the resultant push for diversification of supply is achieving some success in the U.S. Forbes reports that with the U.S. recovery, domestic imports of goods rose 33.7% in the nine months from June 2020 through March 2021, but goods imports from China rose only 6.9% during this time. Part of this may have been due to the Trump tariffs, but it is also partly as a result of business behaviour.
When there is a supply blockage or shortage, importers will beat the bushes to find alternative sources of supply. Some of these will be acceptable partners; others will have delivery and quality problems. Some new sources may end up replacing the original supplier but in the long run, availability and price usually take precedence over strategic calculation as supply chains return to normal. This is likely to happen with China, although many manufacturers and retailers in developed countries will try to hedge their bets by developing a second source of supply.
Governments in free market economies have only limited levers to force trade diversification. They may preach it and may even be able to divert trade by erecting trade barriers like Donald Trump’s tariffs on Chinese imports, but in a free market economy it is difficult to mandate diversification. Besides, many products are fungible so diversion of supply often results in trade flowing to fill the vacuum, with displacement taking place more than diversion. Even in a largely command economy like China, it is not always easy to force importers to change sources of supply other than by imposing artificial barriers such as phytosanitary inspections, denial of import permits or the imposition of tariffs.
For example, the Chinese government has tried to “punish” Australia economically in retaliation for what it sees as anti-China political moves by Canberra, but it has found it difficult to find a suitable substitute for Australian iron ore. In fact, the total value of Australian exports to China in the first half of 2021 have broken all records. Another example demonstrating the difficulty of forcing economic decoupling relates to China’s actions to block imports of Canadian pork in 2019. The justification offered was to protect health and safety, but it was widely assumed in Canada that the import ban was part of China’s way of expressing displeasure at the arrest in Canada of Huawei executive Meng Wanzhou. However, just a few months later shipments resumed. The fact that China was facing a sudden shortage of pork owing to an outbreak of swine fever was surely a factor in the sudden change. All this suggests that decoupling from China is likely to be more rhetoric than reality for most countries, with the exception of a few specialized technical areas or specialized products and commodities, such as rare earths. By the same token, China’s growing middle class will require more inputs, from animal protein to vehicles to fashion accessories, and while China can supply some of its own needs, it is far from autarkic.
Against this backdrop, China’s economic surge is slowing down and returning to a more normal pace owing to ongoing COVID restrictions and some supply and shipping bottlenecks. At the same time, other economies are starting to pick up the slack, returning China to its place of being an important but not the only economic growth engine. As an example, in 2020 Canada’s trade with China surged while its trade with other trading partners, including with its main market the United States, stagnated or declined. Yet according to Statistics Canada, by June of 2021 while trade with China was showing steady growth of almost 12 percent, year on year, trade with the U.S. rebounded with a 34 percent increase.
What does this all mean going forward? China will continue to be a major engine of global economic growth, but it is not immune to supply shocks. On the demand side, there has been some rethinking of supply chains involving exclusive dependence on China, more for economic than political reasons, but it is not easy to disentangle the Chinese economy from the West. Both China and the developed country economies need each other. Moreover, their trade is largely complementary. Despite much talk about economic decoupling, the evidence of it taking place is scant. The challenge ahead will be to manage the political and technological challenges that arise in such a way that preserves the mutual benefit that China’s economic rise has brought to both China and the developed economies of North America, Europe, Japan and Australasia.