Understanding US-China Decoupling: Macro Trends and Industry Impacts
Conceived in 2019, this study seeks to illuminate the costs of decoupling for the United States. The analysis has been complicated over the past year by a shifting landscape. Tensions between the U.S. and China have grown in the aftermath of the COVID-19 outbreak, triggering a broader debate about supply chains, reshoring, and resilience. In truth, because of the many variables at play, it is beyond the capacity of economics to deliver a precise answer regarding the costs of decoupling. Nonetheless, this study offers what we believe is a valuable perspective on the magnitude and range of economic effects that the Biden administration should consider as it weighs its policy agenda with China. The study highlights the potential costs of decoupling from two perspectives: the aggregate costs to the U.S. economy and the industry-level costs in four areas important to the national interest.
Key findings of our assessment of the aggregate costs of decoupling to the U.S. economy include the following:
- In the trade channel, if 25% tariffs were expanded to cover all two-way trade, the U.S. would forgo $190 billion in GDP annually by 2025. The stakes are even higher when accounting for how lost U.S. market access in China today creates revenue and job losses, lost economies of scale, smaller research and development (R&D) budgets, and diminished competitiveness.
- In the investment channel, if decoupling leads to the sale of half of the U.S. foreign direct investment (FDI) stock in China, U.S. investors would lose $25 billion per year in capital gains, and models point to one-time GDP losses of up to $500 billion. Reduced FDI from China to the U.S. would add to the costs and—by flowing elsewhere instead—likely benefit U.S. competitors.
- In people flows, the COVID-19 pandemic has demonstrated the economic impact from lost Chinese tourism and education spending. If future flows are reduced by half from their pre-COVID levels, the U.S. would lose between $15 billion and $30 billion per year in services trade exports.
- In idea flows, decoupling would undermine U.S. productivity and innovation, but quantification in this regard is difficult. U.S. business R&D at home to support operations in China would fall and companies from other countries would reduce R&D spending related to their China ambitions in the U.S. The longer-term implications could include supply chain diversion away from U.S. players, less attraction for venture capital investment in U.S. innovation, and global innovation competition as other nations try to fill the gap.
In terms of industry-level costs, we find the following:
- For the U.S. aviation industry, decoupling would mean reduced aircraft sales resulting in lower U.S. manufacturing output, falling revenues for the firms involved, and thus U.S. job losses and reduced R&D spending—leading to diminished U.S. competitiveness. We estimate that a complete loss of access to China’s market for U.S. aircraft and commercial aviation services would create U.S. output losses ranging from $38 billion to $51 billion annually. Cumulatively, lost market share impacts would add up to $875 billion by 2038.
- For the U.S. semiconductor industry, forgoing the China market would mean lower economies of scale and R&D spending—and a less central role in the full web of global technology supply chains. Decoupling would prompt some foreign firms to “de-Americanize” their semiconductor activities, putting to the test whether that is possible and further motivating China to seek self-sufficiency. Lost access to Chinese customers would cause the U.S. industry $54 billion to $124 billion in lost output, risking more than 100,000 jobs, $12 billion in R&D spending, and $13 billion in capital spending.
- For the U.S. chemicals industry, decoupling would mean a smaller U.S. share in China’s growing market, diversification by China and others from U.S. suppliers, lost competitiveness, and lower R&D spending. This decrease would offset the newfound competitive advantages the U.S. enjoys from lower feedstock costs, thanks to improved extraction technologies. From the imposition of tariffs alone, the potential cost ranges from $10.2 billion in U.S. payroll and output reductions and 26,000 lost jobs to more than $30 billion in output losses and nearly 100,000 lost jobs.
- For the U.S. medical devices industry, decoupling would mean the added cost of reshoring supply chains and restricted product and intermediate input imports from China, along with retaliation against U.S. exports by Beijing. Abandoned market share in China would go to competitors, boosting their economies of scale and handing them future revenue from the market in China, where both rising incomes and an aging population are driving demand for medical devices. U.S. lost market share is valued at $23.6 billion in annual revenue, amounting to lost revenue exceeding $479 billion over a decade.
These estimations are derived from economic models of “normal” before the COVID-19 pandemic; the macroeconomic assumptions about future supply and demand that such models depend on must now be viewed with great skepticism. Moreover, they explore only the economic welfare effects: they do not attempt to price in the costs or benefits to U.S. security, which is a critical factor in the rethink of engagement with China. But the analysis does point to a number of important takeaways for U.S. policymakers, even with the caveats about the limits of economic modeling amid a global disruption:
- First, data analysis is critical to policymaking. China policy requires economic impact assessment, cost-benefit analysis, and a process of public debate and discovery.
- Second, even based on our rough assessment, we can see that the costs of anything approaching “full” decoupling are uncomfortably high. Alternative approaches—including mitigation and in many cases forbearance—would complement any decoupling scenario.
- Third, many elements merit inclusion in a comprehensive U.S.-China policy program, from promoting industry and innovation and technology to preserving the rules-based, open market order and its institutions, and protecting systemically and strategically important assets and industries from threats. In the policy reengineering to come, the central role of market forces in determining winners, and governments’ finite capacity to redistribute resources to ease the process, must be respected.
- Finally, working with like-minded partners on a plurilateral basis to harmonize regulatory approaches in priority areas and to take coordinated actions that address shared concerns over China’s practices is essential to minimizing the costs to the U.S. economy and preventing the erosion of U.S. comparative advantage that would occur if decoupling policies are implemented solely on a unilateral basis.