19th February 2024 – (Beijing) As geopolitical tensions drive the U.S. and China to “de-risk” economic interdependence, India and Indonesia are emerging as winners in the supply chain shuffle. However, China’s manufacturing dominance, particularly in intermediate goods, means complete decoupling is unrealistic. With competitive reforms, China can retain its central position while new opportunities arise for other nations.

In response to rising strategic rivalry, the U.S. is reducing its reliance on China through policies aimed at “de-risking” – including tariffs, export controls and investment restrictions. The goal is to incentivise companies to relocate supply chain capacity outside China, especially to friendlier countries.

Initially, de-risking seemed successful, with China’s exports to the U.S. dropping 20% in 2023 as manufacturing shifted to Mexico and Southeast Asia. However, trade data doesn’t fully capture how de-risking is playing out. China remains the fulcrum of global supply chains and has even expanded its share of global manufacturing value-added.

Complete decoupling is impossible given China’s entrenched centrality as a supplier of intermediate industrial inputs. However, with reforms, China can retain competitiveness alongside opportunities for others. India and Indonesia exemplify how major developing economies can capitalise on supply chain shifts to power domestic growth.

Last year brought a windfall for India as de-risking prompted companies to expand operations. Apple opened its first Indian flagship store and shifted some manufacturing from China. Appliance maker Foxconn vowed to double its workforce in India by 2023. Multiple semiconductor firms announced new Indian facilities worth billions, including US-based Micron’s $3.7 billion chip fabrication plant.

For India, this marks a sea change after years of unrealized potential. Despite Prime Minister Modi’s high-profile “Make in India” drive launched in 2014, investors previously overlooked India as complex regulations and infrastructure deterred relocation from China. Now India’s large domestic market, youthful demographics and low costs are proving irresistible. With 1.4 billion people, over half aged under 30, India offers abundant workers and consumers. Wages average just $240 per month.

Geopolitics accelerated India’s rise, as Western countries court New Delhi despite continued ties with Russia. At the US-India Summit last June, partnerships were unveiled in semiconductors, defence and space, alongside India signing the US-led Artemis Accords on lunar exploration principles.

For technology firms, India’s youth provides skilled, English-speaking labour. Modi’s reforms are also bearing fruit, as infrastructure improves and regulations ease. Corporate tax rates were slashed from 30% to 22%, and new labour laws introduced more flexible contracts.

In Indonesia, de-risking is also remaking global supply chains in dramatic fashion. Nowhere is this clearer than at the Indonesia Morowali Industrial Park (IMIP) in Sulawesi. In just over a decade, this mega project has transformed 4,000 hectares of rainforest into Indonesia’s largest nickel processing hub – fueled by over $5 billion in Chinese investment.

Nickel is essential for stainless steel and lithium-ion batteries. With electric vehicles projected to account for 70% of nickel demand by 2040, securing nickel supply is a new strategic priority. Indonesia holds the world’s largest nickel reserves and now dominates global production after banning nickel ore exports in 2020.

This prompted massive Chinese investment in nickel smelting and refining capacity in Indonesia. IMIP processes Indonesian nickel for export to China’s battery giants. In 2022, Indonesia exported $34 billion in nickel products, compared to just $1.1 billion in nickel ore exports in 2014.

The next stage is moving into battery manufacturing and electric vehicle production. South Korean firms are building a battery plant, while Hyundai launched the first EV assembled in Indonesia last year. Indonesia is creating a full EV ecosystem, with Western and Chinese automakers also setting up manufacturing. Partnering with both US and Chinese firms enables Indonesia to avoid choosing sides. De-risking creates space for middle powers like Indonesia to leverage partnerships with multiple major economies simultaneously.

The wins for India and Indonesia show how de-risking creates openings for developing countries. However, the idea that companies can simply “reshore” out of China is simplistic given China’s manufacturing dominance and competitiveness. Over two decades, China built an unparalleled manufacturing ecosystem. Infrastructure like roads, ports and power plants facilitate efficient logistics. Investments in automation and skilled workers ensure productivity far above rivals like India or Vietnam. Supplier networks enable dense clustering of component manufacturers.

China’s grip is especially firm on intermediate inputs for complex supply chains. It produces over 25% of the world’s intermediate goods, from chemicals to electronics components to textiles. Relocating finished goods assembly is easier than shifting production of specialized inputs.

Foxconn’s 200,000-worker iPhone factory in Zhengzhou highlights China’s unmatched capability in megaproject delivery. The challenges of replicating its infrastructure and workforce elsewhere makes wholesale relocation near-impossible.

Some US policymakers assume that just as manufacturing rapidly shifted to China in past decades, it can now rapidly shift out. But China spent decades methodically building manufacturing capacity, which cannot be quickly dismantled.

Current de-risking effects appear dramatic, like the 20% annual drop in China’s exports to the U.S. However, trade data only shows part of the picture.

In reality, U.S. manufacturing remains deeply dependent on Chinese inputs, often imported indirectly via third countries. One study found US manufacturing’s exposure to Chinese inputs is nearly four times higher than trade data indicates. Shifting final assembly offshore doesn’t break this dependency. Further, actions like U.S. export controls on advanced semiconductors hurt American firms as much as China, while jeopardizing the global electronics industry. Such overreach illustrates the complexities of disentangling mutually reliant economies.

Still, China cannot be complacent and rely solely on previous advantages, as rising costs reduce competitiveness. China’s share of global exports is declining as India, Vietnam and others gain ground. Businesses expect further barriers as strategic competition intensifies.

The solution is revitalising China’s competitiveness through market reforms. Streamlining bureaucracy, supporting private enterprise and promoting indigenous innovation are vital to attract investment and talent. Despite rhetoric, most multinationals are not abandoning China but doubling down on premium segments like high-tech manufacturing and consumer products. With the right policies, foreign firms can thrive alongside domestic champions focused on cutting-edge technologies. China is also pivoting its enormous domestic economy from investment-driven growth towards domestic consumption and services. The population’s increasing affluence expands opportunities in consumer sectors.

Rather than seeking to dominate global manufacturing, China could target strength in value-added areas like R&D, design and advanced materials. Export restraints on commodities reflect a strategy of conserving resources for China’s own industrial upgrading.

Of course, this recalibration is easier said than done. Vested interests resist reforms that threaten their power, while regulators cling to old interventionist tools. But for long-term prosperity, China must enable the world-class private firms driving innovation.

The de-risking agenda rests on the illusion of quickly extricating supply chains from China. However, reducing reliance need not mean outright rejection. Resilience comes from diversification and balance across economic partners, avoiding over-dependency on any single country.

As Indonesia shows, developing nations can benefit from partnerships with both U.S. and Chinese firms in priority industries like electric vehicles. India’s rise will rely on continued trade with China despite geopolitical pressures. Extricating China from the global economic equation is neither feasible nor beneficial. Amidst this recalibration, developing countries have opportunities to strategically insert themselves in high-value segments of shifting supply chains, if they implement key reforms. Meanwhile, China retains fundamental manufacturing strengths, though it must renew its competitiveness.