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Our Co-CIO’s Reality Check on US-China Decoupling

Written by Jeff Xu, Co-CIO (China)

The prospect of a US-China decoupling has been one of the top concerns of LHG's capital partners. To address this concern, our China research team has performed an in-depth study on the subject.

Some key points from the study are summarized below.

(English translation)

Part I. External factors of China's economic rise:

1. The rise of China's economy has caused profound changes in the global political and economic order, and these changes have brought about a series of imbalances in the global order.

2. Entering the 21st century, within the linear GDP growth rate, China's manufacturing sector has entered a non-linear high-speed growth. It is during this period of time that China has grown into the "world factory".

3. China's economic miracle is the direct result of three conditions happening simultaneously. First is China's accession to the WTO, thus enabling smooth access to the global market. But what really matters are the other two conditions: one is that the Western world has entered the era of innovation-driven economy, which has brought about large-scale outsourcing of manufacturing processes, and it was looking for countries that can undertake outsourcing on a global scale; the other is China's land finance system (the privatization of land to support local government’s fiscal revenue), which has enabled China to obtain the most powerful ability to undertake outsourcing from the West in a unique way.

4. But the coupling of these conditions is not repeatable at all, so it is not a replicable model for other countries.

5. The development of China's manufacturing industry, combined with the innovative economy of the West, has had a profound impact on the global economic and trade structure, and has also had a profound impact on the economic and political order of various countries.

6. China's economic rise is highly dependent on the innovation economy of Western countries, so it can also be said that it is another round of (world-level) technological leap, which has contributed to further changes in China's economic and social structure.

7. This round of technological transition is mainly information technology. With the advent of the era of innovation economy, it has promoted a management revolution, brought changes in the organizational form of enterprises, and made large-scale outsourcing of production possible and necessary.

8. To deal with the "post-shortage economy era", companies that can outsource the manufacturing process and devote themselves to creativity and brand building will have a greater opportunity to occupy the top of the value chain. This is the secret of success for companies like Apple. And once you start to enter the era of innovation economy, you must continue to strive for innovation, otherwise companies will be easily eliminated.

Part II. Establishment of supply chain system

1. For the Chinese contractor, there are two conditions that must be met at the same time: first and foremost, the production process must be efficient, otherwise there will be no chance to undertake the contracting task. The premise of efficiency is specialization; the second condition, that is, the production process must be flexible, and the premise of flexibility is that it cannot be specialized, and the inability to specialize will make the production efficiency poor, and there will be no chance at all in the first place. These two conditions must be satisfied simultaneously, but they are contradictory to each other, which brings about a structural problem.

2. The only way is to satisfy the two conditions of flexibility and efficiency at the same time, is to place them at two different levels. In order to have dynamic reorganization within the supply chain network, it is necessary to have distributed decision-making and distributed operation, which cannot be designed by a centralized brain. Because the speed of market changes in the era of innovation economy exceeds any centralized processing capacity, the operation of the supply chain network can only be based on the natural market equilibrium process.

3. At its initial stage of establishing a complete supply chain network, there must be a sufficient number of companies, each with its unique division of tasks, that grow up almost simultaneously to form a complete supply chain network with its own operational capabilities; if companies with such a deep distribution of tasks cannot grow up almost at the same time, no one can survive.

4. A prerequisite for so many companies to grow simultaneously is whether there are enough well-built, large-scale industrial development zones with well-established infrastructure (this can also be classified as urbanization in a broad sense), and at the same time, there is no corresponding industrial capacity in it.

5. This means (in a broad sense) that urbanization precedes industrialization, but this is contrary to the usual historical rhythm in which industrialization drives urbanization.

6. China just followed a reverse historical rhythm: (in a broad sense) urbanization developed before industrialization. The fundamental reason lies in China's land finance, and the development of land finance is directly related to the 1994 tax-sharing reform.

7. Therefore, it can be said that China's economic miracle is entirely dependent on the general trend of the world. China's independent decision-making has a certain role in it, but it is more of a temporal coupling, and China follows the trend. China's economic rise is deeply embedded in the development process of the world economic order. It can be said that China's economic rise and the transformation of the Western economy are the same process. We cannot discuss China issues outside of the world economic order; similarly, as China's economic rise becomes a reality, we cannot discuss the prospects of the world economic order without China's influence.

Part III. The operation of the world economy is inseparable from the supply chain system centered on China

1. China's advantages as a super-sized country are fully demonstrated here. In the years of reform and opening up, especially after the implementation of land finance, a large number of infrastructures have been established, and the logistics potential of a super-sized country has been fully released; On the other hand, China's large population resources – individuals constitute China's huge team of engineers and skilled workforce, enables the supply chain network to function.

2. In fact, the scope of this supply chain network has gone beyond China’s border and is based on the entire East Asia region around the China Sea. China imports a large number of parts and semi-finished products from other East Asian and Southeast Asian nations/regions, completes the overall assembly in China, then exports them to the world. The entire East Asia has been integrated into a huge manufacturing cluster.

3. The so-called large-scale trade surplus of China with developed countries is actually a surplus formed by China representing the entire East Asian manufacturing cluster, which includes a large-scale deficit formed by China's import of parts and semi-finished products from many Southeast Asian countries and regions. In recent years, part of the manufacturing industry has shifted from China to Southeast Asia. This is not a real transfer, but a process of internal structural restructuring of the supply chain network within the East Asian manufacturing cluster.

5. However, the supply chain network itself as a whole will not be substantially affected, and the overwhelming scale of China in this supply chain network relative to other countries makes the reconstruction of the supply chain always centered on China.

6. After incorporating the element of supply chain management capability, we will find that the price of labor and land is actually not the most decisive factor in manufacturing costs. This is also the reason why China's manufacturing industry can develop more rapidly in the 21st century when labor and land costs have risen substantially compared with the 1980s.

7. With the rise of China's economy, the middle-income trap may have been eliminated. The so-called middle-income trap is nothing but an empirical summary of the economic development process of a series of developing countries in Latin America and Southeast Asia since the middle and late 20th century.

Part IV. From " center and periphery " to "dual-cycles"

1. The international economic and trade structure is gradually transforming from the "center and periphery" structure described by Immanuel Wallerstein's world system theory to the "dual-cycles" structure, that is, the economic and trade relations between China and Western countries form the first-degree cycle: China exports manufactured goods to Western countries, and imports technology, capital, and various high-end services from the West; the economic and trade relations between China and other non-Western countries form the second-degree cycle, and China’s exports to developing Asian, African and Latin American countries export finished products and import raw materials from them. These two fundamental cycles are connected primarily through China.

(Original Chinese)


































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