Why De-risking from China May Still Lead to De-coupling – For Certain Key Inputs, but Also for Some Companies

On March 30th, the president of the European Commission, Ursula von der Leyen, gave a keynote on EU-China relations. She emphasized that de-coupling from China “is neither viable – nor in Europe’s interest” and introduced the concept of “de-risking.” This appears to be a well-chosen term since, economically, – de-coupling from China is neither realistic nor reasonable. However, de-risking may still lead to de-coupling, not only for some critical inputs but also for some companies and their business operations.

The EU and China are closely intertwined economically, and both sides have benefited from their interconnectedness. Since Russia’s invasion of Ukraine, however, “de-coupling” – first put forward in the US under the Trump Administration – has become a buzzword in Europe, too, in the discussions surrounding its increasingly complex and difficult relationship with China.

Geopolitical and other developments (such as China’s handling of Lithuania’s opening of a Taiwan office) have made crystal clear that critical dependencies resulting from close economic interconnectedness could be instrumentalized to achieve political goals. Therefore, it appears vital that the EU identify these dependencies with China and eliminate them.

De-coupling, however, was not the right term to use here from the start. If taken to its logical end, de-coupling would mean cutting off all linkages between two objects. In this case, these two economic entities would no longer have interconnections, just like de-coupling a carriage from a train.

It was quickly clear that this could neither be the goal nor was it feasible regarding China. In the absence of an alternative, maybe, the term has persisted until Ms. von der Leyen’s China speech coined the term “de-risking,” which should be accomplished through diplomacy on the one hand and economic means on the other.

Accordingly, de-risking through diplomacy refers to “managing this relationship and having an open and frank exchange with our Chinese counterparts,” while economic de-risking consists of four pillars:

• Increasing the competitiveness and resilience of the EU economy and industry, including establishing “more independence and diversity when it comes to the key inputs needed for our competitiveness. ” – especially in the health, digital and clean-tech sector, and “to strengthen our resilience on cyber and maritime, space and digital, defence and innovation.“
• Better using existing trade instruments, especially those that have been introduced over the last few years, to address security concerns, such as the Anti Coercion Instrument or the Foreign Subsidies Regulation, by taking a unified and “more assertive approach to enforcement.”
• Developing new defence tools for some critical sectors where “dual-use purposes cannot be excluded, or human rights are implicated” (e.g., quantum computing or AI). To avoid leakage of sensitive technology through investment abroad, a tool targeting outbound investment is currently being reflected.
• Aligning with other partners regarding the EU’s economic security, especially with G7 and G20 partners. The focus should be on concluding FTAs (e.g., Australia, India) modernizing (e.g., Mexico) and better using them, for cooperation on sectors such as digital and clean tech (e.g. through the Trade and Technology Council with India or the EU-Japan Green Alliance) as well as on infrastructure investment (the Global Gateway strategy).

Pillar 1 shows that de-coupling is part of an overall de-risking strategy, as it implies the de-coupling of supply chains for some critical inputs from China, if necessary and feasible, i.e., a partial economic de-coupling in very specific areas.

For some companies, however, and especially for those with substantial business operations in China, de-risking could lead to a full decoupling under certain circumstances in the long run. What first sounds like a contradiction and even counterintuitive is becoming an increasingly realistic possibility amidst rising geopolitical tensions that make worst-case scenarios (e.g., the Chinese invasion of Taiwan followed by Western military action and sanctions) more likely.

In October 2021 – four months before Russia invaded Ukraine – the Bertelsmann Stiftung published a Globalization scenarios study that already anticipated a period of rapid upheaval in which technological advances and growing rivalries between the world’s economic superpowers would be intensifying geostrategic competition.

It offers five possible scenarios of what the international order might look like in the future and how businesses might deal with it. The building of two or more economic blocs (esp. US/West vs. China), diverging standards and regulations, as well as the regionalization of supply chains and business operations, are likely developments in most of the envisioned scenarios, even up to the point that:

“Many European companies face the dilemma of deciding in favor of one side or another since they cannot readily meet both blocs’ requirements or must pay a high price if they do.”

Continued US-China power plays could thus lead to separate and even incompatible framework conditions for businesses in the Western hemisphere and China, additionally shielded by high tariff walls.

This would highly increase the risk, especially of those companies with a significant presence in both markets, to be caught right in the middle. The following three examples illustrate this dilemma:

• Import tariffs: The trade war started by President Trump and effectively continued under the Biden administration, though with a lower profile, increases the pressure on companies for which China makes up a substantial share in revenue and production to switch to an “in China for China strategy for both upstream and downstream activities, effectively decoupling their entire value chains in China from those outside.”
• Standards and regulations: Different and, in some cases, incompatible standards and regulations (e.g., for data and cloud applications) in China and their home country might also increase the need for companies to decouple their business operation in China from the headquarters or even from their global operations.
• Sanctions: China’s Anti-Foreign Sanctions Law basically prohibits companies from complying with foreign sanctions. So, if China invaded Taiwan and the US imposed sanctions against China, companies might face the risk of not being able to comply with the legal framework in both countries at the same time: in case they follow the sanctions, they might not comply with Chinese law. In case they do not follow the sanctions, the same holds for US law.

To avoid this kind of dilemma and to reconcile two maybe increasingly incompatible business environments, some companies might be forced to set up completely separate structures to at least try and stay in both markets – one for the Chinese sphere of influence and one for the US/western sphere of influence, as undesirable as this is from an economic and business perspective.

Therefore, while Ms. von der Leyen’s economic de-risking strategy refocuses away from de-coupling on the macro-level (except for specific areas) of EU-China relations, de-coupling will remain in focus for at least some companies regarding their China business.

About the author

Cora Jungbluth is a senior expert in the Europe’s Future Program at the Bertelsmann Stiftung. Her research focus is foreign direct investment and international trade (especially the role of emerging economies). Her research focus is on China, foreign direct investment and international trade (especially the role of emerging economies).

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