By Stephen Nagy & Hanh Nguyen

Journal of Contemporary Eastern Asia Vol. 20, No. 2

Abstract

The COVID-19 pandemic has highlighted the risks of an over-concentration of supply chains in one country. It has motivated stakeholders to pursue diversification strategies. However, a paradox exists. Stakeholders have shied away from a complete decoupling and preferring to selectively enhance economic ties with China. This article explores this paradox by examining supply chain concentration in China as a form of asymmetric interdependence and the countermeasures from the U.S., Japan, Australia, and India to minimize vulnerabilities. It argues that while the COVID-19 disruptions have brought to light the risk of supply chain over-concentration in China, countermeasures are also driven by coercive diplomacy and the
deepening U.S.-China rivalry. The paper also examines the feasibility of diversification efforts by focusing on the capacity and capabilities of alternative supply chain hubs. It finds that while states are actively seeking ways to prevent China from using asymmetric interdependence of supply chains and trade to gain political leverage, there are structural limits to the degree of diversification in the short to mid-term.

Keywords: asymmetric interdependence, supply chain, U.S.-China competition, Indo-Pacific, supply chain diversification

Introduction

The COVID-19 pandemic brought global economic activities and supply chains to a standstill in 2020 (Xu, Elomri, Kerbache, & El Omri, A., 2020). Supply chain disruption associated with the pandemic, an increased use of economic coercion and its impact brought attention the opportunities and challenges of an over concentration of supply chains in China (Uren, 2020). As a response, governments pursued both domestic and international efforts to diversify supply chains. Japan announced subsidies to encourage businesses to either enhance their domestic manufacturing or diversify production networks to Southeast Asia (Takeo & Urabe, 2020). The Biden administration signed an executive order to conduct a review on supply chains critical to U.S. national security (White House, 2021a). Australia, Japan and India recently launched the Supply Chain Resilience Initiative (RSCI), which aims to share best practices regarding diversification and match suppliers (METI, 2021).

However, there are developments contrary to this trend. Despite rhetoric on diversification, governments have not announced or enacted tangible measures to re-orient supply chains substantially. Furthermore, countries continue to push forward with the trade liberalization agenda.

• In November 2020, 15 countries, including members of the Association of Southeast Asian Nations (ASEAN), China, Japan, South Korea, Australia and New Zealand, signed the Regional Comprehensive Economic Partnership (RCEP) (ASEAN, 2020).

• In December 2020, the European Union also announced the conclusion of negotiations for a new investment deal with China called Comprehensive Agreement for Investment (CAI) (European Commission, 2020).

These developments raise questions about the credibility and the extent of supply chain diversification efforts. Furthermore, the business community has not shown enthusiasm for governments’ efforts.

These developments are also not fully explained by international relations theories such as structural realism and liberal institutionalism.

Given structural realism‘s preoccupation with power distribution and related security implications to states, diversification of supply chains might be construed as sensible efforts to reduce states’ vulnerabilities, thus improving their position in the balance of power. Nevertheless, it cannot explain the current trend of creating even wider trade networks, exemplified by RCEP and CAI agreements.

Similarly, since liberal institutionalism emphasizes how institutions and economic connections can establish interdependence among states, mitigating the power of states, the conclusion of new trade agreements is a vindication for the continued march of globalization despite recent setbacks. However, it failed to take stock of the need for supply chain diversification to strengthen them against external shocks, whether they are natural disasters, man-made crises, or calculated geopolitics in the cases of economic coercion.

With this contradiction in mind, this paper addresses the paradox of: Why do countries want to re-orient supply chains out of China? Why do these countries, at the same time, enhance economic ties with China?

To bring light to these questions, the authors will perform a detailed analysis of the drivers and challenges to supply chain diversification. It finds that:

• The concentration of supply chains in China represents a form of asymmetric interdependence, which China can wield as a coercive tool to secure strategic gains vis-à-vis other states.

• Diversification is thus based on four factors.

  First, diverse and widely dispersed supply chains will be less vulnerable to the sudden and dramatic impact of “black swan” events, such as the COVID-19 pandemic in 2020 or the 2011 Tohoku earthquake.

  Second, China’s employment of economic coercion compelled other countries to review the risk of closer economic ties with China, especially whenever their interests do not align with China’s.

  Third, the intensifying Sino-U.S. rivalry runs the risk of creating a bifurcated system with wide-reaching consequences such as disrupting global supply chains, rising production costs, and reduced economic growth.

  Finally, structural issues in China’s economy, such as growing labor cost, protectionist policies and upcoming demographic winter, diminish China’s status as an unrivaled manufacturing hub.

• Despite these concerns, there are limits to what governments can do in the short to midterm to reduce their vulnerabilities and minimize their asymmetric interdependence with China.

  First, China retains several structural advantages for businesses, such as a growing middle class, a large, skilled labor force, a highly developed logistic ecosystem, and the government’s efforts to improve the business environment for foreign investors. Consequently, China remains a top priority for firms and governments, both as a highly profitable consumer market and as a critical manufacturing hub.

  Second, re-shoring the entire supply chains to home countries is economically impractical.

  Third, alternative locations in Southeast Asia also have their constraints. They either do not have the comparable capacity or need to deal with critical bottlenecks such as lack of skilled labor, poor infrastructure and a reliance on Chinese parts and components (Nagy and Nguyen, 2020).

Instead of characterizing supply chain diversification as an attempt to disengage with China or a step to rewind globalization, it is akin to a hedging strategy.

Countries and businesses want the benefit of continued engagement with China, but they are wary about the potential risks of over-reliance. Therefore, the goal is to build a diverse and secure network of supply chains that are resilient to harmful effects of economic interdependence.

In reality, several businesses have followed this approach by adopting “China plus one” strategy, in which businesses diversify their investments and supply chains to other countries while continuing to operate in China.

This paper employs a comparative methodology. It evaluates the strengths and weaknesses of ASEAN and China as global supply chain hubs, using the World Economic Forum’s Global Competitiveness Index which include factors such as market size, workforce skill, infrastructure, business environment and innovation capability.

These factors provide a whole picture of China and ASEAN’s comparative advantages, thus giving insight into how international businesses have not left China en masse in search of new production locations despite risks of supply chain concentration. They also illustrate why Southeast Asian states are unable to replace China as a central hub for production networks.

To further support these arguments, this paper analyzes Japan’s trade and investments with China and ASEAN at three critical junctures. As a leading investor in both China and ASEAN, especially in the manufacturing sector, the activities of Japanese businesses are a good indicator for supply chain trends.

Structure of the paper

• 1. Theory-based review on interdependence

• 2. Hitherto efforts to diversify supply chains in the wake of the COVID-19 pandemic and the rationales behind this effort

• 3. Challenges to diversification efforts

• 4. Japan’s trade and investment data in China and ASEAN

• 5. Summary of findings

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