Is Europe’s bid to break free from Chinese manufacturing doomed to fail?

An assembly line of Volkswagen vehicles in China's First Automotive Works plant in Changchun. Reuters

European companies are increasing efforts to curb their dependence on Chinese goods. Some are looking to shift at least 30 per cent of their production outside of China, and some are even pushing to exit the country entirely.

And it’s not just because of long-standing concerns about supply chain vulnerabilities. It’s also because the European Commission is looking much more closely at goods coming into the continent from China.

For instance, Brussels has launched investigations into Chinese government subsidies for manufacturing, fearing overcapacity and the flooding of cheap goods into Europe, which would undermine the EU’s competitiveness. Europe has already imposed steep tariffs on electric vehicle imports from China, as my colleague Howard Yu noted in this column.

Despite this consequent thrust to “de-risk” from China, the impact on global trade flows may remain limited. Decoupling from the world’s biggest export economy, while a popular narrative, is neither entirely realistic nor desirable.

Even as European companies seek alternative suppliers in countries like India, Bangladesh and Vietnam, these options often come with higher costs and longer lead times. The reality is that Chinese manufacturing remains highly competitive, and its dominance in global trade is firmly entrenched.

For one, while the G7 sources only about 4 per cent to 5 per cent of their industrial inputs from China, the country’s reliance on G7 imports is even lower, according to my research published by the Brookings Institution, a US think tank. This imbalance implies that any industrial disruptions resulting from decoupling would likely hit the G7 harder than China.

Attempting to roll back the clock to a pre-integration era is unrealistic.

Breaking these deep connections will demand costly, long-term industrial and trade policies, like what the US, Europe and Japan are doing in semiconductors. For example, the US is investing more than $50 billion to boost domestic semiconductor production, through the Chips and Science Act.

However, building these industries takes years of sustained effort and political backing, which can be difficult to maintain as power shifts between parties in democratic economies. The real challenge is that these policies are expensive now, while the benefits might feel distant and uncertain.

Consequently, the scope of China decoupling is likely to remain limited.

The economic reasoning behind this is straightforward: manufacturing benefits from economies of scale, when industries cluster together. Businesses group in specific regions to reduce costs and improve quality, which creates a competitive advantage that attracts even more companies to those locations.

Once China gained its foothold by the early 2000s, these natural forces of clustering and productivity growth solidified its dominance. With more than a third of the world’s manufacturing now centred in China, according to the OECD, reversing this trend appears improbable. While it may be possible to compete with China in specific sectors such as semiconductors, medical products and electric vehicles, dismantling its dominance across a wide range of industries seems far-fetched.

For the G7 nations, tackling China’s dominance over global supply chains is a complex challenge, yet emerging economies face an even more difficult situation.

While G7 countries may be able to reduce or reverse their reliance on China in certain industries through policies like US President Joe Biden’s Inflation Reduction Act and Chips and Science Act – which together dished out about $400 billion in grants, loans and tax credits to companies investing in US manufacturing – emerging economies lack the financial resources for such large-scale policies.

For them, China’s dominance in global trade is an inescapable reality. When it comes to the fast-paced development and expansion of the industrial sector, only two types of emerging economies have a real chance.

The first are countries like India with large domestic markets (India’s population tops 1.4 billion) that can be leveraged to develop industrial hubs. The second type includes economies geographically close to China, allowing them to integrate into Chinese supply chains as both buyers and sellers – countries like South Korea and Vietnam.

Interestingly, while it is the US that has led the push to decouple from China, traditional methods of measuring supply chain dependence do not fully capture the extent of America’s reliance on foreign inputs.

When examining not just direct suppliers but also the entire network of indirect connections, it becomes clear that US dependence on China is much greater than it appears. Although the US imports a significant amount directly from China, many of the products it imports from other countries, such as Canada or Mexico, also contain Chinese components hidden deeper in the supply chain.

This makes efforts to reduce reliance on China much more complicated. Even if companies shift their supply chains to countries like Vietnam or India, those nations often still depend on Chinese inputs, meaning China’s influence remains strong.

Completely decoupling from China would require massive changes across entire industries, and the reality is that such a scenario remains highly unlikely. For now, European and American companies will continue to seek ways to “de-risk”, but China’s dominance in global supply chains is here to stay.

Richard Baldwin is professor of International Economics at IMD