De-risking and Decoupling: What’s in a Label?

‘De-Risking’ and ‘Decoupling’ have become the terms of choice for expressing relationships with China. ‘De-Risking’ is preferred by some, including in the EU, since it appears not to foreclose policy options or to assume that ‘decoupling’ is inevitable. This blog looks at what lies behind the use of these terms.

Introduction
 
All countries in the world have to define their relationship with a newly assertive and more determinedly authoritarian China. The issue is particularly acute for democracies where there is a fundamental divide between their own democratic values and the authoritarianism of China under President Xi. The hope sparked by Nixon’s ‘opening’ of relationships with China in 1971 followed by the fall of Soviet communism in the 1990s, that we would see an increasingly connected world converging in attitudes, policies, and values, now looks like wishful thinking. Nor can we expect that international organizations such as the WTO or UN will be able to mediate when differences emerge and quarrels arise. They are also paralysed by differences between their members. Moreover, China continues to defy a 2016 UN tribunal ruling against its territorial claims in the South China Sea. 
 
It has taken time for the realisation to take hold that we are dealing with a different world compared with what we had all hoped for. But over the last years a fundamental change in both government and corporate attitudes has been taking place. Russia’s invasion of the Ukraine has focussed minds on the risks of doing business with authoritarian regimes. The increased use of terms such as ‘de-risking’ and ‘decoupling’ reflects this change in measuring the benefits of closer association with China against the risks. 
 
The risk assessment
 
The start of the redefinition of relationships with China begins with a reappraisal of the risks and benefits of association. For businesses and international investors, the benefits have long been connected with the size and future growth promise of the China market. It is the world’s second largest economy and, in addition to its own promise, has offered a low-cost base for manufacturers setting up supply chains to feed other markets. For foreign investors and businesses, the Chinese domestic market has been judged as simply too big to ignore and stay out of. In addition, until recently the economic growth prospects of China have also held out the prospect of future rewards, even if they might take time to materialise. Now, at the same time as China’s growth prospects are being reappraised downwards, the risks are being reappraised upwards.
 
There are four main categories of risk that enter into the risk benefit calculation:
 
First, there is no rule of law – where the rule of law is defined as government under the law. In China the law is under the government. This means that contracts that are intended to be legally binding are not secure, intellectual property rights are not safe and privacy takes second place to controlling and monitoring the flow of information. Adam Smith argued that the law was needed to overcome distance in relationships. If the law cannot be trusted, distance cannot be overcome. 
 
Secondly, there is no clear distinction between the private or 'non state' sector and the public or government-controlled sector. Chinese private or non state entities have to be careful not to challenge the government and foreign private corporations have had to recognise that even their private Chinese shareholders may reflect the government interest. 
 
Thirdly, there is an increasing recognition that values matter in market transactions. Non- Chinese companies accept that the externalities of their behaviour, particularly in relation to ESG values, are of concern to markets. This includes the need to observe human rights standards in their international business dealings right down to the end of the supply chain. Transparency also matters. Their own reputation is on the line. The observance of these values cannot be counted on in business relationship with Chinese entities or with the government and public sector. The government still has not released data on the impact on the population of relaxing COVID lock-down restrictions. At the least, this suggests the need for caution in establishing links with Chinese counterparts along supply and investment chains.
 
Fourthly, but possibly the most important, there has been increasing awareness of security and defence vulnerabilities. Cyber security is a particular concern. Governments in democracies, their security agencies and their economic regulators each realise that individuals, companies, academic institutions, and government entities are all potential targets for intelligence gathering and that their critical infrastructure needs to be protected against possible harms emanating from China. This concern extends from the operations of Chinese technology and social media companies to concerns about overdependence on China in areas of strategic importance for the future such as AI, battery and storage technology, rare earths and solar panels. Regulators in jurisdictions outside China are well aware that security concerns involve them dealing with the operations of their private business sector so as to ensure that they do not provide the main route into their vulnerabilities in areas critical for their national security.
 
The options
 
In the light of these concerns, those who wish to do business in China, or with Chinese entities, face the following options:
 
Go ahead regardless
 
One option is to disregard these concerns and press ahead with new investments or new supply chain arrangements regardless. A decision not to go ahead has costs attached. Reticence will possibly provide openings for competitors who are less risk averse. The desire to retain a market position or market share will motivate a decision to continue to invest. 
 
Selective engagement
 
A second option is to engage ‘selectively’. The question is about the criteria for ‘selectivity’. For governments there is a need to try to keep channels open in areas such as environmental policy, measures to ensure international capital market stability and debt relief for emerging markets, where cooperation with China should be a win-win for both sides. There is a strong desire to avoid a return to the pre1971 freeze in relationships that would be counterproductive. However, experience of the limits of China’s cooperation with WHO on the origins of the COVID pandemic may suggest that there are limits to engagement even on a selective basis.
 
For foreign private entities ‘selectivity’ means avoiding, or minimising, any engagement in China, or with Chinese entities, where sectors of strategic importance are involved or where human rights or individual values such as privacy may be in question, or where intellectual property rights may be at stake or where cyber security cannot be guaranteed. Once the sensitive boxes have been ticked, the scope for selective engagement may end up highly restricted. 
 
Play for time
 
A third option is to play for time. For foreign private investors this means not increasing involvement in China’s market but not taking active steps to disengage either. If, post Xi, a new leadership group pursues a less assertive policy internationally and a less authoritarian policy domestically, then foreign investors who have maintained their presence may find themselves in pole position to take advantage of the change. Loyalty is a traditional Chinese value. This strategy is illustrated by the survival of HSBC through the regime changes it has experienced since its foundation in 1865. However, it is not a risk-free strategy and the Chinese government recently signalled its possible interest in the break-up of HSBC between its China business and its business in the rest of the world.
 
Withdraw
 
A fourth option is to withdraw from China. This is the decoupling option. Superficially this seems like the least attractive option. It means a return to an earlier era and forgoing on the future potential of China. But it avoids the uncertainties around finding areas for selective engagement, the risks and compromises of maintaining a presence, clashes in corporate values and having to deal with the increasing scrutiny of domestic regulators over defence and security concerns. There has been a dramatic fall in inward investment into China in early 2023 suggesting that decoupling may be preferred to the increasing risks and costs of doing business in China. 
 
Mix and match
 
A final strategy is to mix and match. This means withdrawing and decoupling in some areas but maintaining or even increasing a presence in others.
 
The balance sheet 
 
This listing of options suggests there is no clear distinction between ‘de-risking’ and ‘decoupling’. Both start with a risk assessment and both refer implicitly to a continuum of possible policy responses. ‘De-risking’ is a deceptive term because none of the options short of decoupling are risk free. Complete ‘de-risking’ means ‘decoupling’. Until there is a less assertive and less authoritarian regime in China, decoupling seems the unavoidable consequence of ‘de-risking’.