Risk reduction in trade with China is risky business

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The contest for the word of the year has already ended. In the geopolitics category, the winner is “de-risking”.

This D-word went from obscurity to ubiquity in less than two months. It was the focus of a speech on China made at the end of March by Ursula von der Leyen, president of the European Commission. The risk reduction was then seized upon by the Biden administration. Then, last week, it was approved from a G7 summit.

One reason Western leaders have embraced risk reduction with such alacrity is that it gets them off rhetorical trouble. Previous talk of “decoupling” Western economies from China was frequent chastised as impossible and extreme. Risk reduction seems more prudent and targeted. Western firms are being told they can still trade with China – it’s just that some safeguards are needed.

The kinds of risks that the US and the EU are concerned about can be divided into two broad categories: stuff the West gets from China; and stuff China gets from the west.

In the “things they get from us” category, advanced technology with potential military uses tops the list. The restrictions on semiconductor exports announced by the United States and, last week, from Japan — fall into this category.

At the same time that the G7 nations are limiting China’s access to critical technologies, they are also trying to free themselves from what they see as dangerous dependencies on China. Rare earths and critical minerals that are crucial to battery technology and the green transition top the list. As von der Leyen noted in his speech, the EU imports 97% of its lithium, which is essential for battery production, from China.

Another dependency the West is trying to reduce is that more than 90 percent of advanced semiconductors come from Taiwan, the island vulnerable to a Chinese invasion. The United States Potato chips law of 2022 provided $52 billion in funding to boost chip production in the United States.

The theory behind de-risking is now reasonably clear. The practice, however, is much darker.

Three major difficulties are already emerging. First, the clash between the interests of companies and countries. Second, the difficulty and cost of reducing dependencies on China. Third, a persistent ambiguity about the nature of the risk. Are we worried about political coercion by China or are we really worried about a war?

In normal times, supporting domestic companies that want to export is a key goal of Western governments. But that’s not always the case in the world of de-risking.

Last week Jensen Huang, CEO of Nvidia, the California-based semiconductor group, warned of “enormous damage” to American companies if they are prevented from selling advanced chips to China. But US officials are unrepentant. They point out that Nvidia chips are critical to the development of AI.

They also say that China could easily use advanced AI for all sorts of nefarious purposes, from producing biological weapons (a particular Chinese interest, it seems) to manipulating politics through “fake” news. Further tightening of restrictions on outbound investment to China, both by the EU and the US, will mean more Western firms will experience Nvidia-style controls in the future.

But restricting exports and critical technologies is obviously a two-player game. So the West is also urgently trying to reduce its dependencies on China in crucial areas.

Opinions differ on how easy it will be. Liesje Schreinemacher, Dutch Trade Minister, warned this week that Europe’s green transition will be impossible without China, which is by far the world’s largest producer of solar panels, batteries and the critical minerals that make them up. A Western intelligence official argues: “It took 30 years to build our dependency on China for critical minerals and rare earths, and it will take just as long to resolve it.”

But Jason Matheny, president of the Rand Corporation, who dealt with technology and national security in Joe Biden’s White House, is more optimistic. He points out that “rare earths are actually not that rare.” China’s real roadblock is the processing of critical minerals, which is often a very dirty business. But some countries with relatively low population densities, such as Australia, appear poised to deal with it.

The emerging Western approach to risk reduction is based on three major pillars: reducing dependencies on China, limiting technology exports, but also continuing to encourage Western companies to trade with China’s vast market. It is a more or less coherent policy, provided that the risk from which one hedges is political coercion. But it begins to crumble if the risk is a real war between the United States and China, perhaps over Taiwan. Unnervingly, some US officials now estimate the chance of a military conflict at 50% or more.

If that happens, Western companies will come under immediate pressure to withdraw from China. For a company like Apple, whose products are mainly produced in southern China, or Volkswagen, which makes at least half of its profits in China, which could spell the death of the company. On the other hand, as one Western security official puts it: “If there is a war with China, the impact on the world auto market will be the least of our problems.”

gideon.rachman@ft.com