In this extract [1], portfolio managers of the BNP Paribas Aqua discuss how tense relations between the US and China have ushered in a new modus operandi for the global economy. While the world’s two largest economies have committed to working together in areas such as climate action, competing geopolitical interests cloud cooperation elsewhere.
Security concerns have driven the US to tighten controls on exports of cutting‑edge semiconductors to China and led to a ban on US investment in certain Chinese tech companies. Notwithstanding an improvement in the tone of US‑China relations after last November’s summit — described by Chinese state media as ‘positive, comprehensive and constructive’, the prospect of convergence looks remote.
The combination of trade barriers, tariffs, and large incentives are prompting a slow relocation of supply chains and manufacturing in strategic industries away from China. Fault lines in the Pacific are posing obvious challenges for some companies and are raising the cost of goods.
The trend towards decoupling could, however, reduce supply chain risks across the global economy and is already creating investment opportunities.
Decoupling can improve resilience and spur industry growth
Across several important sectors, the moment of ‘peak globalisation’ has long passed. The replication of supply chains involves costs that are ultimately borne by consumers in the form of higher prices, or by taxpayers via subsidies. Some degree of economic decoupling from China, which dominates aspects of many key global industries, could nonetheless help improve the resilience of the global economy.
The economic and operational impact of the Covid‑19 pandemic highlighted existing vulnerabilities associated with long‑distance manufacturing networks that rely on geographically concentrated suppliers. Local restrictions slowed and, in some cases, stopped the flow of raw materials and finished goods around the world, snarling up manufacturing processes.
Government support for targeted industries can now help develop local sectors and supply chains, and ultimately improve the buoyancy to deal with supply chain shocks. Take the battery industry: China dominates the global lithium‑ion battery supply chain, hosting 75% of all battery cell manufacturing capacity and 90% of anode and electrolyte production. US tax incentives for locally‑made EV components are encouraging the lithium‑ion battery recycling industry to expand: capacity is forecast to increase sixfold by 2030.
Fiscal stimulus for in‑focus sectors is meanwhile supporting the local growth of those industries and, by extension, boosting demand for supporting industries.
Now take chipmaking: according to the US government, companies have announced USD 166 billion in investments in semiconductor and electronics manufacturing after the 2022 Chips and Science Act, which includes USD 53 billion in direct support for the chipmaking industry.
More than a dozen major chip fabrication plants (or ‘fabs’) are being built in the US, with McKinsey estimating total investments of up to USD 260 billion. The multiplier effect of these investments means opportunities for companies whose products and services enable the construction, fitting and servicing of these facilities. We believe that equipment rental is one such sector that is well‑positioned to support the industry’s growth.
The Chinese government meanwhile is pursuing self‑sufficiency and global leadership in a range of sectors deemed strategically important. National high‑tech ambitions include technologies that hold the key to environmental solutions such as renewable energy equipment, industrial automation equipment and EVs.
Five of the largest 11 recipients of Chinese state subsidies in 2021, which totalled roughly USD 31 billion, were EV manufacturers or battery makers. Targeted state support has fostered the world’s largest EV market, creating opportunities for innovative (and investible) companies across the supply chain — in both hardware and software.
Decoupling is a slow process
While US and other governments have initiated efforts to diversify supply chains, there is recognition that this is not possible overnight. Pragmatism often prevails in the near‑term.
The EV battery sector illustrates this well. Rather than ban Chinese imports, the US government is using fiscal incentives to encourage an increase in domestic, or at least non‑China, production. Only EVs without battery components made in China will be eligible for a tax credit worth USD 7 500 per vehicle. Batteries made in the US, by US companies, using technology licensed from Chinese companies may be set to qualify, however.
We believe concerns that Western companies could lose access to the world’s largest market of middle‑class consumers are overdone. Take healthcare, where China’s large, ageing population represents a major market. Restrictions on access to drugs developed by overseas pharmaceutical groups, and often sold or manufactured with local partners, would negatively affect the health of the population.
Nonetheless, we remain mindful of the potential risks arising from the gradual decoupling of the Chinese and US economies. We actively track which industries and parts of the global supply chain look most at risk from geopolitical tensions, as well as those where opportunities might arise. The battery, solar and EV markets are all among those currently in focus.
Dislocations in global markets inevitably create risks and opportunities that active investors can pursue. 2024, a year of prominent elections — including in Taiwan and the US — is likely to present its fair share of both.
Why the US IRA is unlikely to be repealed – whatever the outcome
The Inflation Reduction Act, which is likely to direct more than USD 1 trillion in incentives to support clean energy, has become a major issue ahead of the 2024 elections. Former President Trump, the presumptive Republican candidate, has articulated his desire to unravel the IRA and reverse measures to support the energy transition.
Any US president’s ability to revise legislation depends on Congressional support. Even with Republican control of the White House, the Senate and the House of Representatives, it is our view that a total repeal of the IRA will not happen.
Our confidence rests on history. Despite Trump campaigning on the repeal of the Affordable Care Act (‘Obamacare’), efforts to repeal the act failed to pass in a Republican‑held Congress in 2017. In many ways, the IRA would be more difficult to repeal than the Affordable Care Act.
Since its passage in 2022, more than USD 160 billion has been committed by the private sector to new clean energy manufacturing facilities in states that often or sometimes have Republican congressional majorities. The federal election swing states of Georgia and Michigan are currently the top two destinations for new IRA‑related manufacturing investment, with thousands of new jobs on the way. A repeal would not be in the self‑interest of those states or their elected representatives.
State‑level political dynamics will matter, too. Today, 17 US states have legally binding 100% clean energy targets. These cannot be undone at the federal level.
There is, however, a real prospect for a Trump‑led administration to impair the implementation of certain provisions in the IRA, alongside executive orders to support fossil fuel production and downgrade climate action.
The threat of these actions, although damaging to sentiment, does not change our view about the lasting impact of policy support to date. Fundamentally, the economics of renewable electricity, EVs, and other advanced environmental technologies have improved to the point that they can outcompete incumbents – even without government subsidies.
Indeed, according to the IMF, global subsidies to fossil fuels amounted to more than 7% of global GDP in 2022, far outweighing subsidies for clean energy.
References
1 This is an extract from Outlook 2024 – Why prospects for a more sustainable economy remain undimmed
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