Over the past 40 years, demand for cheaper goods pushed American factories and sourcing offshore to China. Now that China has positioned itself as a challenger to U.S. global leadership, the relationship has changed and the geopolitical risk of manufacturing or sourcing in China has grown. This changes the calculus for firms making sourcing decisions. American companies now endure numerous risks when operating in China and enjoy diminishing advantages, calling into question America’s dependence on China for manufacturing. Comparatively, domestic sourcing carries minimal risk and, in many cases, may be more affordable than manufacturing overseas. As bilateral relations erode, businesses will need to address the emerging risks of economic decoupling and war. By reshoring, firms can hedge against these concerns and help maintain a stable international order.

Risks and Declining Opportunities

Businesses face varied risks when they source in China. Annually, U.S. industry loses $225 billion to $600 billion in revenue from China’s theft of American intellectual property. This is a byproduct of Chinese industrial policy; IP is stolen and put to use by state-controlled companies that enjoy subsidized production and exclusive access to markets. Because most IP is taken from foreign direct investment, innovative U.S. firms face this risk merely by operating in China.

Businesses must also contend with risks from China’s authoritarian governance. Firms can’t operate in China without Chinese Communist Party (CCP) approval. This presents challenges for management, as decision-making becomes subject to party influence. This restriction directly hurts manufacturing, as demonstrated when the Zero-COVID policy halted many industries. Such mercurial policies not only threaten disruptions to production but also negatively impact a company’s value as investors balk at the uncertainty.

Additionally, sourcing in China faces the risk of international sanctions levied in response to the CCP’s repressive policies. China is currently perpetrating human rights abuses against Uighur Muslims in the provinces of Xinjiang and Tibet. As the extent of these crimes is revealed, countries are likely to restrict the import of Chinese-made goods. China also has abysmal environmental standards, polluting more than any country of similar developmental level. As the impact of climate change accelerates, tolerance for environmental irresponsibility will diminish, and emissions-based tariffs will raise the cost of doing business in China.

Sanctions on China impose risks to any foreign organization operating there due to Beijing’s counter foreign sanctions law. This law codifies the means through which the Chinese government can retaliate against organizations affiliated with a sanctioning body – meaning that, if the U.S. sanctions China, U.S. companies can be the targets of Chinese reprisal.

China is extremely susceptible to drought. Beyond its human implications, a disruption in the Chinese water supply would massively disrupt global food-supply chains (China produces 25% of the world’s grain), shrink the available labor force, and curtail much of China’s industrial capacity. Droughts are hard to predict, so by transferring production to the U.S., firms hedge against that uncertainty.

Also, U.S. firms are reaping fewer rewards from manufacturing in China. China is simultaneously facing a population decline and a rise in labor rates, meaning that the cost advantage once enjoyed by American companies is disappearing. As the gains of manufacturing in China shrink, the risks grow.

All these risks are amplified when considering the fragility of transoceanic, just-in-time supply chains. The pandemic clearly demonstrated that shortages of critical goods would result from an anemic U.S. domestic manufacturing capacity and lack of inventory. Chinese geopolitical risks expose firms to similar supply-chain disruptions. The deteriorating U.S.-China bilateral relationship is a much more predictable situation than the emergence of a novel virus. Relying heavily on China, or any nation in Southeast Asia, for manufacturing exposes a company’s sourcing to unnecessary supply-chain risk if a conflict between the two superpowers ignites. Reshoring products most vulnerable to supply-chain disruption would provide maximum predictability and security.

Decoupling and War

An emerging risk of overreliance on Chinese manufacturing is the threat of economic decoupling from the U.S. As the Chinese economy matures, it will have less demand for external investment and consumption. China has shifted its focus toward domestic industries (as detailed in the “Made in China 2025” plan), absorbing foreign-owned businesses and restructuring joint-venture agreements, thus compelling more technology transfer and facilitating greater IP theft. China’s strategy is aptly described in Germany’s “Strategy on China” document, which states: “China’s economic strategy aims to make it less dependent on other countries, while making international production chains more dependent on China.”

When China achieves a combination of sufficient industrial capacity and consumer demand, it will be capable of decoupling unilaterally. If this happens, the Chinese market will become more restricted or completely cut off to U.S. firms, hurting their ability to manufacture and sell products in China and supply the U.S. market.

A China-initiated unilateral decoupling holds the greatest risk to U.S. manufacturers if domestic alternatives remain inadequate. A decoupled China and industrially weak U.S. disrupts the balance of power, effectively removing any credible economic deterrent that the U.S. has against Chinese aggression toward Taiwan. If the economic disincentives of lost U.S. business are removed, a self-sufficient China will be emboldened in its pursuit of Taiwan. Further, American economic insecurity caused by a decoupled China increases the likelihood that the United States would see itself as a declining power caught in the Thucydides Trap, leading the U.S. to be more aggressive in an effort to to arrest China’s ascent.

Reshoring mitigates the risk of decoupling from (or by) China because it slows China’s growth and stymies the current flow of stolen IP that is boosting China’s domestic industrial rise. If American manufacturers return home, the renewed industrial strength of the U.S. will strengthen American deterrence of Chinese regional aggression and allow the U.S. to compete more effectively with any Chinese attempt at decoupling unilaterally.

Total decoupling between the U.S. and China is risky because it increases the likelihood of war between the two countries. When economic ties are severed, few disincentives exist to restrain either country from pursuing its geopolitical goals, and when those goals are as disparate as those of the U.S. and China, the likelihood of war grows.

If a war between the United States and China occurs, it will become practically impossible to recover capital from China or Taiwan, and the risk of expropriation will be elevated. Because Beijing seeks to reclaim control over Taiwan, if the U.S. commits to defending Taiwan, the entirety of the Asia-Pacific will become a battlefield of a kind yet unseen. Current estimates place the risk of a Chinese move against Taiwan at around 3.5% per year, but that risk can be expected to rise if fewer economic disincentives are at play, as would be the case following decoupling.

What We Can Do

Compared to China, domestic sourcing is free from geopolitical risk for American firms, and in many cases, domestic sourcing is more cost-effective.

When companies source based on Total Cost of Ownership instead of Free on Board (FOB) price, 30% of products are more profitably sourced domestically. If a 25% Section 301 tariff applies, that sourcing proportion rises to 50%. Allowing for geopolitical risk raises the percentage still further. Firms can compare sourcing in China to sourcing in the U.S. by utilizing the Reshoring Initiative’s free online “Total Cost of Ownership Estimator.” A revised edition with the aforementioned risks factored in is set to be released later in 2023. The Estimator will help the user calculate the margin reduction on sales lost due to a geopolitical event. The economic feasibility of reshoring is clear and is demonstrated by the fact that the rate of reshoring plus foreign direct investment (FDI) in the U.S. has surged from 6,000 jobs/year in 2010 to 360,000 jobs/year in 2022.

Globalization makes it prudent for companies to include an estimate of geopolitical risk in the evaluation of each domestic and foreign source. Geopolitical considerations have the potential to greatly affect revenue, and the ability to mitigate those risks should be factored into sourcing decisions. As Bindiya Vakil, CEO of Resilinc, a leading supply-chain risk-management firm, stated: “Procurement from suppliers should not rest solely on cost savings, but also on revenue impact.” It is now clearly good business for a company to spend a few dollars more to have all of the components available so that it can ship the end product and make thousands of dollars in margin. This sentiment was echoed by Paul Bingham, director of transportation for S&P Global’s economics and country risk division, when he said, “By diversifying supply chains you’re buying insurance, which is really what it boils down to, so that your business can survive if there is ever an enormous disruption in the relationship with China.”

The Reshoring Initiative has posted our best estimates of the annual probability of a major geopolitical incident for nine countries and six regions, along with sources for our estimates. For example, we estimate the probabilities of a major impact on sourcing to supply the U.S. market to range from 0.05% per year for U.S. sources to 0.4% for Mexican to 3.5% for Chinese.

The advantages that businesses once sought through single-sourcing in China are rapidly vanishing, and the current state of U.S. manufacturing undercuts America’s ability to maintain its leadership against a peaking China. By bringing manufacturing back home, American firms simultaneously shield themselves from this risk and help the United States continue to stabilize the world. A declining U.S. and surging China is the worst-case scenario for peace. By contrast, a strong America can deal confidently and flexibly with a surging China. If China knows that it will peak before the U.S. sufficiently declines, it will be motivated to deal pragmatically with the U.S.

Harry Moser is the founder and president of the Reshoring Initiative. He holds engineering degrees from MIT and an MBA from U of Chicago, has 55 years manufacturing experience and is in the Industry Week and Association for Manufacturing Excellence (AME) Halls of Fame. Daniel O’Hara graduated from Penn State University in 2021 with a B.A. in International Politics. He is a Reshoring Initiative volunteer on projects related to geopolitical risk and U.S.-China issues while pursuing employment in the field of international relations.