It’s US vs. China in an Increasingly Divided World Economy

For decades, the U.S. and other Western countries sought to make China both a partner and a customer in a single global economy led by the richest nations. Now trade and investment flows are settling into new patterns built around the two competing power centers.

In this increasingly divided world economy, Washington continues to raise the heat on China with investment curbs and export bans, while China reorients large parts of its economy away from the West toward the developing world.

Benefits for the U.S. and Europe include less reliance on Chinese supply chains and more jobs for Americans and Europeans that otherwise might go to China. But there are major risks, such as slower global growth—and many economists worry the costs for both the West and China will outweigh the advantages.

The strategies are growing harder to unravel as both sides sink more resources into them.

Chinese factories are replacing Western chemicals, parts and machine tools with those from home or sourced from developing nations. China’s trade with Southeast Asia surpassed its trade with the U.S. in 2019. China now trades more with Russia than it does with Germany, and soon will be able to say the same about Brazil.

China’s outbound investment now mainly goes to resource-rich places like Indonesia or the Middle East, rather than to the U.S.

Major Western companies including Apple, Stellantis and HP are looking to shift production from China. Financial firms like Sequoia Capital have moved to curb or ringfence their China activities.

More than one-third of U.S. companies surveyed by the U.S. China Business Council, which represents American companies in China, said they’ve reduced or paused planned investment in China over the past year, a record high and well above 22% last year.

“The world is splintering into rival spheres,” said Noah Barkin, senior adviser with Rhodium Group, a New York-based advisory firm. “There is a momentum…that in a way is self-propelling. There is a risk it accelerates over time and becomes more difficult for governments to manage.”

Slow growth

The International Monetary Fund said in October that fragmentation between China and the West was weighing on the world’s economic recovery this year. A more severe break between U.S.- and China-led blocs could cost the global economy as much as 7% of gross domestic product, worth trillions of dollars, IMF research suggests.

The economic split deprives companies of access to vital markets that drive profits and makes it harder to share technology and capital, depressing growth.

Costs are already adding up for major companies, especially in European nations like Germany, which thrived in recent decades by selling autos and high-end machinery to China. German and Japanese automakers like Volkswagen and Toyota now account for about 30% of China’s auto market, down from almost 50% three years ago, as Chinese brands have expanded, according to the China Association of Automobile Manufacturers.

From China’s standpoint, an economic sphere of influence with Beijing at the center might not offer enough growth to keep the country from slipping into long-term stagnation as it faces collapsing birthrates and excessive debts. China’s success has depended heavily on access to the West’s big-spending consumers and technologies.

U.S. imports from China in mid-2018 accounted for as much as 22% of all its imports. In the 12 months through August, that had shrunk to 14%, according to Census Bureau data, though in dollar terms bilateral trade has grown.

Some Western money is returning to the U.S., or going to places like Mexico and India, which attracted four times as much investment in new factories and offices as China last year, according to data from the United Nations Conference on Trade and Development.

Kempower, a Finland-based manufacturer of fast chargers for electric vehicles, plans to invest $40 million over five years in the U.S., said its chief executive officer, Tomi Ristimäki.

He hopes the U.S. will become as important to the company as Europe, and said he has no plans to enter China’s electric-vehicle market. “The political atmosphere has changed. We are not concentrating on China,” he said.

Jungheinrich, a Hamburg, Germany-based forklift truck manufacturer with annual revenue of nearly 5 billion euros (about $5.3 billion), put China at the top of a strategic agenda it published in 2020, aiming to expand its footprint there. The company recently replaced China with the U.S. as its priority market, said its chief executive officer, Lars Brzoska.

Jungheinrich hasn’t made a decision on whether to move out of China, where it has two factories and almost 1,000 staff, Brzoska said, particularly in times of heightened geopolitical tensions.

“Everybody’s thinking about a potential invasion of China into Taiwan,” Brzoska said. “If this happens, it’s a big, big issue for the whole world. We may be better off with a different footprint.”

‘Two to tango’

China, meanwhile, has invested big sums in Indonesian nickel factories to supply China’s EV industry. Tech firms Tencent and Alibaba have expanded across Asia, Africa and Latin America. Other Chinese companies have targeted renewable energy projects in Latin America and Africa.

Latin America, Africa and developing markets in Asia now account for 36% of overall Chinese trade, compared with 33% for its trade with the U.S., Europe and Japan, according to a Wall Street Journal analysis of Chinese customs data. As recently as last summer, that trio of advanced markets accounted for a larger share of Chinese trade.

Part of the explanation is Chinese factories are moving to countries such as Vietnam, India and Mexico to keep selling to U.S. customers while avoiding U.S. tariffs. But China’s growing expertise in affordable smartphones, cars and machinery that appeal to developing-world customers is also helping drive the shift at the expense of Western rivals.

Chinese automaker Great Wall Motors said last year it would spend $1.9 billion in São Paulo state in Brazil over the next decade to produce hybrid and electric cars. BYD is investing $600 million in Brazil and $500 million in Thailand, where it’s a top EV seller.

Chinese home appliance maker Midea Group last year opened new facilities in Egypt and Thailand, and is building plants in Brazil and Mexico to serve local markets.

“While it might seem that the West is driving decoupling, as they say, it takes two to tango,” said Allen Morrison, professor of global management at Arizona State University’s Thunderbird School of Global Management and co-author of a book on business strategy for China.

Back in China, local brands like Genki Forest are increasingly vying with Western names such as Coca-Cola. A new Huawei Technologies smartphone with ultrafast data connectivity uses a Chinese-made semiconductor, helping it compete with Apple.

As Chinese companies displace Western makers of tools and components for finished goods, the country’s use of imports in industrial production has declined by around 50% since its 2005 peak, even as exports have grown, according to data from CPB, a Dutch government agency that tracks global trade.

The widening split follows decades of integration. China’s opening up in the 1980s and its accession to the World Trade Organization in 2001 ignited a new phase of globalization, bringing investment to China and cheap consumer goods to Western consumers.

That economic order started to crumble when Western leaders began questioning China ties, which had decimated job markets in some U.S. and European communities. Western companies complained they had to hand over technology to Chinese partners in return for market access.

In its initial stages, economic decoupling was hesitant and mostly centered on trade in products directly affected by U.S. tariffs on Chinese imports such as semiconductors, computer hardware and auto parts.

After President Donald Trump raised tariffs on around 60% of Chinese imports, President Biden moved to prevent China from acquiring high-end computer chips and imposed new curbs on U.S. investment into China. Washington has dangled billions of dollars in subsidies to draw manufacturing back home.

Foreign direct investment into China over the four quarters through June was 78% lower than it was a year earlier, Chinese data show.

A complete decoupling between China and the West isn’t in the cards though, assuming there’s no military conflict.

China’s low production costs and vast consumer market still make it indispensable for many companies. BASF, the German chemicals company, is investing up to around $10.5 billion in China through 2030. Starbucks, Ralph Lauren and Hormel Foods have been expanding there.

Brands with links to China such as TikTok and fast-fashion giant Shein are also building large businesses in the U.S., though they face political pressure that could constrain their growth.

While U.S. imports of Chinese products such as semiconductors and IT hardware have tumbled in response to tariffs, purchases of toys, games and other products not hit by Trump-era duties have soared, according to analysis by the Peterson Institute for International Economics.

Chinese officials say they still welcome Western investment, including companies like Tesla, which is scaling up battery production in Shanghai. Washington describes its policy toward China as “a small yard with a high fence,” meaning it only wants tight controls in sensitive sectors such as computer chips, but otherwise wants bilateral trade and investment to continue.

Still, the evidence suggests the loosening of economic ties between China and the U.S.-led West is gathering speed. In September, Xi skipped a meeting of the Group of 20 major economies after Beijing persuaded members of the Brics economic group, with Brazil, Russia, India and South Africa, to invite more members, including Egypt and Iran.

“We are at the end of the beginning,” said Adam Slater, lead economist at Oxford Economics. Decoupling “does have some momentum now, and I think it has a way to run.”

Write to Jason Douglas at jason.douglas@wsj.com and Tom Fairless at tom.fairless@wsj.com