Trade & investment, explained.
The Chinese International Supply Chain Expo, 26 June 2026 in Beijing, China (Kevin Frayer/Getty Images)
Diversification away from China is real – but for most firms, wholesale exit remains commercially irrational.
Subscribe to The Informer for monthly expert analysis, and to Events for advance notice of visiting world leaders and distinguished guests.
You may unsubscribe from Lowy Institute newsletters at any time. For information on our privacy practices and how to unsubscribe, see our Privacy Policy.
When geopolitics outruns the economics of supply chainsWhen geopolitics outruns the economics of supply chains
Geopolitics is changing where firms manufacture faster than it is changing where the economic advantages of manufacturing reside. East Asia captures this dilemma particularly well. Japanese manufacturers are diversifying portions of production away from China towards Southeast Asia and India, while retaining large-scale operations within China. Chinese manufacturers are moving in the opposite direction, expanding production abroad as tariffs, market-access conditions and localisation pressures make overseas manufacturing increasingly necessary.
These movements run in opposite directions but expose the same underlying tension. Japanese firms must decide how much production can economically move away from China’s industrial base; Chinese firms must determine how much of that network can travel with them as they internationalise. In both cases, the factory is only part of the calculation.
Diversification away from concentrated production in China is real: surveys by the Japan External Trade Organization (JETRO) (Opens in new window) point to Japanese companies rebalancing manufacturing locations. Japanese electronic component maker Tamura plans to reduce its production bases in China, (Opens in new window) while fellow component maker TDK is adding battery-cell production in India even as China remains its principal production base for these batteries. Yet diversification has not generally translated into wholesale substitution of China.
For many firms, China's supplier depth, scale, skills and manufacturing capabilities remain commercially attractive even when geopolitical risk argues for reducing exposure.
Whether a component is produced in China therefore becomes less important than whether China remains embedded anywhere behind it.
Chinese manufacturers confront the reverse challenge as they expand overseas. Their internationalisation involves more than establishing final-assembly plants: suppliers are beginning to follow lead firms abroad (Opens in new window). Chinese electric-vehicle makers entering Europe, for instance, must decide whether to export from China and absorb trade barriers, assemble locally while retaining much of their Chinese supply chain, collaborate with European partners, or undertake deeper localisation. Chinese electric-vehicle maker Xpeng has opted for local assembly through Magna in Austria (Opens in new window), illustrating one response. European policy, meanwhile, is moving towards extracting greater domestic value from foreign investment: the proposed Industrial Accelerator Act (Opens in new window) includes “Made in EU” provisions and seeks to ensure that foreign investment contributes more directly to European industrial capacity.
The result is a tug of war. Chinese firms want access to European markets while preserving their competitive advantage; Europe wants Chinese investment, but increasingly on terms that create jobs, suppliers and industrial capabilities within Europe. Political geography is beginning to circumscribe the economic geography that Chinese firms would otherwise prefer.
There is an even more consequential possibility: what happens when national security, rather than commercial efficiency, becomes the overriding objective? SpaceX offers a revealing example. Its reported efforts go beyond removing production or suppliers located in China. (Opens in new window) The ambition approaches the creation of supply chains with zero Chinese exposure, extending scrutiny to supplier personnel, equipment and internal systems. Whether a component is produced in China therefore becomes less important than whether China remains embedded anywhere behind it.
Here, efficiency is no longer the principal consideration: political geography, driven by national security, overrides the economic geography of efficiency. Yet this creates its own paradox. The deeper scrutiny extends through suppliers and sub-suppliers across multiple countries, the more costly monitoring and verification become – without ever providing complete certainty that every Chinese connection has been eliminated.
These developments reveal different dimensions of the same supply-chain transformation. Japanese firms confront the problem of diversification: geopolitical risk encourages them to reduce concentration in China, while commercial logic continues to favour access to its industrial base. Chinese firms expanding abroad confront the problem of localisation: they seek to carry with them the suppliers and capabilities underpinning their competitiveness, while host governments increasingly want more of that value created locally. SpaceX represents the furthest point on this spectrum – de-Sinification – where national security seeks to override commercial efficiency by eliminating Chinese exposure even within third-country supply chains.
The implications go beyond where the next factory is built. A “China plus one” approach can reduce concentration risk, but it cannot by itself answer how much production should move, which locations offer durable geopolitical resilience, or how deeply alternative production networks remain connected to China. Nor can governments assume that directing investment elsewhere will reproduce the capabilities required.
The emerging contest is therefore not simply over the geography of manufacturing, but over the terms on which industrial networks are reorganised. Firms will continue to balance efficiency and resilience; governments will increasingly add national security to that calculation. Sometimes these objectives will coexist, sometimes they will pull in opposite directions, and in extreme cases security may override efficiency altogether. The harder governments and firms push the two apart, the more costly and uncertain that separation is likely to become.
About the author
G. Venkat Raman
G. Venkat Raman is Professor of Humanities and Social Sciences at the Indian Institute of Management Indore, where he teaches and researches geopolitics, China, and global governance.
The most-pressing world events explained by Lowy Institute experts and global contributors, in your inbox, every Thursday.
You may unsubscribe from The Interpreter at any time. For information on our privacy practices and how to unsubscribe, see our Privacy Policy.
