Domestic Substitution versus Regional Diversification: A Strictly Matched Counterfactual Analysis of China's Manufacturing Supply Chains

Abstract Abstract Which approach more effectively reduces supply-chain exposure: domestic substitution or regional diversification? Using OECD Inter-Country Input-Output data for 2016–2022, we compare the performance of 19 Chinese manufacturing industries under these two strategies through strictly matched counterfactual simulations. Strict matching holds the target industry, donor economy, upstream industry, and input coefficient reduction identical within each pair, varying only the replacement supply destination. The analysis traces direct and indirect production requirements and distinguishes total external exposure, source concentration, and exposure to the largest single source. The results show that domestic substitution yields a larger reduction in total external exposure in all 399 matched pairs. Regional diversification produces lower source concentration in 242 pairs, but its advantage narrows as adjustment intensity increases. More notably, at an adjustment intensity of 20%, regional diversification reduces the Herfindahl–Hirschman index (HHI) in all 133 industry–year observations while increasing total external exposure in 122 of them. This occurs because alternative suppliers generate additional indirect foreign production requirements through their upstream networks. The central finding distinguishes reducing external dependence from redistributing it: a more balanced distribution of sources does not imply lower overall external dependence. We provide a transparent basis for evaluating sourcing configurations across multiple dimensions.