The 21st century will be dominated by four major trends (and myriad sub and derivative trends) that corporate decision-makers and investors will have to successfully navigate in order to thrive and perhaps survive. The rise of China and the nature of its relations with the United States; climate change; the technological revolution and the impact it will have on societies and the nature of ‘work;’ and the role of the United States – as the defender of the norms and rules that it designed and benefited from in the post-war era: these are the tectonic issues of our time and they are already profoundly impacting the operating environment.
While each of these trends warrants a book, let alone a single chapter, the latter three are relatively slow-moving, and their trajectories will ultimately very much reflect the aggregate action of actors from nation states to individual citizens. It is China’s emergence as the world’s largest economy (on a purchasing power basis) and the evolution of its relations with the U.S. – the single most important bilateral relationship of the century, that is playing out in ‘real time.’ In this process, national-level decisions and objectives are having a profound impact on the global economy, the post-war geopolitical alignment landscape and the role of the U.S. as the global hegemon.
While locked in a trade dispute, both economies face building (and related) economic headwinds and the leaders, Donald Trump and Xi Jinping, each face domestic pressures to ‘win’ – though it is unclear that the two sides are even playing in the same game. But it is nothing less than technological superiority and economic self-determination that is at stake, and the ramifications for countries, companies and citizens are profound.
Complicating the picture is the U.S. presidential election in November 2020 and the rapidly developing impeachment process. While there are indications of coming economic weakness, U.S. headline data has remained remarkably resilient in 2019 and economists are split on whether or not a recession looms, and if the onset would be timed to impact the election. While Mr. Trump fronts an unarguably sui generis presidency, it is also true that the ‘power of incumbency’ effect is strong in the American system. The Democrats are going through the arduous process of finding their candidate to stand against Trump in the general election. It is tempting to think of the country polarizing into “anyone but Trump” and “MAGA” camps, but Trump’s approval ratings inched up over the summer to the highest levels of his term. There are mixed data messages – his job approval ratings have never been above 50%, but his personal favorability rating has increased by about ten percentage points since he was elected. This election promises to be as partisan and, frankly, nasty as any we’ve seen. As such, and particularly considering moderating economic data, and the need to distract from the impeachment narrative, having China as bete noire may serve the President’s narrative. Furthermore, taking a strong line on Beijing (and not signing on to an agreement that while addressing the trade balance, fails to address the structural issues the U.S. has with China) deprives the Democrats of one avenue of attack against the incumbent.
Trade Talk Jockeying
Earlier in 2019, it appeared that the U.S. and China were headed toward an agreement… until it abruptly fell apart. In the event, the wording of the lengthy draft document stipulated a heavily imbalanced set of actions on the part of China, without corresponding concessions on the part of the U.S. Ultimately, this was untenable for Xi Jinping. There is a tendency in the American media to portray Xi as a nearly omnipotent leader, especially now that China has eliminated term limits and he faces the possibility of an ‘endless presidency.’ The reality of course, is more nuanced. China’s elite is more factional than simplified reporting suggests and Xi needs to justify the mandate with which he’s been entrusted. Therefore, he is no more able to deliver a flawed deal than Trump is. But it is also possible that China waited too long to reach an agreement – and this led to a moving of the goalposts. In essence, Trump doesn’t actually have many articulated grievances with China, other than trade. And the trade deficit is a number that can be ‘fixed.’ Trump doesn’t take an interest in China’s internal affairs (such as the treatment of the Uighurs in Xinjiang) or Taiwan and he doesn’t engage in a philosophical debate over the merits of representative democracy over Communist Party rule. Trump’s focus has been near single-mindedly on trade and his preferred instrument for action is tariffs, with a resultant clear impact on multinational corporations, even purely domestic ones.
It is certainly the case that China has taken advantage of and prospered under the system of globalization promoted and defended by the U.S. Between China’s accession to the WTO and 2016, the country’s GDP grew from $1.3 trillion to $11.2 trillion, a near nine-fold increase. As such, its share of global GDP quadruped to near 16%, and it has accounted for roughly one third of global growth since 2012. China became the world’s largest exporter in 2009 (displacing Germany) and between 2000 and 2017, it went from producing about a quarter of America’s manufacturing output to generating more than the U.S. and Japan combined. While much is made of recent headline data showing Chinese growth slowing to the lowest level since 1990, the reality is that the economy has been in a structural slowdown for a decade. While it is difficult to detail precisely what Chinese growth is, it is still roughly double the U.S. growth rate and essentially equivalent to growing by the size of the Australian economy. At the same time, global cross-border investment, trade, bank loans and supply chains have been diminishing relative to global GDP – exacerbated no doubt by Sino-American tension, but frankly underway since the financial crisis.
The Tariff Battles
U.S.-imposed tariffs have had an impact, and the trade balance with China has indeed narrowed. However, it is worth noting that the U.S. deficit in goods trade with the world overall has continued to widen, meaning tariffs have served to shift the point of origin of goods, whereas the overall trade balance is determined by the U.S. savings and investment balance. Of course, considering the trade balance alone distorts the full picture of the economic relationship between the two countries. The U.S. is increasingly evolving to a services-based economy – and therein it has a surplus with not just China, but the world. Furthermore, revenues and profits made by subsidiaries of U.S. companies and their affiliates aren’t counted either. Nevertheless, there are costs. The IMF has estimated that tariffs imposed by the U.S. and China will cut global growth by 0.5% – that may not sound significant, but it equates to about $450 billion, which is bigger than the South African economy.
Through July 2019, tariffs on Chinese imports have raised about $21 billion. However, the administration has already committed to aid farmers hurt by the trade war to the tune of $28 billion. Even so, farm bankruptcy filings are up 13% through June 2019, year-on-year. This following the decline in farm product exports to China from $24 billion in 2014 to $9 billion in 2018. While some observers may be incredulous that 70% of farmers still backed Trump in August, it is notable that the support was 79% as recently as July 2019.
For its part, China has retaliated, and it should be noted that its moves have essentially been proportional and responsive rather than pre-emptive and escalatory. Having said that, China has definitely targeted industries with jobs that are concentrated in districts that voted for Trump. This highlights one of the risks of engaging in a trade war with an autocracy – it can and will focus its punishment on its adversary’s politically sensitive pressure points, even at the expense of its own consumers and economy, whereas democratic government must consider the ballot box ramifications of weaponizing trade tools.
Due to the trade imbalance, the U.S. has more to tariff than does China. But Beijing has numerous weapons in its arsenal with which to fight this battle. It can restrict U.S. access to rare earths metals, it can (slowly) diversify its holdings of U.S. Treasuries, it can further loosen in-country IP protections. And, it can use tourism as a weapon. China is the biggest source of tourists in the world, spending over $250 billion last year (vs. less than $150 billion by Americans). Indeed, Chinese spending in the U.S. is now America’s biggest ‘export’ to China. There is certainly a precedent: following the deployment of the THAAD missile defense system in South Korea in 2017, Chinese tourism to South Korea fell by 50% – jeopardizing the Olympic Games attendance and therefore revenues. A 50% reduction in travel to the U.S. could mean an $18 billion hit to the American travel industry.
All of the above is important to markets and to the global economy in the near term. But the reality is that as complex and dislocating as the trade war is, it is one battle in the bigger war. China has an articulated objective of technological dominance and regional hegemony, while the U.S. wants to remain the technological superpower. It is this strategic competition that will dominate the geopolitical and geo-economic narrative for the foreseeable future. It is also why there is bi-partisan support for a hard line on China (as evidenced by not one of ten Democratic presidential candidates indicating in a debate that they would roll back the Trump-initiated tariffs). This battle represents the single biggest threat to the U.S.-built (and heretofore protected) global order. So, while the trade balance can be solved with relative ease, the bigger challenges lie ahead.
It is important to remember that China is actually not trying to remake the global order in a wholesale fashion; it is seeking to revise rather than replace key elements of the international system. China is a big country and the ruling elite need to provide their citizens with a pathway to better lives. China’s population in aggregate has about a quarter of the standard of living of the rich Western countries. If that standard of living were to increase to just half, China’s economy will be larger than the U.S. and EU combined. But ‘getting rich’ doesn’t happen in a vacuum – the subjugation of China by smaller European powers in the past is seen as justifying the leaders’ need to be militarily and technologically strong as well. And Xi, knowing that China is facing an acute demographic cliff (due to the legacy of the one-child policy) later this century, must harness his country’s formidable human capital now.
The period between the end of World War II and the series of compounding shocks of foreign policy overreach (characterized by the Iraq war), the western financial crisis, and inequality in the U.S. reaching levels not seen since the eve of the Great Depression, that led to a crisis of confidence in the U.S. role in the world, saw the U.S. emerge as the greatest military, economic and ‘soft’ power the world had ever seen. A new sense of vulnerability has led to a National Security Strategy that no longer attempts to guide China to make ‘the right strategic choices for its people, while we hedge against other possibilities” (2006), but rather views Chinese power as malign and treats Chinese capabilities and intentions as the same thing, rather than assuming that an economic power that is becoming the largest in the world would understandably want to protect its position.
Replacing the U.S.?
“China seeks to displace the U.S. in the Indo-Pacific region, expand the reaches of its state-driven economic model and reorder the region in its favor,” (National Security Strategy 2017). On the other hand, for a country that is highly dependent on imported raw materials and remains a primarily export-driven economy, it makes sense that it no longer wants to outsource the security of its supply chain to the U.S. Navy, as it has effectively done.
The assumption coming out of the Cold War was that the collapse of the Soviet Union proved that autocracies couldn’t thrive economically. Therefore, China would either have to become a democracy (of some sort) or fail economically. But China has done neither. And rather than “The End of History,” the world has seen some eighteen democracies disappear since 2000. The Communist Party view has been, particularly since Tiananmen Square, that prosperity is a function of stability rather than democracy. It is this conviction that also drives China’s control over the internet, social media and personal data. The Great Firewall of China is not only the greatest non-tariff trade barrier in the world (allowing for the rise of domestic tech giants that don’t really have to compete with America’s most innovative companies such as Google and Facebook), but it enables even greater political control.
Trade wars, American resistance and the need to control the tiller on the economy are driving China’s ambition to further its indigenous innovation. China spends more on importing semiconductors than it does on importing oil. But the move to 5G, the Internet of Things (IoT) and Artificial Intelligence is creating an opportunity for China to make a giant leap. In 2018, China filed almost as many patents as the U.S. did, and fully 10% of those were by Huawei – a company that employs 80,000 people in R&D alone. The U.S. government and many U.S. companies are adamant that Chinese telecom equipment and software suppliers in general – and Huawei in particular – constitute a strategic threat to the U.S. ‘ecosystem.’ The fear is that whoever controls the networks, ultimately controls the information flow. There are concerns that ‘back doors’ are built into the systems and that China, employing its 2017 National Intelligence Law compelling companies to cooperate with the government, wherever they operate, could even shut networks down.
But there are near-term questions about whether the U.S. administration is actually committed to this fight and if its primary concern is with national security on this front. The President has undercut the Department of Justice by suggesting that charges against Huawei CFO (and daughter of the company’s founder) Meng Wanzhou could be dropped as part of a trade deal. The precedent being the easing of penalties on ZTE after a personal appeal to the president by Xi himself. In other words, the signaling is confusing.
For multinational corporations, the stakes are high. The administration’s hostility to globalization by definition targets the phenomenon’s greatest economic actor – the MNC – as much it does China itself. And herein lies the rub: the Administration and other China hawks believe the U.S. and China should be economically and politically decoupled. They want to unlink global supply chains and envision a less open and more protected economic operating environment. This will lead to further insecurity on the part of allies and doubts about the viability of international institutions. But for the President himself, trade is demonstrably paramount, and it is fair to say the world is unlikely to see another president so economically focused. As Financial Times columnist, Janan Ganesh, puts it, “until now, it has been soothing to regard Trump as the storm before the calm. He would disrupt U.S.-China relations and future leaders would mend them again. But the opposite could be true.” So, the election matters for China-U.S. relations. And the multinational corporation must be vigilant and on-point to defend against becoming collateral damage in this epochal battle.