Managing China’s decline.
Ten years back it had appeared that China’s ascent to global economic and, as a result, military hegemony was a sure bet. For the prior two decades Beijing surely could not believe it’s luck, being invited to fully participate in the global economy by the US, and West, and multilateral agencies, there by being given a leg up with the assumption that Chinese economic development would be a win win. China would secure access to markets, finance and technology, it would benefit from rapid economic development and, as living standards improved, the assumption was that its Communist leadership would eventually succumb to ceding democracy to its population. The result would be a China ‘more like us’, and less liable to be a strategic and military rival and threat to the West, but instead a partner.
Western capital quickly embraced the opening up to China. In the late 1970s Western economies were themselves struggling with competitiveness problems, an oil price shock, and over-regulation, including ever increasing environmental standards and increasing pressure from organised labour, increasing the costs of doing business and making it even more difficult to compete with newly industrialised Asian countries. Many of the latter with typically more managed political regimes, but with planned economic development models and free labour markets. Western capital/multinationals saw literally “manna from heaven” able to exploit cheap Chinese labour, made docile for them by the authoritarian vents of the Chinese Communist party, and a managed undervalued exchange rate, plus next to no environmental standards. The Chinese state reaped the benefits from huge current account surpluses, intervening to keep the CNY cheap, building a huge war chest of FX reserves ($3.2 trillion as of June 2024), and therein global buying power in the process. China was able to exploit its economic muscle - the pull factor - by demanding technology transfer from multinational companies where they could, and stealing technology where they could not.
Western consumers initially thought they were also getting a great deal as well as they benefitted from cheap China imports, global deflation as a result, and seeming real wage gains as a result - turning a blind eye to Chinese labour exploitation, and environmental destruction. That also blinded them to the export of Western manufacturing jobs east, and the destruction of organised labour, and hence the negotiating power of Labour in Western economies. But they were being moved down the global value chain with their jobs de-skilled. Elites, the upper and middle classes, in the West and China benefitted greatly. One might argue that Chinese labour even benefitted from securing employment, rural to urban migration and perhaps now better economic and social provision.
It is though now pretty clear that the big losers in all this was labour in developed economies, which eventually saw the emergence of rust belts and now a voice given to this impoverished class by the likes of MAGA and Brexit. The irony though is that many of the backers of MAGA and Brexit are many of the same billionaires and industrialists that did best out of the China trade for the prior thirty years. One has to question their concern now for the poor state of the working classs in developed markets, the very same class that they worked so hard to undermine by actively supporting the export of jobs to China. The new MAGA and Brexit elites have perhaps now realised that their ticket to holding on to political power rests in Rust Belt/Red Wall constituencies, and now want electorates to believe they care about the lot of the workers they sold out on years back. It is though a powerful message that resonates with working class voters - ‘China stole their jobs and prosperity’ and it was somehow the deep state that drive that process. Even though the reality is a little more complex and Western capital played a central part, and even massively prospered in the trade.
The upshot of all this is a new world of tariffs, protectionism and trade wars as the US, realising that the Chinese communist party has no intent to surrender to democracy (that should have been clear after Tiannamen), but was on track for economic and military hegemony, has tried to counter China’s economic ascent. And in Western political and policy circles the agenda to rein in China has become so politically irresistible that it is now mainstream.
The West seems to have caught China just in time. And it is striking is that this policy appears to be working to slow China’s inevitable, not so long, march to global economic hegemony.
The Chinese model had, indeed, appeared invincible. Globalisation, combined with a cheap currency, and a newly (less new now) Asian industrialising planned model of development, backed by a huge wad of foreign exchange reserves able to buy access to global markets and natural resources supplies via the One Belt One Road initiative, had appeared as a turbo charged model of development. Chinese policy makers appeared to have the long vision, and made few mistakes. Unlike the US, China avoided getting involved in costly and ultimately failed wars. The full focus was on economic development and hegemony. China appeared invincible and its policy makers geniuses.
But China is now making mistakes. And Chinese policy makers, we are now realising, are only human.
With the main conduit of its economic rise - globalisation - increasingly constrained by the U.S., and ultimately fearful of a military clash with the U.S., for the first time we are seeing indecision by Chinese policy makers.
Faced by an increased US threat, Xi has responded by concentrating power, taking out rival power centres. But this has just accentuated his problems as it has reduced the checks and balances within the system. It has made it more likely that bad policy choices are made as there are fewer people able and willing to kick the tyres of new policy initiatives.
China is unclear how to respond to the pushback from the U.S. and the West - responding by tit for tat tariffs might play to the nationalist constituency at home, but it risks spiralling trade wars and global trade autarky, and accelerating the demise of the golden goose of globalisation that has been laying the golden eggs of Chinese economic development.
China’s response has been on the one part to try to divide and rule the West, by reaching out to important trade partners in Europe, in the EU and the UK, to try and cut deals aside from the US - perhaps to isolate the US, and lobby’s for US moderation. But attempts to break Europe off from the US come at an inopportune time as Europe is feeling insecurity following Russia’s invasion of Ukraine, and is even more reliant on the US for its defence - albeit Trump’s isolationist agenda might well force Europe to look inwards for its defence which might create opportunities again for Beijing to win over allies against the US on the trade war front. But as yet, it remains the case that when the US comes calling Europe still has to follow its lead.
At home, China has learned from Russia’s response to the imposition of Western sanctions after the annexation of Crimea in 2014, by building up the economic defences, accumulating reserves and trying to reduce vulnerabilities - by reining in imbalances. In Russia back in 2015 Ilabelled this approach “Fortress Russia” economic policy settings, and I would describe China’s policy’s settings now as “Fortress China”. It means tighter fiscal and monetary policies than would otherwise have been run - less willingness to resort to stimulus on global and China specific growth slowdowns. The importance of high growth targets has diminished. Sustainable growth is now the focus. And efforts are underway to address obvious structural imbalances in the economy, including the housing bubble, and debt heap. Inevitably this adjustment brings losses - property investors front and centre - and mindful of a potential political backlash it is resorting to a more populist, egalitarian agenda. Private healthcare and education have been reined in, with efforts also to be seen to be fighting corruption - corruption and inequality were previously seen as the acceptable consequence of the dash for higher growth. The authoritarian Communist regime is now much more mindful of popular opinion, even mindful of popular concern over environment failures but therein all increasing the costs of doing business. In the prior rush for growth at all cost, without constraints on globalisation, the Chinese authorities appeared to turn a blind eye to extreme wealth creation and corruption - as there was so much growth as to ensure plenty of trickle down. But by now accepting a more prudent growth agenda, they are much more mindful of inequality, corruption and the risk of a social and political explosion as a result. Xi’s response is centralisation, more control and authoritarianism but also a regime which is more responsible to the sensitivities of the masses. Almost going back to socialist principles, at least for the masses, if not the family.
Business seems to be confused. Is it still ok to make money, at all cost?
What sectors are next in line for the ire of the Communist Party?
This comes as international investors see the writing on the wall from US and Western policy forwards China and are thinking of diversifying away from China, near shoring or foreign shoring.
The net result is investment is struggling and the desire is to get capital out of the country. This has fuelled more oversight by the Chinese state to crack down on capital flight. All this just accentuates the crisis of business confidence. Few foreign and domestic businesses now want to invest.
Notable in response to protectionism and near shoring, China is looking to insulate itself by riding the wave. It is investing in manufacturing capacity in Europe, and closer to market in the US. In
Europe this has seen investments in Hungary, Serbia, and talk now of
Turkey. These investments give China access to EU markets. It is exporting capital, but the irony herein is that ultimately it may be exporting Chinese jobs. The irony is that Chinese capital is now following the path trod by their own Western counterparts 30-40 years ago when they sold out the Western manufacturing base to relocate in China. China is now creating its own rust belt towns by moving manufacturing to Hungary, Serbia, et al. Longer term this could create the same social and political challenges for China.
One investor I spoke to recently assumed that a Trump 2.0 presidency would just end up cutting the “mother of all trade deals” with China - Beijing would just play to Trump’s ego. But in a scenario where the US has finally stalled China’s drive to economic hegemony, the question is surely why would it stop now? Unless that is China agrees to all US demands, totally throwing in the towel, including full US market access, an end to currency manipulation (albeit with capital flight that might actually mean a weaker CNY), assurances on intellectual property theft, and the rest. I just doubt that Beijing has the stomach for any such deal - or even realises that it needs to make such concessions. Logic then suggests that relations remain tense/difficult, and Chinese policy remains in a state of confusion, and ultimately the Chinese economy is at a turning point in terms of decline relative to the U.S. Capital flight will continue, and the only turning point will come when China itself faces a systemic crisis, which would now be global given the size of the Chinese economy - for some kind of time out between the US and China. An alternative is that before then, China’s economic difficulties become so intense that Xi resorts to gunboat diplomacy to play the nationalist card ar home - watch out Taiwan, and for nasty developments in the South China Seas.