Forced U.S.-China Decoupling Poses Large ThreatsDr. Harry G. Broadman
There are two putative goals of the current US administration for proactive policy “decoupling” between the U.S. and China. The first is to reorient U.S. firms’ supply chains away from China to U.S. sources, which would have the effect of helping to achieve President Trump’s principal trade policy goal with China: elimination of the bilateral U.S.-China merchandise trade deficit. The second is to prevent China’s further progress in the global race for superiority in innovation and market dominance in advanced technology products and services.
It is not up for debate that China has both engaged in trade policies that are not WTO-compliant ever since its accession to the WTO in 2001 as well as in the piracy of intellectual property and technology decades before it joined the WTO and still does. Yet, not only will the U.S. goal of forced bilateral decoupling between the two largest economies fail in a marketplace whose structure is now inherently globalized, but the policy tools being waged by the U.S., combined with its go-it-alone approach to try to contain and isolate China both economically and technologically, will not induce the changes Washington seeks from Beijing.
Indeed, there is an appreciable risk that the outcomes produced by the U.S. strategy of proactive decoupling will serve to only make the U.S. worse off and jeopardize global economic growth. There are far more effective ways to deal with China’s conduct and to generate outcomes that will more greatly benefit both the U.S. population and the world community.
What is Decoupling?
By the same token, there will be—in fact, there is already—a gravitational pull away from some business investment in China towards other locales. This is the result of both the rise of wages and other production costs in China as well as the perception of more hospitable investment environments, including lower business costs, in other countries. In this respect, Washington’s pursuit of decoupling from Beijing might be seen as a policy to hasten China’s centrifugal force.
There are several pathways being implemented or under discussion by the U.S. government to bring about proactive decoupling from China. Most of them are highly visible; others are less so. There is also a myriad of impacts that will be generated, some of which are intended; perhaps more will be unintended. In fact, one of the Trump Administration’s primary goals of decoupling—closing the bilateral merchandise deficit—will likely not be achieved. (As I have noted elsewhere in this space it is not an economically meaningful goal in the first place.) In addition, it is likely that many of the efforts aimed at decoupling will engender larger costs to the U.S. and other countries than to China.
Regardless of whether one is in favor of, or opposed to, the U.S. decoupling from China, the implication of such a policy is clear: it means the U.S. is adopting an explicit statist strategy, arguably to a level that is unprecedented in our lifetimes.
The irony of this pursuit in the context of our dealing with China—that is now celebrating its 70th anniversary of formally embracing communism and the establishment of the Chinese Communist Party (CCP)—cannot be overlooked.
How Did We Get Here?
After all, China has huge scale as the largest populated country on earth. Moreover, since its advent of economic reform in the late 1970s, the country achieved enviously high rates of economic growth for a number of years; it offered relatively low wages, and it has registered a rapidly rising consumer class. Today, China’s GDP per capita in PPP terms is US$16,200; the comparable statistic for the U.S. is US$55,700. Still, there remain large swaths of China that are very poor.
Besides, many Americans believe that the U.S. market-oriented system is not one—with very limited national security exceptions—in which Washington should direct where our private sector companies should or should not make investments or with whom to engage in international trade. In this regard, for the U.S. investors who have had a rough time of it in China, it is the companies themselves (and their shareholders) who bear the costs of making bad investment decisions.
The starkest example of this is the acquiescence of some U.S. firms to Beijing’s demands to surrender technology and intellectual property as the ‘price of admission’ to the Chinese market. This is a case where Nancy Reagan’s famous dictum in reference to American’s attraction to drugs to “just say no” would have made eminent sense. Many leaders of U.S. firms still do not understand that in many emerging markets, interest groups—especially government kleptocrats— are eager to just test the resolve of foreign businesses. Worse still, once one set of executives falls into the trap, the erosion of the investment environment is conflated for subsequent groups.
It is common knowledge that in the forty years since China began its quest for economic reform, the underlying fabric of the world economy has become globalized, in large part driven by an untold accelerated pace of technological advances across numerous sectors. The result is a system of international commerce marked by an extensive diversity of spatially complex supply chains of component production and assembly operations.
That the Chinese economy of today is the central fulcrum of this multinational corporate network is unquestionable. The journey the Chinese economy has taken has been driven as well as shaped by globalization.
Nevertheless, does this mean that China will always remain so and that U.S. as well as other businesses operating in China will not alter and diversify their geographic footprints in some fashion in an evolutionary process? No. For two reasons.
First, as I have written elsewhere in this space, the rise in Chinese wage rates as well as the pronounced risks associated with corruption, state interference, and “fuzzy” property rights, are already prompting foreign businesses in China to shift, in part or in whole, to other locales around the world. In the Asian region, for example, companies with long histories of operating in China are establishing their newest subsidiaries in the ASEAN states—a trend that I have referred to as a “China 2.0 strategy”. In fact, some Chinese firms are themselves moving out of China to lower cost countries. Still, businesses of almost every nationality do not turn on a dime. Policy makers who underestimate the inertia of corporate decision-making—especially when it comes to changing the location of operations and complex global supply chains—are almost always sorely disappointed.
Second, the Chinese economy is slowing. Some in the U.S. mistakenly attribute this development to the pain engendered by Washington’s trade war with Beijing. To be sure, the Trump Administration’s tariffs on Chinese imports have exacted some cost on China. However, the decline in China’s growth is secular; it has been underway for years well before Donald Trump moved into the White House.
Most importantly, the fundamental contradictions inherent in China’s “socialist market economy” policy paradigm have become exceedingly exposed. Xi Jinping knows full well that the bicycle propelling the pyramid scheme of the state owned banks (SOBs) pretending to lend money to the state owned enterprises (SOEs), who, in turn, pretend to pay back the SOBs can peddle for only so long before it tips over. His creation of the Belt Road Initiative—in essence designed to export to other countries the excess production capacity of Chinese SOEs—can help only so much. The rub is that the SOEs, which are the largest employers in the country, are the raison d’etre of the Communist Party. Without question, therefore, Xi’s
What Are the Components of Trump’s Decoupling Policy?
The other set would involve the use of “non-price mechanisms” such as the imposition of quotas (for example changing the number of Chinese student or worker visas issued); the revocation of permits required by Chinese entities to conduct activities in the U.S. (such as the listing of Chinese firms on U.S. stock exchanges or the amount of Chinese funding U.S. universities might be enabled to receive); or outright prohibitions (such as bans on U.S. firms selling inputs to Huawei).
In all of these cases, the President must make some type of declaration or issue a finding of fact as prescribed under existing laws. At the same time, the Congress, in almost all instances, either has the existing authority to block such actions, or if it currently does not, it certainly has the power to pass legislation seeking to thwart them. (Whether the Congress would have enough votes to overcome a Presidential veto of such legislation is of course germane.)
Suffice it to say, President Trump’s actions in these areas are not only the most extensive by any U.S. president in living memory, but they also are being formulated, issued or tweeted almost daily. Accordingly, here are just a few samples of some of the most visible of them.
Tariffs on Chinese Imports. There are three strands on how the implementation of U.S. tariffs on Chinese imports is affecting (or can affect) the extent of a U.S.-China decoupling.
First, Trump is imposing tariffs on imports from China that are the outputs from U.S. subsidiaries operating there in the hopes such operations will “move back home”. The problem is that unless there are other reasons (as noted above) why such subsidiaries would want to move their operations out of China, Trump’s tariffs have the effect of those firms exporting their Chinese-produced goods to markets other than the US. Indeed, there are numerous examples of U.S. firms operating in China across a wide variety of sectors (such as cameras, shoes, smart phone components, electronic instruments, industrial equipment, luggage, sportswear, etc.) where this has been the case, including moving operations to Cambodia, Mexico, Thailand, India, Vietnam, Taiwan, Bangladesh, and several countries in Africa.
Second, Trump’s placement of tariffs on US imports from native Chinese operations is imposing costs on US-located firms who rely on such goods as inputs in their US factories to produce end-products either sold in the US or exported from the US (or on US customers who otherwise purchase those Chinese products for their use directly). The news media is replete with stories of US manufactures trying to seek exemptions from Washington for subjecting their imported Chinese intermediate goods to US tariffs.
As one might expect, these moves are generating a variety of reactions by Beijing that Mr. Trump has not anticipated. Depending on the importance of the sector and company in question, sometimes the Chinese are creating economic incentives to help offset the negative effects of Mr. Trump’s tariffs so U.S. firms do not leave. In other cases, Beijing is proactively retaliating against Mr. Trump’s actions through the imposition on US firms operating in China of extra layers of regulations or the deliberate slowing down of certain permit approvals.
Ordering U.S. Firms to Leave China. This past summer President Trump tweeted “… Our great American companies are hereby ordered to immediately start looking for an alternative to China, including bringing your companies HOME and making your products in the USA.” Much to Mr. Trump’s regret, however, unlike Xi Jinping, he cannot command U.S. companies to move in that fashion.
Banning US Portfolio Investment in Chinese Companies. The White House and some members of the U.S. Congress have been in the process of designing restrictions on Chinese firms from being listed on U.S. stock exchanges. If this were to occur, it could have the effect of curbing U.S. portfolio investment in Chinese businesses. Indeed, the discussions have even included proposed actions to outright delist such firms already trading on U.S. exchanges. At present, more than 150 Chinese businesses are listed in the U.S. In total, their market capitalization is greater than US$1 trillion.
While the pace and depth of these potential actions have certainly quickened because of the objective to pursue decoupling, the fact is there have long been concerns about the quality and independence of the audits and financial information about U.S.-listed Chinese firms. These have been driving worries that American investors who are not fully informed about the fundamentally weak nature of corporate governance of Chinese firms would be subject to adverse risks. But let us be clear: any investor worth his or her own salt—even native Chinese buying shares of Chinese firms on the Shanghai and Shenzhen exchanges—would do well to recognize such risks are beyond the pale.
From a U.S. policy perspective, there are two major contradictions with any contemplated action to delist Chinese firms from the U.S. stock market.
First, if any firm—whether Chinese or American—does not meet certain accounting and transparency standards, they have no business being allowed to be listed on U.S. exchanges to begin with. It is hard to criticize the Chinese for this; rather it is the U.S. financial regulators who are at fault. This breech of duties has been going on for years.
Second, since decoupling’s champions are aiming, in part, to reduce the bilateral merchandise deficit between the U.S. and China, do not they realize that curbing U.S. portfolio investment into China will have the exact opposite effect? Economics 101 is clear on this: the result of such a policy will be the weakening of the Chinese currency, which in turn will promote— not decrease—Chinese exports.
Included in the review are contracts and donations that have been used to help finance the operation of U.S. universities’ overseas campuses; a panoply of research activities; academic partnerships, and cultural exchange programs.
Some of the activities receiving such financing—such as overseas campuses—are highly profitable enterprises for otherwise cash-strapped U.S. universities, especially publicly funded schools. At the same time, other funding streams have been used to leverage cutting-edge research of some of the most promising U.S. scholars.
This begs the obvious question: In the absence of foreign government funding, who in the U.S. will step up to the plate and make the requisite investments in our universities?
Banning Huawei. No one that I know seriously believes the notion that Huawei operates as entity independent of the government of China. On this score, Mr. Trump and his team have it correct—plain and simple. They have been trying to persuade international allies to shun the adoption of Huawei’s products.
Nevertheless, here is the stark reality: Huawei is the world’s No. 1 telecom supplier and No. 2 phone manufacturer. Not surprisingly, when Mr. Trump tried to prohibit U.S. firms from selling their components to Huawei the 3rd week of May
Making things worse for Washington is that major U.S. players in the high tech industry do not have much confidence in the Trump administration’s strategy vis a vis Huawei. Microsoft President and Chief Legal Officer Brad Smith said the U.S. government’s actions toward Huawei should not be taken without a “sound basis in fact, logic, and the rule of law.”
Since the U.S. reprieve of its sanctions on Huawei in June, Washington has renewed the reprieve several times. If this looks like a U.S. strategy of kicking the Huawei “can down the road” you would be correct. Frankly, the U.S. is not sure how to handle the Huawei dilemma. Simply put the current stalemate is neither a desirable nor a sustainable outcome.
The Global Impacts of Trump’s U.S.-China Decoupling Policy Are Particularly Worrisome
• Technological bifurcation, which could fundamentally jeopardize harnessing global benefits from advances in science and technology. The sustainability of such bifurcation, however, will significantly depend on which technology (or set of technologies) gives rise to the largest economies of scale and scope. One need only think of the transitions that took place across differing technology standards and modes of listening to recorded music (LPs v. 8-track tapes v. cassettes v. CDs v. electronic audio files) or watching recorded videos (VHS v. Betamax v. Blue-ray v. DVDs)
• An undermining of global cooperation of macroeconomic management, especially within the context of the G20. This was not an issue when the Chinese economy was considerably smaller than it is today. Given the population size of China, however, it is hard to imagine in the near- to medium-term a global economy where the policy conduct of the Chinese will not be a major issue in the stability and growth of global markets. An offsetting factor will be continued increases in the size of the Indian economy, whose growth in recent years has overtaken that of China.
• Forestalling the development and implementation of collective remedies to abate climate change. Like macroeconomic management, if China’s policy towards climate change veers away from the direction of what much of the rest of the world’s position is on this score, the negative externalities could be significant. Needless to say, it is that the current U.S. administration’s position here that is the one most at variance with the global community.
One might have some sympathy for a man whose career has centered on engaging in New York real estate transactions, which are largely bilateral in nature. However, the numerous economic and diplomatic advisors surrounding him around the Cabinet table, quite a few of whom have deep backgrounds as practitioners in global finance, cross-border business operations and international trade negotiations, certainly know better.
What to Do?
What to do? Let’s tell it like it is: China is knowingly in broad violation of the legal WTO commitments it signed in 2001.
This is not a pejorative view of China—by any means. Like every nation, the Chinese have the absolute full right to have whatever type of economy they wish. But no country can have its cake and eat it too. Fundamentally, this is a values statement: the goals of Xi Jinping and the Chinese Communist Party, which he leads, are not those shared by the U.S. and many other nations.
If on the other hand, we want to close our eyes about China staying in the WTO, then the only other choice is to terminate the WTO all together since it has zero credibility. However, here is where things become dismal. The Trump administration is itself operating outside the WTO. Indeed, the current occupant of the Oval Office seemingly would quite welcome the demise of the WTO.
Without question, that is an outcome the overwhelming number of the world of nations will deeply regret. As a result, one should be hopeful this would have little chance of occurring.
The question then is: Who will step up to the plate and spur the collective action the world so deeply needs now