Some thoughts on China

It has been an interesting week on the China front following the news that the US is to impose a tariff of 10% on $200bn of Chinese imports with effect from next week. The timing of a series of discussions this week on Chinese economic prospects with some experts in the field thus proved fortuitous, and whilst they reinforced the little I do know, they also served to put the subject in a wider context.

To start with the trade issues, the primary reason for US action against China can be traced to the strategic plan unveiled in 2015, Made in China 2025, which intends to place China at the forefront of technological advancement and which was described by the US Council on Foreign Relations as a “real existential threat to U.S. technological leadership.” More problematic for the US, and indeed many other western nations, is that China is seeking self-sufficiency via technological substitution i.e. switching foreign technologies for those developed at home, which would shut the US FAANG industries out of one of the world’s largest consumer and business markets. Not only is there a growing belief that Made in China 2025 violates WTO rules by setting targets for self-sufficiency, but there is a real concern that China is seeking to achieve its goal of technological supremacy by expropriating western technology via fair(ish) means (forced technological transfers in return for permission to operate in China) or foul (espionage).

The view from non-Chinese Asia is that US actions to clamp down against technological expropriation are understandable, but the way the US has handled the situation leaves a lot to be desired. The US would be in a better position to get China to take heed of its position if it had all its allies onside first – after all, the technology transfer issue is common to all western nations – but it has instead succeeded in antagonising the EU and Canada by threatening trade sanctions against them. Failure to present a united front may thus undermine US efforts to force China to the negotiating table. Equally, however, there is a view that China perhaps ought to recognise that it has been one of the main beneficiaries of its accession to the WTO, and that it can afford to be more magnanimous rather than pursue its goal of simply “making China great again.”

Another question that was raised in this week’s discussions is the extent to which China can afford to retaliate in any trade war. It is well known that the US imports more from China than China does from the US, and as a result the trade sanctions will initially hurt the Chinese most. Due to this factor alone, China will struggle to match the US in a tit-for-tat escalation. But there is a more fundamental political problem. Next year marks the 70^th anniversary of the foundation of the People’s Republic of China, which will be marked with great fanfare, and in 2021 the Chinese Communist Party will celebrate its centenary. The Chinese authorities have no desire to spoil the party by creating additional economic difficulties. Indeed, it is arguably in their short-term interests that the world economy remains strong so as not to damage export prospects which would risk spoiling the party.

Moreover, as I noted earlier this year, simulation analysis conducted by Bloomberg Economics suggests that the optimal economic response is for China not to respond to the US actions. The rationale for this is that whilst China will take a hit, it will suffer even more if the trade war escalates, since this threatens to spill over into other important Chinese export markets, depressing global trade and making life even more difficult for China.

Having grown rich and powerful on the back of an export- and investment-driven growth model, China is attempting to redress the balance by developing a more consumption-driven economy. But there are some clouds on the horizon. One is that demographics are turning against China. The population aged 15-64 peaked in 2015 and within a decade it will have declined back to levels prevailing at the turn of the century. Japan hit peak labour force in 1995. But at the time, its GDP per head in per capita terms was around $43,000 – more than three time current levels in China (~$12,000). This is not to say that per capita incomes will not increase further. As the chart shows, real per capita incomes in Japan have continued to rise even though working age population is falling – it just becomes much harder. Moreover, the Chinese economy is heavily indebted, with the non-financial sector operating under a debt burden equivalent to 250% of GDP – about the same size as in the US, but with more unfavourable demographics and lower incomes, and much larger than other developing markets (Brazil is at 150% and Russia 80%).

One way to boost incomes, of course, is through technological innovation – hence the Made in China 2025 programme, which is where we came in. But what exactly is the underlying motivation for the policy? One argument is that the primary objective of Chinese leaders down the ages has been simply to feed its vast population. It is thus not interested in the rest of the world for any other reason than as a means to keep the show on the road. This has been made relatively easy in recent decades by the industrialisation and urbanisation programme which has allowed China to put labour to use in higher value added activities, thereby boosting incomes. But this process may be about to become more difficult, which is where the politics starts to get tricky.  Historically, China has relied on strong leaders at such times who can marshal the economy’s resources and if Xi Jinping is anything, he is a strong leader. Accordingly, we perhaps ought to view the recent push to restore China to its rightful position at the top table as an attempt to give the country a unity of purpose at a time when economic conditions may be turning less favourable.

I do not pretend to be a Chinese expert but I found some of these thought-provoking ideas very interesting. As a parting shot, it is notable that China is led by a strong populist leader, in much the same way as the US, and both have similar goals for their country (and indeed for themselves). It is thus ironic that the US and Chinese leadership should find themselves on opposite sides of the negotiating table when in fact they have much in common.