The high costs of disengagement for China – Chine Magazine

From Project Syndicate, by Georges Magnus – For more than three decades, the global economy has been defined by unbridled integration and unprecedented interdependence. Neither political disputes nor localized wars could slow the train of globalization. Markets were markets, business was business, and multinational corporations became more multinational. Not anymore.

In this new era of strategic competition between China and the West, disengagement is the order of the day. While this trend will stifle economic growth, increase business costs (via supply chain restructuring), and raise prices for everyone, the economy that loses the most may well be China.

The People’s Republic of China would not be what it is today without globalization. International trade, investment and access to capital markets have spurred economic growth, while the transfer of knowledge – aided by the engagement of students, scientists and scholars – has enabled technological levelling.

Ties with the outside world have also forced China to introduce a legal system capable of establishing and enforcing contract and intellectual property law. And the expansion of China’s economic power has allowed the country to increasingly project its power overseas.

But in recent years, the openness that underpinned globalization – the “rising tide that lifted all the boats” – has given way to a geopolitical, zero-sum mindset. International trade and finance have increasingly been shaped by national security considerations. Export controls, blacklisting of companies and market access restrictions in sensitive sectors, such as certain advanced technologies, have become commonplace.

The Sino-American rivalry has reflected and accelerated this change. The United States has targeted China with a variety of measures – including restrictions on imports, exports and investments – and added dozens of Chinese companies to their so-called entity list. Other countries have also tightened their surveillance of Chinese investments and restricted certain types of trade with China. Sanctions for human rights violations committed by China in Xinjiang and Hong Kong have also been introduced.

China may not have initiated the disengagement process, but it seems determined to see it through. By refusing to condemn Russia’s war on Ukraine, its leaders have made it clear that they believe the United States – and the West more broadly – is in terminal decline and now is the time to challenge the existing world order.

Beyond retaliatory sanctions and tariffs, China has stepped up its efforts to become self-sufficient in cutting-edge technology and science, through heavily state-centric and protectionist industrial policies. Its objective is to “penalize” its economy, in particular by de-Americanizing its supply chains.

It is impossible to know precisely to what extent this is possible. But China’s efforts to achieve self-reliance will certainly not succeed in all areas. As The Economist reported in February, China struggles the most in areas with longer and more complex supply chains, such as mRNA vaccines, agrochemicals, computer operating systems and payment systems.

In semiconductors, China remains dependent on foreign suppliers, despite public investments of tens of billions of dollars. Similarly, China has failed to break its foreign dependence in aerospace and automobiles. And its efforts to develop a renminbi-based alternative to US dollar-based financing and payment systems have yet to gain traction.

But China’s attempt at autonomy could not only fail; it could backfire on you. As The Economist report also pointed out, when Chinese companies are cut off from foreign competition and expertise, their capabilities are diminished.

Despite the adverse economic consequences, it is to be expected that the geopolitical disengagement will continue. China will try to build an alternative financial infrastructure and the United States will remove Chinese companies from its stock exchanges. The U.S. Congress is reportedly already considering legislation to restrict or prohibit U.S. foreign direct investment abroad in several sensitive sectors, just as it does Chinese investment in the United States. Trade measures to diversify supply chains and ensure the supply of critical inputs, such as rare earths, are also to be expected.

As the disengagement progresses, many critical sectors — like the internet — will likely split into two separate blocs, each with their own rules and standards. The divide in digital standards, data management and usage arrangements, and network equipment and telecommunications services will widen. Market access restrictions and new approval and licensing requirements will proliferate.

These changes will come at a time when China is already grappling with several serious challenges, including unfavorable demographics, a weak real estate market, an overstretched banking sector, stalled productivity, politicized governance and the consequences of its policy. zero COVID. the “miracle” China’s economy appears to be well past its peak. Annual economic growth could well fall to 2-3% in the coming years, which means that the official target of doubling per capita income and GDP between 2020 and 2035 would not be achieved.

This slowdown will have considerable consequences. To start, China’s ability to compete with the United States will be compromised. China’s economy may never surpass that of the United States, especially if the value of the renminbi drops 20-25% in the next few years.

In addition, the prices of raw materials – especially those essential to China’s housing and construction sector – will fall. While the higher costs of newer, more regional supply chains will generate inflationary pressures, weaker Chinese demand and a cheaper renminbi will reduce them.

Foreign investment flows to China will decline as funding is increasingly allocated to other Asian countries or emerging markets. While China will not become “uninvestable” (as long as a military conflict does not break out), international investors will keep their Chinese portfolios underweight. Although the renminbi enjoys comparable status to the Japanese yen, British pound and Canadian dollar, it will not come close to supplanting the US dollar.

Chinese President Xi Jinping has staked his government’s legitimacy on China’s continued prosperity. But that’s getting harder and harder to achieve – and disengagement is a big reason why.

George Magnus, a research associate at the China Center at the University of Oxford and SOAS University of London, is the author of Red Flags: Why Xi’s China Is in Jeopardy (Yale University Press, 2018).

Copyright: Project Syndicate, 2022.

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The high costs of disengagement for China – Chine Magazine

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