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The tremendous impact of a US-China investment and technology war

The impending bifurcation of the world internet economy will disrupt many industries, companies and national economies.

The tremendous impact of a US-China investment and technology war

This is an edited extract of the opening speech delivered in Sydney this month to the Chief Economists Forum, held annually by the Financial Standard.

There are three main dynamics which are shaping the changing global, economic and strategic order. Each is interacting with the other and intensifying the impact of them.

First is the end of a pattern of economic growth that has been driven by successive waves of opening up – liberalisation of flows of capital, then trade, and finally movement of skilled people – that led to a period of accelerating global economic integration around the world.

The second dynamic is that the global strategic order led by dominant US military and economic power is now being destabilised.

The third dynamic is weakness in Western political institutions, the splintering of political parties and the splintering of society’s sense of community into narrowly focused interest groups and identity groups which have led to governments being unable to act, even where they know what they need to do. We’re seeing everywhere weak governments and generally a loss of confidence in Western political structures.

What we see increasingly are countries turning to protectionism, more state intervention, higher taxation, and that even amongst traditionally free-market political parties.

Income and wealth inequality adds to this issue. What we see increasingly are countries turning to protectionism, more state intervention, higher taxation, and that even amongst traditionally free-market political parties. I was talking to someone who had been asked to advise the Conservative party in the UK recently. What they really wanted to know, he said, was how could they introduce some of Jeremy Corbyn’s economic policies while looking as if they were still a free-market conservative party.

This period of increasing globalisation was given a new lease of life for nearly 20 years from the time that China under Deng Xiaoping opened up. China’s integration into the world economy proceeded while it also accepted the global strategic order as being in its interests. This period ended when Xi Jinping came to power, even if we didn’t realise it at the time.

The US-China economic relationship will never be the same again. This has been hard for people to accept. My colleagues kept on saying to me, you know, there’s so much common interest here, surely there’s going to be some understanding reached and all this unpleasantness will be over.

People have been slow to understand this just as they were very slow to understand just how ambitious Xi Jinping was when he came into power and just how fast he would move to try to achieve his ambitions. 

Well, now we can say if Donald Trump and Xi Jinping are going to meet – it looks as if they will – there will be some sort of deal. It may be at least a truce to postpone escalation of the tariff war. Maybe in time we will get a larger agreement on Chinese purchases of agricultural goods, energy and maybe some movement in foreign investment rules and the treatment of intellectual property. But what we know already is that any deal will not fix the US trade deficit that Trump worries about. We also know that it won’t fix the underlying problems posed by tight party control and a state sector-dominated economy that squeeze out the private sector and fail to provide a level playing field for foreign firms. 

This is not a Trump issue. We tend to talk as if it is, but it’s a bipartisan view. Democrats and Republicans in the Congress and most of the business community in the United States share the view that something needs to be done to shift the terms of engagement with China.

Their worry is not that Trump is going to be too tough. Their worry is that he will claim victory with an inadequate deal.

Donald Trump and Xi Jinping in talks during the 2017 G20 meeting in Hamburg, Germany (Photo: White House)

All of this of course is bound up in a strategic competition which will last for a couple of decades unless something dramatic changes within China, or the United States gives up wanting to be a super power. 

Economically, China is too big to be cut off. The situation is different from the Cold War with the Soviet Union, which was a failing and small economy. But the analogy is useful for us because it shows how strategic competition inevitably is carried out on a global scale, even if right now China is focused on pushing the United States out of the Asia-Pacific.

In the economic area, the key part of the competition we need to watch is that of technology and investment controls.

In the economic area, the key part of the competition we need to watch is that of technology and investment controls. The new US controls cover investments in critical technology, critical infrastructure, sensitive real estate and, notably, personal data. They will cover companies that are majority Chinese owned, companies with minority participation and companies with close Chinese associations.

In addition, new export controls will cover a wide range of “foundational and emerging” technologies crucial for the next stage of economic growth. The Huawei story is only one part of this much larger and crucial trend.

These new controls, along with differing approaches to the use of the internet, the treatment of personal data and the need to protect networks from cyber-attacks will lead to a separation and competition in this key space for economic growth. They will affect every country in the world. It will pose us difficult choices and lead to the fracturing of global markets in the fastest growing part of them.

These two dynamics of strategic ambition and search for technology dominance intersect most acutely over Taiwan which, of all the troubled spots in Asia, has to be the one that we should worry about most. More even perhaps than North Korea, certainly in the immediate future, and the South China Sea.

Working out the contours of the new US-China relationship will take time. It’s clear China will play a big role in the global economy going ahead and that there are areas of mutual interest. A deal will no doubt make some progress on these. 

Also, China’s current account situation is changing. It needs capital inflows, hence its eagerness to get into bond indexes. US financial institutions obviously are very interested here.

Trade in areas which are important for the growing middle class in China will obviously continue and no doubt there will be some shifts in China on foreign investment, but the reality is we’ve passed the point of peak globalisation. 

There are three big questions which it is worth keeping at the back of one’s mind in looking at the overall picture. The first is has Xi Jinping made a big mistake? Is his reluctance to proceed with economic reform going to lead to stagnation and a middle income trap? There are certainly a lot of people, in the leadership even, who worry that he’s made the wrong choice. And they worry that his strategic ambitions have created unnecessary enemies. 

The second big question is how much of what China is doing now is durably Chinese and will survive the Xi Jinping era, and how much is Xi Jinping’s version of Marxism and Leninism with Chinese characteristics or Xi Jinping thought? What of that will be discarded? 

The third big question for us is whether the United States has the capacity to renew itself and help recreate with its economic partners and its allies, a new stable, political and economic order in the world.

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