The Trade War, Economic Decoupling and Future Chinese Strategy Towards America

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Remarks prepared for Lowy Institute event, Sydney, 13 June 2019

Making sense of the US-China trade war is difficult in itself. Trying to make sense of where it may lead in a wider “decoupling” of the US and Chinese economies is more difficult again. But understanding where both these developments may take us in terms of China’s future grand strategy towards the United States is perhaps the hardest task of all.

 

Nonetheless, we have reached just such a juncture in US-China relations - one that now requires us to ask ourselves these fundamental questions, given that the answers we formulate in response will, of themselves, also shape the future of this, the single-most consequential relationship of the twenty-first century.

 

I wrote earlier this year in a short publication entitled “The Avoidable War” that as of 2018, we have seen a major new inflection point in the post-war relationship between America and the People’s Republic of China. Phase one of the relationship covered the quarter century of strategic hostility from the founding of the People’s Republic until rapprochement under Nixon and Kissinger. Phase two covered the next twenty years of Sino-US strategic collaboration against Moscow until the collapse of the Soviet Union in 1991. Phase three covered the next twenty years of economic collaboration and engagement, highlighted by China’s succession to the WTO in 2001, China’s emergence as the new global factory, through until the end of the Global Financial Crisis.

 

Phase four has been marked by the rise of Xi Jinping and an economically self-confident China, one prepared to emerge from the shadows and exercise a more assertive regional and global foreign and security policy.  This has also been characterised by the re-emergence of a renewed Chinese strategic partnership with the Russian Federation. And now this fifth period of the relationship has seen the United States formally abandoning its forty year-long policy of strategic engagement with Beijing, and instead its formal embrace of an as yet undefined period of “strategic competition”.

 

In truth, this did not begin under the Trump administration. During the second Obama administration, the outline of a more robust American response could already be seen militarily through the US “pivot to Asia”, and then economically through the Trans-Pacific Partnership.

But if we are looking for official signposts to mark the end of one era and the beginning of the next, the release of the US National Security Strategy in December 2017 followed by the new US National Defence Strategy of February 2018 fulfils that purpose.

 

Since then, the US-China relationship has entered into a new and uncertain terrain where there are no longer any clear rules of the road. Both the conceptual framework of the past (strategic engagement) and the extensive institutional machinery of the relationship (the advanced bilateral apparatus growing out of the Strategic and Economic Dialogue or SED) have been effectively abandoned. And as of June 2019, nothing has effectively taken its place.

 

Apart from the bilateral trade negotiations led by the Chinese Vice Premier Lui He on the one hand, and on the other the uneasy American triumvirate of US Trade Representative Bob Lighthizer, US Treasury Secretary Steve Mnuchin and US Commerce Secretary Wilber Ross, very few bilateral mechanisms have survived. This becomes particularly problematic when the single remaining track of the bilateral relationship (i.e. the trade negotiations) itself ends up being suspended, as has been the case since the implosion of the eleventh round of negotiations in Washington in early May.

 

We therefore seem to be thrown back to an almost nineteenth century relationship where the principle point of political contact between the two administrations has now reverted to embassies, ambassadors and the occasional special envoy. Indeed, the relationship has become the most brittle it has been in the last thirty years, going back to the aftermath of Tiananmen in 1989.

 

We therefore live in difficult and dangerous times when the absence of extensive political engagement and substantive political communication across the breadth of the relationship means we now find ourselves depending on the ancient crafts of speechmaking, textual analysis and the crudities and ambiguities of diplomatic signalling. Given that this is such a consequential relationship, many of us find this strange indeed. Not just strange, but increasingly unstable and potentially dangerous as the politics of miscalculation and miscommunication become more pronounced.

 

My purpose therefore today is to begin to examine the three questions raised at the outset of these remarks:

 

• To explore where the US-China trade war may go to next, including the prospects for some form of resolution;
• Second, to ask: with or without a trade deal, what are the prospects of a wider economic decoupling between China and the United States in the future;
• Third, to ask where these developments may take us in the future as the Chinese leadership begins to reappraise China’s long-term strategy towards the United States and its friends and allies around the world.

 

I do so because I still entertain the old-fashioned view that getting our analysis of what is actually going on is a necessary precondition for determining policy on what could or should be done about it.

 

The US-China Trade War

 

This time last month, I was having breakfast with a Chinese friend in Chengdu, the prosperous provincial capital of Sichuan, discussing the increasingly toxic US-China relationship. The only newspaper available that morning was the less-than-world-renowned Chengdu Commercial Daily. But the headlines that day took my eye, particularly the bright red-lined box high on the front page, announcing publicly for the first time China’s three new red lines in the ongoing US-China trade war.

 

It was clear we were now in a whole new world of pain in bringing an end to an increasingly debilitating trade war. China would not now be budging on America’s insistence on retaining tariffs for a period following the deal’s signing; nor would China be accepting the US unilaterally re-imposing tariffs in the future if the US deemed China not to be complying, while denying China the right to take any retaliatory measures itself; nor would China tolerate President Trump’s ever-increasing, administratively  determined “purchase order” for American goods that China would be required to buy to bring down the bilateral trade deficit to a number of Trump’s political choosing. The significance of all this was not so much the substance of China’s objections but that China chose to make them public, thereby making it impossible for Beijing to yield on them in the future. In China’s eyes, if there’s to be a deal, most if not all the movement was now going to have to come from Trump.

Beijing then proceeded to unleash an avalanche of nationalist rhetoric against the US of a type I hadn’t seen in 30 years. America was now routinely described as a swaggering bully. The People’s Daily reminded its readers that the People’s Republic, less than 12 months after its founding, had fought the US to a stalemate in Korea. In late May, Xi Jinping then went south to Jiangxi, from where the Communist Party had set out on the Long March in 1934 and lost 90 percent of its forces before finally winning the war against the Nationalists 15 years later. Xi also happened to visit a rare-earths facility in Jiangxi, and while not being so crass as to state publicly that America was ultimately dependent on Chinese rare earths for America’s own needs across multiple industry sectors, the point was nonetheless made loud and clear that China had leverage too. The message to the domestic body politic was also clear: that the world has thrown a lot at China over the last 5,000 years, but we Chinese have a long, long history of enduring pain, and we always prevail.

 

Meanwhile, on the policy front, China has calculated that a full-blown trade war, if it comes to that, will cost its economy around 1.4 percent in growth per year. A full range of fiscal, monetary and infrastructure investment measures are already under way as part of a stimulus strategy to keep growth above the magical six per cent threshold. Other measures are in the pipeline.

 

Adding fuel to the fire, President Trump on May 15 announced that the Chinese telecom giant Huawei would become a “listed entity” under US law, effectively barring American firms from supplying Huawei with essential components for their products. China retaliated on 31 May by announcing its own “unreliable entities list” on which it would list any international firm that took “discriminatory actions” against Chinese firms or actions hostile to China’s national security interests. Foreign firms, it seems, are about to be caught in the cross-fire.

 

Given all the above, what now are the prospects for a resolution? The bottom line is that if the politics can be managed, both sides still need a trade deal. If Trump wants to be re-elected, he has to sustain US economic growth through 2020 after what is already a very long growth cycle. To do that, he cannot allow negotiations to collapse because market confidence would collapse along with them. The real economy could then go into recession in a year he can least afford it. As for Xi Jinping, there is a limit to how much China can continue to rely on economic stimulus to prop up growth. Chinese debt to GDP now runs at approximately 248 per cent (although this is largely domestic). China’s private sector also performed badly in 2018 for reasons quite separate from the trade war. Putting the trade war to bed is therefore important for China in restoring market confidence. Although not at any political price.

The likelihood of a deal now hovers around 50-50 – the ultimate contest between politics and economics. My prediction is that the Osaka G20 Summit will see a “reboot” to the negotiating process. And after Osaka, Trump is likely to yield on the first two of China’s new red lines. And Xi will increase the quantum of the proposed Chinese purchasing agreement from China’s previous offer, although not by as much as Trump has demanded. That way, enough face could be saved all around. Of course, raw politics may still derail the lot, including Trump’s rolling calculus of what he needs to sell to his political base, and what deal he needs to wedge the Democrats who are currently seeking to outflank him to the right on China. Time will tell.

Cold War, Containment or Decoupling

But while there may be a solution to the immediate trade war, the technology war has barely begun. And on that score, we should all fasten our seatbelts to face the risks of an even more fundamental economic decoupling of the world’s two largest economies in the future. This raises, in turn, the even more important question of what economic decoupling might actually look like - in the internet, telecommunications, fintech, and the whole new uncharted world of artificial intelligence.

If we think that trying to comprehend the prospective decoupling of the British and European economies is hard enough, as an analytical exercise it pales into insignificance against the complexities that would arise from unravelling the financial, technological and global supply chain ties that now bind the United States and China, the world’s two largest economies, after forty years of sustained economic engagement.

The challenge is real. The language we use to describe it is important too. In international relations, words still matter. They don’t just describe what is going on in the real world. They can also shape, and in some cases determine, what happens as well. That’s because language influences behaviour.

There is at present a lot of loose talk, both in Beijing and Washington, about a “new Cold War”, a new doctrine of containment as well as this notion of economic decoupling. I argue, for example, that the idea of a second Cold War between China and the United States violates basic definitional accuracy concerning the actual circumstances we now face. Unless of course the underlying political objective of those using this language is actually to bring such a Cold War about.

The last Cold War, between the United States and the Soviet Union, had four basic characteristics. First, both Moscow and Washington were committed to mutually assured destruction, a thousand times over, through the targeting of their massive nuclear arsenals at each other’s command, control and communication centres, as well as broader civilian populations. That does not accurately describe the nature of US and Chinese nuclear weapons doctrine. And that leaves to one side the fact that despite recent efforts at the modernisation of its nuclear rocket forces, the Chinese arsenal is not even ten per cent the size of the American arsenal.

Second, the United States and the Soviet Union were engaged in a global, ideological struggle to the death. Despite the fact that the Chinese and American ideological systems are deeply opposed, the reality is that beyond certain academic journals, it is hard to find much evidence in the real world of a struggle for hearts and minds between Chinese authoritarian capitalism and American liberal capitalism. To interpret the BRI as clear evidence of such a struggle represents considerable analytical over-reach, at least at this stage of its evolution.

Third, during the Cold War, the United States and the Soviet Union were engaged in multiple, armed, proxy wars across Asia, Africa and Latin America. Whereas China and the United States are now involved in a global competition for political and economic influence, there is no evidence of any proxy wars between the two, either underway or in prospect.

Fourth and most important of all, the Soviet Union and United States had negligible economic engagement with each other. By contrast, the trade, investment and capital market connections between the United States and China are comprehensive, create mutual dependency and are of profound importance to both countries’ future economic growth. In addition, China, unlike the Soviet Union, is fundamental to the future of the global economy as well.

In other words, Cold War analogies do not take us very far at all in understanding the current challenges of the US-China relationship. It’s perhaps understandable that commentators and analysts in both capitals struggle to identify appropriate historical analogies to illustrate the relationship’s current complexity, let alone its possible future trajectories. But as suggested above, deploying the language of a new Cold War right now has little utility, unless of course those using it are seeking to give effect to their own self-fulfilling prophecies.

This leads us to the question of containment. It should be recalled that when George Kennan first developed the idea of containment, through a combination of his famous “Long Telegram” from Moscow in 1946 and his famous “X” article of 1947, he did so from Moscow, when the outline of the Cold War was already clear.

Second, the logic of containment was to prevent other states falling into the Soviet strategic orbit as had already occurred in Eastern Europe. A clear strategic line in the sand was being drawn between those states and Western Europe. Again, whereas some may seek to define China’s BRI strategy as pointing in the same or similar direction, at present that would constitute a very long reach indeed.

Third, and perhaps most importantly, Kennan’s underlying assumption was that by circumscribing the Soviet Union’s global economic engagement, ultimately the Soviet domestic economy would implode under its own internal pressures, driven in large part by the oppressive burden of an ever-expanding Soviet military budget. In the case of China, it’s difficult to see how these economic preconditions apply. China is already the largest economic partner of more than 125 countries around the world. Indeed, that horse has well and truly bolted. Despite the non-convertibility of the Chinese currency, China has also already become a core component of the global financial system, not least through it having the largest single international holding of US treasury notes.

And while it’s true that China’s economic growth has been turbocharged by exports over the last forty years, just as it’s true that technically those export markets could in large part be cut off, China’s future economic model assumes a large-scale conversion from external demand to internal demand as Chinese domestic consumption takes off. China’s hybrid economic model, despite its continuing rigidities, is nonetheless infinitely more market-flexible than anything the Soviet Union ever came up with. Not to mention that Chinese military expenditure as a proportion of the country’s total budget is modest by ancient Soviet, or, for that matter, even modern Russian standards.

None of this is to assume an economic containment strategy against China would be incapable of delivering significant damage to Chinese growth. It would. Just as it would deliver enormous damage to both the American and global economies on the way through. Nonetheless it would be heroic to assume now, as Kennan did back then in the case of the Soviet economy, that the Chinese economy could be brought to its knees. Shutting the door on China’s economy with the rest of the world might have been possible up until end of 2001 when China joined the WTO. But that opportunity has long since passed us by.

Finally, on the containment question, it’s worth recalling that it took more than forty years for the Soviet economy to implode in 1991. In China’s case, 2060 seems a very long way off indeed.

This, therefore, brings us to decoupling. This seems to have become the “term du jour” in many parts of official Washington and Beijing.  But once again, it’s important to be careful about the language we employ, and what exactly is meant by it. 

For example, when we think about the concept of “decoupling”, it can be seen as a conscious strategy on the part of China or the US. Or it can be seen simply as the unintended consequence of a series of actions by either party, which in turn set off a chain of events, whose cumulative effect over time is to create two competing sets of standards, systems and patterns of engagement across the global economy, each with critical economic mass.

Decoupling has already occurred between China and the United States in the internet. This has been a direct consequence of the two countries’ political systems. But whether it is internet content, search engines, or the broader regulatory regime, the bottom line is that we are already heading in the direction of two radically different digital worlds - one anchored in America, the other behind one form or other of the Chinese firewall. And third countries, particularly BRI countries, may find themselves in an increasingly uncertain no-man's-land in between.

We see the same development already unfolding in the digital payment systems around the world. China’s Alipay, WeChat Pay and UnionPay systems have been rolled out not just across China, but much of the world. At the same time, traditional American credit card payment systems are not universally accepted in China. China has deployed many non-tariff barriers to limit their penetration. The war is on, therefore, as to who will control the global digital payment system of the future. This is critical because here we are talking about the financial engine-room of digital commerce and the wider global digital economy.

The decoupling of the two countries’ telecommunications systems is also well under way. This is justified by both countries on national security grounds. American telcos have negligible access to the Chinese domestic market, although American mobile devices so far have some market penetration. Huawei has now become a listed entity under United States law. Other Chinese telco providers also face the prospects of far-reaching American restrictions. Furthermore, the battle for Huawei is well and truly underway across third-country markets, both in the developed and developing world. Huawei already dominates 5G technology in much of developing Asia, Africa and Latin America. The United States is seeking to prevent further encroachment by Huawei in western markets, including among its closest military allies.

Once decoupling in the telco, broadband and digital economy sectors is complete, we are then left to speculate as to the roll-on consequences for the future of Chinese and American global supply chains. China’s new “unfriendly entities list” in retaliation against America’s listing of Huawei and potentially other Chinese companies will result in corporations around the world having to navigate this increasingly complex minefield, as they revise their future global supply chains to avoid the animus of these two giants of the twenty-first century global economy.  This, rather than technological innovation, could well become the cause of the next great global disruption.

Given the complexity of these supply chains already, and the multiple technological components that make up a single product, it is not difficult to envisage a return to more inefficient forms of vertical integration within single firms, or else the rearrangement of future supply chains within either of these emerging, self-contained geo-political spheres of influence. Thus we begin to see the beginning of the end of globalisation of itself, the structural efficiencies it has delivered to the global economy through better resource allocation, as well as the increased global living standards and poverty reduction that have come about as a result.

Finally, of course, there is the decoupling already under way in artificial intelligence. China is acutely conscious of its strengths and potential in this critical domain. It understands its unparalleled access to big data and the machine learning possibilities that come from that. And its leadership is acutely aware of the vast array of military, economic and social applications that flow from whoever conquers first and most effectively the commanding heights of this new technological frontier. America too is conscious of the dilemma it faces in retaining its technological edge in high technology in general and AI in particular given the emerging China challenge, the limitations it faces in its own access to big data, and the privacy and other legal constraints that exist in Western liberal democracies. For these reasons, we can already see the opening up of a binary AI world where once again countries will ultimately be making a choice.

The question arising from all the above is not where economic decoupling starts, but where it is likely to stop. And if it cannot be easily stopped, where does this decoupling, justified on national security grounds but facilitated by the growing political appeal of classical forms of protectionism and economic nationalism, actually lead us? If we are beginning to see a more fundamental unravelling of the economic globalisation project that has been underway in earnest since the end of the last Cold War, then where does that take us? Are we wittingly, or unwittingly, creating the economic conditions for a real rather than imagined second cold war of the type discussed above? And if indeed this becomes the case over the decade to come, what then happens in foreign policy and national security policy? Do we in fact end up creating the conditions for a more comprehensive political and strategic decoupling between China and the United States, thereby creating the conditions for a more generalised second Cold War. Or worse?

In summary, it seems as if the dynamics of economic globalisation are slowly being turned on their head before our very eyes. For the last thirty years, the logic of economic globalisation has been to transcend national politics and protectionism and to bring the world closer together. Yet now, with economic globalisation reaching its apogee by the start of the Global Financial Crisis almost a decade ago, it has generated its own internal contradictions, powered by the politics of populism, protectionism, and classical geopolitical rivalry, to generate a different and more fragmented world altogether.

For these reasons, both the United States and China, together with other members of the international community, need to think through very carefully indeed where these new and unsettling trajectories may take us all. Both for their own interests, and the world’s.

Implications for Chinese Strategy Towards the United States

Having recently spent several weeks in Beijing in May and June this year, it seems that these recent developments in the US-China trade and economic relationship have caused our Chinese friends to undertake a fundamental rethink about the long-term direction of their own strategy towards the United States. This occurs within the context of a wider review of China’s long-standing assumptions underpinning their overall worldview of the sort of international order Beijing is likely to face in decades ahead. Indeed, Beijing is beginning to conclude that the world of the last twenty years may no longer be the world they face in the future, thereby requiring a possible change of strategic course on China’s part as well.

China’s Continuing Strategic Objectives

It’s therefore important to remind ourselves of what China’s enduring strategic objectives are. To recap briefly on a recent address I delivered at the US Military Academy at West Point, I argue there are seven core elements to the Chinese Communist Party’s worldview. Indeed, these are perhaps best understood as seven concentric circles of interest, moving from the domestic to the international, although in the party’s mind all are clearly linked. Together they make up what I describe as the Chinese national equivalent of Maslow’s hierarchy of needs.

 

At the core of these interests lies the absolute centrality of keeping the Communist Party in power. As a Marxist-Leninist Party which secured power through violent revolution, this should never be forgotten. This is followed by:

• maintaining national unity, including Tibet, Xinjiang, Taiwan and Hong Kong, all central in the Party’s eyes to its continuing national political legitimacy;
• ensuring economic growth in order to raise living standards to advanced economy levels, while also maintaining environmental sustainability;
• cultivating benign and ultimately compliant relationships with China’s 14 bordering states;
• securing China’s continental periphery by projecting its economic and geostrategic influence across the Eurasian continent;
• projecting its maritime power across East Asia, the western Pacific, and the Indian Ocean; avoiding armed conflict with the United States while seeking to decouple, over time, America’s network of Asian alliances;
• optimising good relations with the developing world—across Asia, Africa, and Latin America—thereby enhancing China’s position in developing country markets while also consolidating Chinese interests in the institutions of global governance where G77 support is often critical;
• reforming the existing institutions of global governance over time, gradually aligning the practices, personnel, and culture of these institutions in a manner more closely aligned with Chinese interests and values, while also creating new international institutions where China is at the core.

 

China’s Analysis of its Changing Strategic Environment

 In seeking to understand how China forms its national strategy, we need to have a clear understanding of how China views its international operating environment. The reason this is important is because while the seven sets of objectives described above may be relatively constant, the political and policy environment in which China operates, both at home and abroad, is subject to constant change.

That’s why China deploys its own formal, analytical processes to define the “objective” nature of the short and long-term historical developments and trends with which the Party must contend. The disciplinary framework which the Chinese bring to bear to this task is heavily shaped by the Marxist-Leninist theoretical frameworks of their inheritance, combined with certain classical Soviet methodologies for understanding the changing nature of state power. These include the analytical disciplines of historical materialism and dialectical materialism, as well as Soviet concepts of “comprehensive national power” and the “correlation of forces”.

Furthermore, it’s important to understand that our Chinese friends regard these processes as “scientific” and the conclusions wrought through them as being “objectively correct”.  These conclusions are not reached lightly. They are the product of focused intellectual effort. And once reached, they tend to remain in place for a long time rather than shifting with a single US presidential election, the rise and fall of various governments around the region or the world, let alone the highs and lows of the long-term economic or business cycle. In other words, China seeks to take a deeper analytical view of the underlying drivers of regional and global change before locking on to its conclusions about what China is facing and what Chinese policy should be in anticipation and/or in response.

Since 2002, the key Chinese conclusion about the domestic and international environment it faces has been that China continues to experience a period of unprecedented “strategic opportunity”. It is important to understand what Chinese political leaders and policy analysts mean by this term.

Specifically, it means that China is able to pursue its domestic economic development agenda in a stable and peaceful environment without any real risk of major war. Second, it means that the forces driving economic globalisation will continue and that these will continue to accommodate, support and enhance China’s modernisation agenda. Third, it sees the United States in a period of relative international decline, and while the US will remain for some decades still the world’s only economic and military superpower, a more multipolar global order is seen as slowly emerging, where China’s relative influence will continue to increase. Fourth, these processes of relative American decline have been accelerated by America’s preoccupation with the rolling military engagement in the Middle East across multiple wars; the damage done to American economic power and prestige through the Global Financial Crisis; and the increasing travails of what is seen as a dysfunctional American, and now broader Western, democratic system.

Changing Chinese Strategy Under Xi Jinping and the Domestic Political Reaction to it

Until the rise of Xi Jinping, China’s strategy in response to this analysis was a gradualist one, best encapsulated in Deng Xiaoping’s famous maxim of “hide your strength, bide your time, never take the lead," (and only take selective initiatives when you can). As I’ve written before, this gradualist approach changed in 2014 under Xi Jinping when, following the party’s Foreign Affairs Work Conference of late that year, China embarked upon a more activist strategy around the region and the world. This new strategy took many forms in China’s international policy settings. It was also amplified by a more activist political and economic strategy on the home front.

For example, to secure the party’s future, Xi Jinping embarked on an unprecedented anti-corruption campaign. To secure his own political position, he also engineered the purge of all his active political opponents. He then abolished term limits for the position of the presidency in order to pave the way for the possibility of continuing in office beyond 2022. He also outlined a new ideational vision for the party and the country in three parts, all with an eye to consolidating the Party’s legitimacy in the eyes of the people:

• First, for China to build a “moderately prosperous society” by the time of the Party’s centenary in 2021;
• Second, for China to become a “modernized, fully developed, rich and powerful” nation by the 100th anniversary of the People’s Republic in 2049; as well as
• Third, an intermediate objective, now set for 2035, whereby China would become fully “modernised”, a date which appears to coincide with the Party’s estimation of when it will have surpassed the United States as the world’s largest economy according to market exchange rates, and a date when Xi Jinping could still conceivably be in office.

On the question of national unity, Xi Jinping has presided over a large-scale crackdown in Xinjiang, an increasingly assertive policy towards Taiwan as well as a hard line approach to Hong Kong, although recent developments there may suggest the limits to such an approach.

On the economy, Xi Jinping has insisted on a much bigger and bolder role for the Party, as opposed to leaving economic management in the hands of the technocrats of the state apparatus, as occurred under his predecessors. He has also sought to do so in a manner which is now compatible with the principles of sustainable development, or to deploy the Chinese terminology, the principles of “eco-civilisation”. In this sense, Xi Jinping has become deeply mindful of the Chinese people’s basic expectations for clean air, clean water, clean soil and clean food, as well as national and international action on climate change. Furthermore, on the economy, Xi Jinping has embraced a China 2025 strategy aimed at overcoming China’s historical weaknesses in innovation and technology, but also stating explicitly China’s intention of dominating these domains in international markets in the future, including his new national strategy on artificial intelligence.

As for China’s neighbouring states, Xi has pursued a complex strategy of both confrontation and accommodation, driven in part by the overall temperature and trajectory of the US-China relationship. For example, Xi prosecuted a sharp set of border engagements with both Japan and India during his first term, only to extend the olive branch to both Tokyo and Delhi after the election of the Trump Administration in 2016. In the meantime, Xi has invested much political energy in the deep reform of the China-Russia relationship, maximising the two countries’ common economic, security and foreign policy interests, thereby turning Beijing’s extensive northern border with Moscow into a zone of economic opportunity rather than continuing strategic anxiety.

On China’s maritime strategy, Xi Jinping has pursued a more assertive strategy in both the East China Sea and the South China Sea. His island reclamation program has been extensive, as has been their subsequent militarisation. Similarly, China’s maritime tactics against US and other regional naval assets has been increasingly sharp. The number of near incidents at sea involving US naval vessels has also increased. China’s naval modernisation has become the fulcrum of Xi Jinping’s doctrine on the professionalisation of the PLA - so that it can “fight and win wars,” not just put on impressive parades.

On China’s continental periphery, the Belt and Road Initiative across Eurasia speaks for itself. A strategic accommodation has been reached with Russia over central Asia. China now has a growing strategic presence in the Gulf, the Red Sea and East Africa, and across the Indian Ocean. China’s diplomacy towards Eastern and Western Europe, as well as Brussels itself, has become ever more active as China seeks to turn Europe into a major economic and ultimately strategic ally.

As for the global rules-based order, Xi Jinping’s China has been more active in the institutions of the United Nations and the Bretton Woods institutions. It has also invested in new institutions beyond the post-war order, including the Asian Infrastructure Investment Bank, the New Development Bank and once again the BRI.

Most international commentators are aware that these various initiatives by Xi Jinping’s administration have attracted criticism abroad. What they are less familiar with is that there has also been some criticism at home as well.

The anti-corruption campaign has been criticised for being politicised and for its selective targeting of political opponents. The China 2025 strategy, particularly its explicit state targets for Chinese domination of all major high-tech sectors into the future, has also attracted significant internal criticism for having elicited a hard-line American and European response. There has also been criticism of BRI for being too ambitious, too expensive, and too wasteful – as well as generating negative reaction against China in many target countries. Similarly, there has been criticism of the strategic wisdom of island reclamation in the South China Sea, evidenced by the success of the Philippines’ legal case against China in the Permanent Court of Arbritration, wider political reactions across Southeast Asia, as well as providing physical and photographic evidence to the American and international body politic that China now, by definition, was no longer a status quo state. And then, on top of the above, there has been criticism of Xi Jinping’s decision to repeal term limits for the office of president, suddenly crystallising in international political opinion the view that Xi Jinping will not only be China’s next Deng Xiaoping but possibly China’s next Mao Tse-Tung. In other words, leader for life.

The common theme in these internal critiques of Xi Jinping has been strategic and political overreach in conscious contravention of the longstanding wisdom of successive generations of Chinese political leaders following Deng Xiaoping’s long-standing doctrine of restraint. Instead, according to Xi Jinping’s internal critics, China has been out there “loud and proud” and, as a consequence, for the first time since 1978, generating significant structural opposition abroad to the realisation of China’s long-term political strategy.

One further vulnerability on Xi Jinping’s part has been China’s soft economic performance in recent years. There have been a number of contributing factors to this. First, there was China’s homegrown financial crisis of 2015 which saw the collapse of Chinese equities markets and a run on various Chinese financial institutions until the state intervened.

Second, after the crisis of 2015, Xi effectively put on hold the new economic blueprint for China adopted by the administration back in 2013. That blueprint sought to move away from China’s old economic model of labour intensive, low-cost manufacturing for export, strong state-owned enterprises turbocharged by high levels of state infrastructure investment to a new model based on domestic consumption, service industries and a dynamic Chinese private sector, with new industries based on technological innovation and a declining state economic sector.  

Third, following 2015, the Chinese private sector began to lose confidence in China’s overall economic policy settings. They concluded that state-owned enterprises were now being preferred over the private sector in the allocation of credit, and that the Party had begun to exert greater and greater levels of control over what private firms did and on how much they could grow. This resulted in declining levels of private sector confidence, translating in turn into declining levels of private sector investment, growth and employment.

These factors, taken together with the direct impact of the US-China trade war during 2018-19, as well as its more general impact on Chinese domestic economic confidence, began to place Xi Jinping under considerable economic pressure.

These then, are the wider political circumstances in which Xi Jinping has had to respond to the recent politics and economics of the trade war during the critical developments of May 2019. In other words, the trade war is not simply an economic phenomenon for the Chinese leadership. It occurs in a context of Chinese politics as well, where some within the leadership have begun to question the wisdom of the leader’s perceived overreach across multiple policy fronts.

China’s Current Strategic Reappraisal

Nonetheless, beyond the immediate politics and economics of the trade war and the possibility of a broader economic decoupling between China and the United States, the deeper question remains of a more far-reaching Chinese reappraisal of whether Beijing’s overall strategic operating environment has now fundamentally changed for the worse.

As noted above, Chinese strategic planners have long been disciplined in the business of separating out the tactical from the strategic; the short term from the long term, the trivial from the important. China’s strategic culture disinclines it to respond to a single headline, or even several years of headlines in Western newspapers. Instead, their own analytical processes cause them to go back to basics in order to reach deep conclusions on the central question of whether China is still in fact in the same “period of strategic opportunity” that it concluded it has been in since it joined the World Trade Organisation back in 2001. Or whether this has now fundamentally changed, requiring China too to set a new strategic course.

My observations from my recent time in Beijing is that all the assumptions of the last twenty years are now under formal review. At this stage, it remains uncertain as to what precisely this review process will conclude, although it seems as if China may now be on course to indeed change its overall strategic guidance to its various agencies of state, given the new complexity and unpredictability of global politics and economics as seen from Zhongnanhai. Indeed, the earliest indications from Beijing are that China sees its external environment as fundamentally changing on a number of critical fronts, and in a generally more hostile direction. Regional armed conflict is no longer seen as a remote possibility, given possible trajectories on the Korean Peninsula if and when Trumpian diplomacy with Pyongyang breaks down. China is also now anticipating a more vigorous US response to its actions in the South China Sea. Renewed US arms sales to Taiwan are seen as potentially fomenting a future crisis across the Taiwan Strait. On the economy, globalisation is now seen as being in retreat. And a more nationalist and protectionist West may well turn against China, in which case Europe, Japan and to some extent India become the key. American hostility to China is now seen as structural as a new Thucydidean dynamic takes hold of all sides of Washington politics. Corporate America is no longer seen as a structural ally in supporting the stability of the US-China relationship. And a newly energised human rights constituency is seen in Beijing as having more widespread political support, animated by recent developments in Xinjiang, Taiwan and Hong Kong. Although, of some consolation to Beijing, America’s global brand is seen as becoming increasingly and perhaps irreparably damaged under Trump.

All of which would tend to point to a much more mixed strategic outlook compared with the “period of strategic opportunity” that has governed Chinese strategic thinking for the last twenty years. This in turn would require of China a more self-reliant, less internationally dependent national strategy for the future, to safeguard China’s interests in a much less stable world. Or it might just result in China taking a truly bold step of throwing open the doors of its economy to the rest of the world, excluding the United States. Early Chinese engagement with the TPP would be a signal of this latter approach. The jury, however, is still out on what conclusions will be reached. And it will be for some time. After all, detailed dialectical analysis takes time. 

The importance of all this for the rest of us in the international community is that if in fact China does conclude that its international operating environment has turned in a fundamentally hostile direction, it will then adjust its strategies and policies accordingly. That’s why this period of review is so critical. If, for example, Chinese policy was suddenly to become more aggressively nationalist or more stridently protectionist or more binary in its international political engagement, the rest of the world would soon know it, feel it, and experience it.

In the meantime, however, China is likely to continue its current pattern of international engagement. The review process will take time. The Chinese ship of state rarely turns dramatically. It’s a more gradual and deliberative process. But once conclusions are reached, and a new direction identified, then turn it does. We have seen it before at certain critical junctures of its modern history.

Conclusion

What China does in the future is important for us all. But watching China respond to these dynamics in isolation is a bit like the sound of one hand clapping. The other hand at play in all this is of course the United States. And the open question remains as to which way the United States will now go in the prosecution of its own wider, long-term strategy towards China in this new age of strategic competition.

The core questions in Washington are what happens to the rest of the US-China economic relationship, not to mention the foreign policy, security policy and human rights relationship, if President Trump does manage to secure a trade deal with Xi Jinping. Will economic decoupling continue to unfold, haphazardly or otherwise? If so, will it be limited to key technology sectors, or will it be broader than that? And will we see a much more vigorous response by the United States rolled out in relation to Taiwan, the South China Sea, the BRI, Xinjiang, and other core points of Chinese international political and policy sensitivity?

Second, what will happen in these other policy domains if in fact we do not secure a trade deal?

Third, if President Trump is not re-elected, what will be the points of commonality and difference between his administration’s China policy and that of the next Democratic president, whoever she or he might be?

However, these three sets of questions all turn on a more fundamental uncertainty about what kind of global power President Trump wants America to be in the future. And about what sort of global power the Democrats want America to be in the future. This fundamental question is important given the new social, economic and political forces at work within the wider US domestic body politic which are in the process of reshaping both Republican and Democratic Party politics, including their traditional approaches to foreign and security policy.

Finally, there is also the question of third countries as they seek to anticipate where China ultimately lands on the question of its long-term strategy towards the United States, its allies, the region and the world. And where, for that matter, America lands as well in its own deliberations. For the Europeans, the Japanese, the Indians, the Southeast Asians and the Australians, these profound dynamics at play right now in the future of the US-China relationship also create real uncertainties as they carve out our own contingency plans for the future. Already in parts of Europe, Japan, India and South East Asia, there are early signs of some form of strategic hedging about the future. Indeed, it would be surprising if it were otherwise.

We therefore live in difficult and dangerous times. And for countries like Australia, this will require a razor-sharp lens on Beijing, Washington and other critical global capitals to understand where these deep changes in global and regional geopolitics may now take us all.