US-China decoupling and the eve of economic destruction

This year will go down as the century’s worst if measured by the disruption, misery and strife that has marked the Year of the Rat. There seems no end in sight to the cascading series of crises afflicting millions of people around the world. Even those with no religious bent must wonder whether the Four Horsemen of the Apocalypse have been let loose as drought, wildfires, hurricanes, floods and pestilence continue to wreak havoc. But geopolitical rivalry between Washington and Beijing remains the bookies’ choice for the most destructive runner in the field. The US and China are headed for serious conflict with no ­circuit-breaker in sight. The speed with which the relationship has unravelled and the systemic impact of the falling-out has surprised even the pessimists. Disputes over trade and technology have now spilt over into telecommunications, business, financial markets, education and national security.

Virtually every tool in their national armouries is being weaponised for geopolitical purposes as both countries seek to advance their interests at the expense of the other in an economic version of military arms racing.

The dangerous, downward spiral in the relationship threatens to do lasting damage to the already stressed global economy and the fraying, rules-based international order. A big concern, with direct implications for Australia, is that decoupling of the US and Chinese economies will be more severe than previously thought, threatening our economic recovery.

How decoupling plays out matters more to Australia than any other country because of our trade dependence on China and the US position as the world’s largest economy, our biggest investor and major ally. Often forgotten in conventional analyses of trade and economic disputes is that the international trading system established by the US was also about alliance management.

Twelve months ago, the consensus view was that decoupling would be limited to some areas of technology and advanced manufacturing because the US and Chinese economies are joined at the hip. Divorce would be a form of mutually assured economic destruction and therefore unlikely. Veteran China watcher Arthur Kroeber points out that American companies have more than $US700bn ($980bn) of assets in China and do around $US500bn a year in domestic sales there. Despite the trade and tech wars, 70 per cent of American companies don’t anticipate reshoring.

But if Donald Trump wins in November, this judgment may need to be revisited. Trump blames China for the devastation caused by the coronavirus and the setback to his election prospects, and has vowed to decouple the US from China’s economy. “Whether it’s decoupling or putting in massive tariffs like I’ve been doing ­already, we’re going to end our ­reliance on China once and for all,” says Trump.

The use of tariffs and other forms of trade discrimination for geopolitical purposes — what Walter Russell Mead calls the “Trumpification of world politics” — is fast becoming a first resort for the larger economies. So it would be wrong to single out Trump for weaponising trade. China started down this road long ago.

Administration hawks such as trade adviser Peter Navarro believe the best way of preserving America’s dwindling economic and technological lead and protecting against avaricious Chinese practices is to reduce trade exposure to China and restrict the country’s access to American technology and education.

The debate within the administration is over the extent of that decoupling, and the uber hawks seem to be winning. They are determined to lock the US into a hard decoupling to make it difficult for the Democrats to reverse the ­policy in government. But there is not much likelihood of that: Joe Biden’s China ­policy is little different from Trump’s. He won’t risk being painted as soft on America’s main rival.

Trump was never an ideological China hawk. Ever the pragmatic deal-maker, his instincts were to secure a better deal for the US by pressuring Xi Jinping to make concessions on trade, until the full force of the coronavirus shredded his plans to campaign on a strong and growing economy. His souring view of China gave hawks the opening they needed to drive home the message that the US must rectify a dangerous over-dependence on China.

To their dismay, US health authorities discovered an astonishing over-reliance on China for everything from masks and personal protective equipment to essential medicines, reaching more than 90 per cent for antibiotics, cortisone and ibuprofen. Fears that Beijing might exploit this dependency have been heightened by provocative suggestions from Chinese government advisers that the export of antibiotics to the US might be curbed in retaliation for Trump’s punitive tariffs.

Xi has reined in his own uber hawks for the moment, hoping that a Biden win will provide an opportunity for a relationship reset. But as an insurance policy he has accelerated efforts to become more self-reliant in everything from semiconductors to advanced manufacturing, education and financial technology.

Xi’s recently announced Dual Circulation Theory is a declaration of intent to create a more resilient Chinese economy, future- proofed against external shocks and anticipated disruptions to international trade. Heavy on Chinese Communist Party sloganeering designed to signal the party-state’s policy priorities, DCT places renewed emphasis on spurring domestic demand (internal circulation) to compensate for a likely reduction in the exports that have fuelled the country’s stellar growth for decades (international circulation).

As with most major CCP pronouncements, DCT has a geopolitical purpose. “It is first and foremost a strategy for Chinese decoupling and the continued advance of power,” says economist George Magnus. This is driven by the confluence of four factors: a less conducive environment for Chinese exports; the souring of China’s relations with the US and other Western nations including Australia; its still high dependence on foreign technology and know-how; and the impact of the coronavirus which has reinforced the momentum towards greater self-reliance globally.

“The new strategy will be a cornerstone of China’s economic policy for years to come,” says trade analyst Stephen Olson. It is likely to shape the 14th Five Year Plan to be implemented next year. But its success hangs in the balance.

The DCT is a blueprint for ­income and wealth distribution from the state to the private sector which, if fully implemented, would require structural reform and political change that could eventually challenge the CCP’s primacy. It’s also economically flawed. To increase domestic consumption, Magnus argues, the CCP will need to lift wages, lower income inequality, discourage high levels of household saving and expand social security, all of which are incompatible with ­export competitiveness.

Data is also being weaponised along with trade. Chinese tech billionaire Jack Ma has called data more important than oil in driving the 21st century economy. The ability to collect, manipulate and use big data is the key to dominance of the foundational technologies that will define the industries of the future — artificial intelligence, quantum computing, robotics, semiconductors, energy storage, hypersonics and next- generation telecommunications.

The US and China are striving for economic and technological supremacy in a fight neither can win, but both fear losing. The ultimate prize is the ability to set the rules and control the information highway. Driving this change is techno-nationalism — defined by the Hinrich Foundation’s Alex Capri as “mercantilist-like behaviour that links tech innovation and enterprise directly to the national security, economic prosperity and social stability of a nation”.

Capri says China has been steadily closing the technology gap with the US because the CCP is funding its innovation agenda “on a scale never before seen in history”. By 2030, China will have an R & D budget of $US900bn and — unless the US makes adjustments — will invest at least $US70bn more per annum than all US industrial, government and academic R & D institutions combined. Capri says: “In response to decades of Beijing’s techno-­nationalism, the US has embarked on its own innovation offensive … that could surpass the scale of the moonshot projects during the space race with the former Soviet Union.”

Technology analyst JS Tan holds a similar view. “For most of the internet’s history, the West dominated the online world. Embodying a mix of social progressivism and economic conservatism — known as the California Ideology — Silicon Valley became rulers of the open internet and champions of the free flow of information. Neoliberalism, in other words, went online.” But Silicon Valley’s neoliberal order has come to an end and a new era of tech ­nationalism has emerged.

Responding to criticism that they are prepared to co-operate with Beijing but not Washington, leading US technology companies are starting to get on board Trump’s innovation agenda. Tan believes this turnaround is driven by fear of being branded disloyal and anxiety that the rise of China’s tech industry may spell the end of Silicon Valley’s dominance. Former Google CEO Eric Schmidt recently warned in an opinion piece for The New York Times that ­Silicon Valley must work with the Pentagon or China would win.

But Trump is also “trying to out-China China”, says Fiona Alexander, a former US official and policy strategist at the American University in Washington. This means playing hard ball with China’s technology champions, severely restricting their ability to operate in the US and putting pressure on other countries to ban the use of Chinese apps and technology. Trump wants to deny China access to all American data — from military communications carried on undersea cables to 5G-enabled smart refrigerators and television sets — by establishing a “clean network” of trusted systems that the CCP can’t touch.

This is beginning to threaten data on apps and the hard infrastructure that moves data around the world, jeopardising China’s tech business model. The Clean Network Program, announced in August, already includes nearly 30 countries. While China could withstand breaking off economic ties with the US alone, it would take a much bigger hit if American allies cut off Beijing.

Many other countries are joining Trump in opposing China’s techno-nationalism. Capri says the US is seeking “alignment with the security, economic and ideological objectives of the EU and other historic allies”. Australia, Japan and the UK have already excluded Huawei from their 5G networks. India has banned more than 100 Chinese apps, including video-sharing platform TikTok, and is co-operating with Australia and Japan on an Indo-Pacific Supply Chain Resilience Initiative launched in September and clearly aimed at China.

Kroeber thinks that Huawei is probably finished as a maker of 5G network equipment and smartphones once its inventories run out early next year unless a Biden administration were to cut a deal. He believes that Trump is winning his implicit bet that China needs access to US markets, capital and technology more than the US needs access to Chinese markets and imports. US national security can be strengthened at less cost “which is an absolute gain in Trump’s zero-sum world”.

The risk is that the whole ­global ­economy could decouple if the US and China continue down their ­diverging paths.

The dilemma for Australia is how to steer the ailing ship of state through the decoupling storm at a time of historic weakness and uncertainty. Some economic separation between the US and China is unavoidable and, ­indeed, necessary to preserve the integrity of a robust, open trading system and democratic values, freedoms and institutions. Unless it is opposed, China’s techno-­nationalism, gaming of international trade and domination of global supply chains would entrench its authoritarian system and make us more vulnerable to coercion.

But every effort must be made to keep decoupling within manageable limits. A hard decoupling would not only delay and complicate Australia’s economic recovery. It could also sow the seeds of a second global recession, or even depression, as the US-China trade and tech wars would likely intensify, further fracturing global ­supply chains, reducing international co-operation and opening up new areas of conflict.

A more astute, managed decoupling is required. Australia needs to embrace common approaches with other democracies that still permit global engagement and open trade with one another and China, while building a new consensus for ­reform of trade and technology governance.

Global supply chains will continue to underpin international trade, albeit with higher levels of redundancy. But there will be a much higher priority on self-­reliance and national resilience. These will be the guiding principles in a product- and industry-wide reassessment of the capabilities required for security, development and critical public goods. Decoupling and the weaponisation of data are accelerating the shift to greater state intervention even in liberal democracies, where a renewed focus on strategic industries and national champions is likely, along with pressure for new social contracts.

US-China decoupling is legitimising greater government intervention in market economies in the name of national security and greater self-reliance. Scott Morrison has intuitively grasped this shift and is moving to reinvent the Coalition as a reformist government not afraid to trumpet the virtues of big spending and to pick strategic winners. They include university courses, new energy technologies, defence, critical minerals, space industries, agricultural processing, digital connectivity and the establishment of a strategic petroleum reserve.

Politically, this is a smart move. Although it may alienate some traditional supporters, given the damage inflicted on the economy by the coronavirus it is likely to win more converts than detractors and make the Coalition a more difficult target for Labor. But the government needs to define what should be produced in Australia for national security reasons and what we should keep importing. A detailed inventory of the sovereign capabilities required to prosper in a more divided, protectionist and decoupled world would be a good start.

The biggest problem will be managing China risk. Xi is already committed to diversifying away from Australian raw materials and produce in his quest for greater self-reliance, irrespective of what we say or do. It would be prudent to plan for significant reductions in our commodity exports to China, including iron ore, as Brazil begins to ramp up production and Beijing looks to accelerate the development of mines in ­Africa.

There are also likely to be significant falls in the number of Chinese students and tourists coming to Australia. Peak China has passed. The sooner we accept this reality, the sooner a new Australian economy will arise, fit for the times.

Alan Dupont is CEO of geopolitical risk consultancy the Cognoscenti Group and a nonresident fellow at the Lowy Institute.