The Necessary War

The interests of the U.S. and China are set to collide, for the simple reason that the Chinese recognize that they find themselves in a profoundly unfavorable position.

By REIHAN SALAM
President Trump and Xi Jinping arrive for the state dinner with the first ladies in Beijing, China, on November 9, 2017.

Despite the heated rhetoric of the past few days, a trade war between the U.S. and China does not seem imminent. 

But it may be inevitable.
Almost immediately after the Trump administration announced its plans to impose tariffs on a broad array of Chinese imports, with an eye towards compelling the Chinese government to address intellectual-property theft and other trade abuses, Chinese officials responded by threatening tariffs of their own, shrewdly training their fire on U.S. imports from constituencies crucial to Republican political fortunes. 

Many observers have thus concluded that we’re on the cusp of a devastating economic confrontation.

Of course, nothing is set in stone. 

Just as President Trump dialed back his steel and aluminum tariffs, to unruffle the feathers of various allies, it is likely that something similar will happen this time around, particularly if the Chinese make concessions, as I expect they will. 

Beijing recognizes that they are more vulnerable to a disruption in trade flows than their U.S. counterparts, thus giving them a strong incentive to moderate their stance. 

In this instance, the U.S. and China will likely step back from the brink.
In the longer term, though, the interests of the two countries are set to collide, for the simple reason that the Chinese recognize that they find themselves in a profoundly unfavorable position. 

While Xi Jinping is quite willing to deploy cosmopolitan rhetoric—witness his many paeans to global free trade—it is always in service to Chinese national interests as understood by the leadership of the Chinese Communist Party, which maintains, correctly, that we live in a rivalrous world. 

Given America’s naval dominance, it would be foolish of Beijing to rule out the possibility that the U.S. might one day subject them to an economic blockade, or worse. 

This would be true even if the current occupant of the White House communicated in dulcet tones rather than in bellicose late-night tweets. 

To preserve their autonomy, the Chinese believe it necessary to do everything in their power to substitute for sophisticated imports, whether the world’s already-rich market democracies scream bloody murder about it or not.
U.S. politicians portray the Chinese as unscrupulous economic predators, who have managed to game the rules of international trade to grow at America’s expense, usually in connivance with feckless U.S. elites. 

Trump in particular placed this narrative at the heart of his presidential campaign, as have countless others. 

And I don’t doubt that there is some truth to it. 

It helps to look to the origins of China’s economic opening. 

Ultimately, the wrenching decision to surrender centralized control of many aspects of Chinese society was rooted in the fear that as neighboring states grew wealthier, they’d gain in relative power. China would grow more vulnerable to foreign coercion, of the sort seen during the country’s “century of humiliation.” 

Throughout the 1960s and ‘70s, companies in Japan, South Korea, and Taiwan learned how to sell their wares in the U.S. and other faraway markets. 

By the time China opened its economy in the late 1970s, containerized shipping was a more mature technology and China was desperately poor. 

Moreover, the international trading system had evolved, thus giving Beijing less room to maneuver. The Chinese didn’t really have the option of simply mimicking what their neighbors did, at least not at first. 

Instead of building its own champion exporters, China cautiously opened itself up to foreign companies that wanted to offshore low-level production. 

And then mid-level production. 

And then, eventually, pretty much all production, from soup to nuts.
In Playing Our Game, political scientist Edward Steinfeld lucidly describes how offshoring was a two-way street. 

One of his central observations is that “in the networked world of global production, there inevitably arise lead firms and follower firms, rule makers and rule takers.” 

In short, multinationals were the rule makers and Chinese firms were, by and large, the rule takers. 

While multinational firms offshored elements of production to their Chinese counterparts, the Chinese in effect offshored governance of the production process to foreigners—a marked departure from the autarkic ethic of Maoism.
How did offshoring work in practice? 

Whereas a factory in the U.S. or Germany might have built products using a similar mix of labor and capital, factories in low-wage countries, China very much included, would have done things quite differently. 

Milton Ezrati offers a useful illustration in his book Thirty Tomorrows. 

Say a piece of production equipment has been shipped from Germany to China to be used in a Chinese factory. 

Once assembled in China, the equipment would be “de-engineered” in various ways to disable some of its higher-end automated functions, because an abundance of low-wage labor meant that you could do more things by hand, and to make it easier to use, because low-skill workers would generally be better suited to using a simpler process.
Unlike the world-class Japanese companies that duked it out with American corporate dinosaurs in the 1970s and ‘80s, Chinese companies didn’t really compete with U.S. companies, or not until recently. 

They’ve been more like sidekicks that help U.S. companies earn higher profits by lowering their costs. 

By liberating U.S. companies willing to offshore their production from their near-total dependence on the U.S. workforce, Chinese workers helped supercharge the growth of U.S. multinationals, sending their value skyrocketing. 

Though the U.S. represents a shrinking share of global GDP, globalization has helped U.S. multinationals grow even more dominant than in decades past.
At the same time, however, the Chinese have sought to rise from their subordinate position, and to foster formidable multinationals of their own, with increasing success. 

The fruit of these efforts can be seen in the rise of China’s consumer internet giants, which have flourished behind the country’s so-called “Great Firewall,” an instrument of mass surveillance and repression that has also proven an effective tool of industrial policy. 

It has become routine for U.S. technology firms to cede the Chinese market outright to local firms, so cognizant are they of the unlevel playing field. 

Viewed from Beijing’s perspective, however, allowing the Alphabets and the Facebooks of the world to operate without constraint would be sheer madness: They’d expose their citizenry to external influences, which in turn would threaten the stability of the regime. 

Having closely studied the collapse of the Soviet bloc, and of various other one-party states around the world, the Chinese government has no intention of surrendering control. 

Thus far, expectations that rising affluence would lead to calls for liberalization, let alone competitive multiparty politics, have not been borne out, to the surprise and dismay of the U.S. foreign-policy community. 

Even if the Chinese government were to become more responsive to the mass public, it is not at all obvious that this would entail dismantling its distinctive brand of innovation mercantilism: Indeed, it might lead to its reinforcement, as ordinary Chinese citizens rally around the flag.
China’s desire to strengthen its indigenous enterprises is not limited to the consumer internet sector. The “Made in China 2025” initiative, for example, is all about establishing Chinese dominance in a number of emerging industrial technologies. 

The country’s “one belt, one road” (OBOR) effort can be understood in a similar light: as a means of shifting Chinese private investment from the U.S. to various Eurasian states that are more susceptible to Chinese influence, and that will evolve into receptive markets for Chinese goods and service. 

It is a very 19th-century vision, and there is no guarantee that it will succeed. 

But there is also no denying its logic. 

If China sees the U.S. as its most formidable rival, why exactly would it continue to rely on Boeing when it has the scale to manufacture its own sophisticated aircraft, which might one day be deployed against the U.S. and its allies?
I take no pleasure in the thought of a more confrontational relationship between the U.S. and China, and I certainly hope it can be avoided. 

The only way to do that, I suspect, would be for the Chinese government to drastically change its policies by promoting increased consumption among Chinese consumers, thus reducing its domestic savings and easing global imbalances, a prescription championed by the veteran China analyst Michael Pettis. 

Under the current dispensation, state-owned enterprises and the export sector are heavily subsidized at the expense of Chinese consumers. 

By cutting taxes on Chinese households, and strengthening the country’s threadbare safety net, the government would greatly improve living standards among ordinary Chinese. 

And indirectly, a consumption-led approach would increase China’s appetite for imported goods and services, thus addressing some of the grievances of its trading partners. 

At times, Beijing seems to be moving in this direction, albeit in fits and starts. 

Yet moving too quickly might cause fissures within the Chinese Communist Party, as the economic interests that benefit from the status quo remain inordinately powerful. 

Don’t expect an economic perestroika anytime soon.
It’s more likely that the symbiotic relationship between the U.S. and China, in which U.S. firms rely heavily on Chinese intermediate inputs and vice versa, will unravel in slow motion. 

Automation will, over time, offer U.S. multinationals an alternative to China-centric global production networks. 

And perhaps Trump’s America First agenda will give way to an Americas First agenda, in which U.S. dependence on Chinese manufacturing prowess is supplanted by deeper integration with neighboring economies, not unlike the way German industrial firms are enmeshed with suppliers in central and eastern Europe. 

All this may sound fanciful. 

But China only entered the World Trade Organization in 2001; our mutual entanglement is not quite old enough to vote. 

The forces pulling the U.S. and China apart are more powerful than those keeping them together.

Chinese Golem: Globalization Has Created a Chinese Monster

Xi Jinping's dictatorship isn't what the end of history was supposed to look like.
BY EMILE SIMPSON 

Chinese dictator Xi Jinping speaks at the opening session of the 19th Communist Party Congress in Beijing on Oct. 18, 2017. 

On Sunday, the Chinese Communist Party Central Committee recommended ending the two-term limit on the presidency, paving the way for Xi Jinping to stay in office indefinitely. 

This surely marks the end of an era — and not just for China, but also for the West.
For the West, the era in question started with the end of the Cold War, as old enemies became “emerging markets.” 

China had already started opening its markets to foreign investment since 1978 under Deng Xiaoping’s reforms. 

But only in the 1990s did the private sector take off there, and Western firms promptly rushed in to profit from the breakneck speed of Chinese economic growth.
The beauty of the post-Cold War emerging market story was that it was apolitical. 

Recall the famous identification of the leading emerging markets by Jim O’Neill in 2001 as the “BRICs” (Brazil, Russia, India, China) — four states from different groupings during the Cold War now viewed together as the leading protagonists in a new era of peaceful globalization under the Pax Americana. 

Some called it the end of history.
But this apolitical approach was premised on the assumption, inherited from the Cold War, that democracy and capitalism go hand in hand, and that the extension of free markets would bring global convergence to the Western economic model, as the Washington Consensus predicted.
Confidence in globalization saw massive amounts of Western capital and intellectual property flow to emerging markets, above all to China. 

But few in the West registered the geopolitical significance of this at the time. 

Instead, they praised the economic growth story. 

And not without good reason: the integration of China into global markets lifted a billion people out of poverty. 

It remains a testament to the material benefits of removing geopolitical obstructions from the development of global business.
But this story of global cosmopolitan peace has been on the rocks for some time. 

Russian privatization in the 1990s ultimately produced a mafia state controlled by an oligarchy. 

More broadly — with a few exceptions, mainly in Eastern Europe, where democracy did take hold (current problems notwithstanding) — capitalism has expanded since the end of the Cold War in spite of democracy, not alongside it.
And nowhere is this more evident than in China. 

It’s now abundantly clear that despite the West’s pious belief in the transformative power of free markets to encourage “reform,” China is headed toward more, not less autocracy. 

Indeed, China has broken a path toward a new form of totalitarianism in which one man will sit atop a police state with access to ubiquitous data gathered about citizens by social media and online shopping platforms and a vast human and electronic surveillance apparatus to track their every move. 

Look no further than the ghastly “social credit score” system that Beijing wants to roll out by 2020 to get a sense of how wrong the idea has proven to be that free markets will bring about democratic change, or even minor liberalizing reform in China. 

A billion people may have been lifted out of poverty, but only to find themselves living under cyber-totalitarianism.
The geopolitical consequences of this realization could be very profound indeed. 

In the Cold War, the West faced totalitarian communist regimes whose economic model and political system were both alien to what the “free world” claimed to stand for. 

Of course, the link between capitalism and democracy was always tenuous, not least given the reality that many of the West’s allies were not democratic. 

But now, if it was ever in doubt, we know for sure that capitalism and democracy don’t have to go together: Capitalism is up for grabs, and you don’t even need to support the Pax Americana to plug into it

How does this end? 

We don’t yet know, but the question may well come to be the defining feature of a new geopolitical phase the world seems to have entered. 

Note how far removed from the happy story of liberal globalization is the language of the Trump administration’s December 2017 National Security Strategy: “China and Russia challenge American power, influence, and interests, attempting to erode American security and prosperity.”
Admittedly, this comes in the context of a presidency that bizarrely refuses to carry out U.S. congressional sanctions on Russia for interference in the U.S. 2016 elections. 

But the more important point is that Western states and their citizens are becoming increasingly alert to the need fundamentally to reappraise the value of the integrated global capitalism they have more or less promoted since the early 1990s. 

I am not talking about a reappraisal in light of the inequality that economic growth has produced, or the massive outsourcing of manufacturing jobs that created rust belts on both sides of the Atlantic, which is a separate discussion. 

Rather, this reappraisal concerns the inconvenient truth, which surely now is undeniable, that the West’s own economic policy has encouraged, if unwittingly, the rise of deeply illiberal regimes in much of the former communist world.
What practical effect this produces in the foreign and economic policies of the West depends, on the one hand, on the extent to which the West is prepared to sacrifice material wealth in support of its public values; and, on the other hand, on the extent to which authoritarian states, above all Russia and China, attempt to export their values abroad. 

One could list any number of areas where this dilemma will play out, but the most important near-term litmus test will be whether the West responds to China’s Belt and Road Initiative as a benign economic project, or as a geopolitical threat.

World's most protectionist country

With Pen Plan, China Etches Nationalist Economic Policy 
By CHUIN-WEI YAP
 
BEIJING—After a five-year effort, one Chinese company recently achieved a mission of national interest: helping develop the first fully Chinese ballpoint pen.
What’s not clear is whether it made economic sense.
Chinese manufacturers produce 38 billion ballpoint pens a year—80% of the global market.
But they didn’t make the nib, the part that holds the ball at the tip, long preferring the quality of Japanese and European made versions.
Then, Beijing prodded them to look onshore.
Xi Jinping has vocally defended free trade and globalization in recent days, stepping in as U.S. President Donald Trump flirts with trade protectionism.
But at home Beijing’s policy makers often promote a “Made-in-China” ethos, tapping a rich vein of nationalist sentiment.
The quest, framed as a catalyst for homegrown innovation, has defined how goods are made in major Chinese industries, at the expense of efficiency.
Studies rank China’s economy, the world’s second largest, among the most closed. 
From cars to wind turbines, Beijing limits foreign participation in domestic production. 
Citing “food safety,” Beijing insists that almost all grains consumed in China are domestically grown, and sets artificially high prices to support bumper harvests. 
State media touts locally made consumer products including bidets and rice cookers.
The stationery giant spearheading the nib mission, Beifa Group Ltd., defended the nib strategy as it began mass-producing the pen part this month despite signs that Japan can match the cost.
Officials hoped the domestic effort will pave the way for other advances in Chinese precision engineering.
“It’s meaningful to have a breakthrough in the core technology for the domestic industry,” Zhang Xuelian, Beifa’s spokesman, said in an interview.
“What if there’s a war?”
Beifa’s contribution to Chinese self-sufficiency began in 2011 when the Ministry of Science and Technology asked companies to “achieve the localization of pen-product technology.”
Beifa’s research division took on the development of a key part of the ballpoint: the bullet-shaped, 2.3-millimeter-wide metal socket that feeds ink to the half-millimeter ball at its tip.
The ministry provided $8.7 million for the research, which Beifa undertook with state-owned Taiyuan Iron & Steel Group Co., China’s largest stainless-steel mill.
By September, the mill produced its first fully-domestic ballpoint pen.

Not so smart nation: Despite making almost 40 billion ballpoint pens a year, until recently China was struggling to manufacture one component domestically. 

The project became a focus of national pride.
Li Keqiang played it up during a visit to the Taiyuan mill early last year.
Officials distributed it to foreign leaders at the China-hosted Group of 20 summit in September.
“It’s done! We’ve broken the Japanese and German monopoly,” a local branch of the Communist Youth League, a faction of China’s ruling party, headlined a post this month on a popular microblogging platform.
Such nationalist sentiment has risen in China amid historical grievances between China and Japan, as well as Mr. Trump’s threats to impose tariffs on Chinese goods and interfere with Beijing’s policy in Taiwan and the South China Sea.
While Xi defends globalization abroad, his nationalist policies favor state-run companies back home. 
China unfairly restricts access to its markets while flooding markets with low-price exports such as steel, helping to stoke a populist backlash abroad against globalization.
But when it comes to ballpoints, officials from Japanese and European pen-manufacturing associations separately said there has never been trade friction that may have led China to fear a blocked supply of nibs.
“Any threat or restriction in supply is not conceivable,” said Manfred Meller, secretary of the European Writing Instrument Manufacturer’s Association.
“Japan and Europe produce and supply ballpoint nibs to everybody.”
World Trade Organization records indicate that China has been involved in only one trade complaint over ballpoint pens: Brazil in 2008 investigated, then imposed antidumping duties against, Chinese pen exports.
Analysts say the century-old technology is neither costly nor esoteric.
Official data show China spends $17.5 million a year to import the nibs at an average cost of less than a cent each.
Chinese officials say domestic output reduced the cost of nibs by a third, to $13,000 a ton.
But the savings may prove short-lived.
After it won government approval of its ballpoint, Beifa said its Japanese supplier offered it price cuts to match China’s production cost.
Taiyuan, which didn’t respond to calls for comment, this month issued an industry standard for the Chinese nibs.
Observers say that is a precursor to a state-backed monopoly.
Beifa has placed an initial order with Taiyuan, and hopes to end imports within two years.
It says China’s project is vital for strategic purposes, but is otherwise ambivalent.
“From an economic standpoint, it may not be all that necessary,” said Ms. Zhang, the Beifa spokeswoman.

Drop the Act!

Forget Xi’s ‘defense’ of globalization. China just fortified the Great Firewall.
By Emily Rauhala

Xi Jinping traveled to the World Economic Forum in Davos, Switzerland, last week to tout Chinese leadership on global trade.
In his keynote speech, he used words like “connectivity.”
Protectionism, he told the audience, is like “locking oneself in a dark room.”
With trade-skeptic Donald Trump now in charge in Washington, the Chinese president was quickly cast as his free trade-loving foil.
The Financial Times called Xi's speech a “robust defense of globalization.”
The Wall Street Journal described it as a “full-throated defense of free trade.”
But as Davos drew to a close, a timely reminder that open borders are not really Xi's thing: Over the weekend, China announced a new, year-long crackdown on “unauthorized Internet connections.” 
That means another fortification of the Great Firewall that largely keeps China's Internet users in a “room” of their own — and hurts U.S. companies along the way.
A statement published on the website of the Ministry of Industry and Information Technology on Sunday said regulators will spend the next year “cleaning up” the Internet by taking aim at companies that provide virtual private networks, or VPNs, that allow people to access blocked sites, including the likes of Twitter and Facebook.
In recent years, China has tightened control over the Internet, strengthening the Great Firewall in the name of “Internet Sovereignty” — a Xi slogan that calls for each state to exercise absolute control of its slice of the Web.
Lester Ross, a partner at Wilmer Hale's Beijing office who advises U.S. and Chinese tech companies, said the notice fits squarely with this vision.
“Broadly speaking, it is consistent with the emphasis on "cyber sovereignty" as opposed to international connectivity,” he said.
It is still unclear how, exactly, the new rules will be implemented.
Often this type of announcement is deliberately vague.
Internet companies in China are already closely regulated and VPNs providers are already subject to crackdowns — including one ahead of political meetings last March.
But experts on China's Internet said the notice seems to take aim at Chinese companies providing VPN services to individuals in China — and not, say, those helping multinational companies connect with their home office.
William Long, a Chinese tech blogger, said the new rules could bolster existing efforts to get Chinese VPN providers to gather data on users.
Although well-established Chinese tech firms are already storing this type of information, Long said, unregistered upstarts providing low-cost VPN accounts on a small scale may now be forced to register and comply — a surefire way do discourage would-be connectors.

Xi Jinping At Davos, World's Most Powerful Beggar

By Gordon G. Chang

Xi Jinping will address the World Economic Forum on Tuesday in Davos, the first time a Chinese leader has done so.
Chinese state media tells us he will speak strongly in favor of globalization. 

That message will be difficult to accept, however, as his country is closing off its market, restricting outbound capital flows, and delinking from the world.
Yet there is a more important storyline about the trip to the Swiss Alps. 

Xi will be begging for foreign investment. 

His country needs cash.
Xi, according to Chinese officials in Geneva, will advocate “inclusive globalization.” 

Jiang Jianguo, the chief of the State Council Information Office, said Xi hopes for “a human community with shared destiny.” 

As People’s Daily said Saturday, he “will present a confident, open, responsible, and positive Chinese voice to the world.”
Xi may be “confident,” “responsible,” and “positive,” but “open” he most certainly is not. 

He has, after all, been closing off the Chinese economy with enhanced state subsidies, unnecessarily restrictive national security rules like last November’s cyber security law, and highly discriminatory prosecutions of multinationals. 

His tenure has been marked by the increased favoritism toward state enterprises.
Xi’s general approach is embodied in his signature phrase, “Chinese dream.” 

That dream, unfortunately, contemplates a state-dominated society, and a state-dominated society does not sit easy with the notions of an open economy. 

Call it China for Chinese competitors only.
Moreover, since the fall of 2015 he has informally restricted outbound transfers of cash. 

Last fall, Xi began applying those restrictions in earnest to foreign companies. 

For instance, multinationals can no longer “sweep” $50 million worth of currency out of the country using expedited procedures. 

The limit for this popular procedure is now only $5 million.
The concern in the foreign business community is that Beijing will further restrict cash transfers, and this, of course, discourages not only inbound money transfers but also additional foreign investment.
This is a particularly bad time for Xi to do that. 

Last year, foreign direct investment, which for decades has powered the Chinese economy, increased only 4.1% in yuan terms. 

When measured in dollars—what really counts—FDI fell. 

The renminbi in the onshore market last year plunged 6.95% against the greenback.
Continued depreciation of the “redback” is another significant disincentive to invest in China, of course.
And while China’s leader talks about globalization in Davos, his economy is in fact de-globalizing. 

In 2015, China’s two-way trade fell 8.0%. 

Last year, exports tumbled 7.7% and imports fell 5.5%.
The decline in imports could have been even more severe last year because the Chinese have been using fake import documentation to smuggle cash out of the country. 

Net capital outflow might have increased in 2016 from the year before.
For 2015, the highest estimate of outflow was Bloomberg’s $1 trillion. 

So far, the biggest number for last year comes from Christopher Balding of Peking University’s HSBC Business School. 

He has gone on record saying there may have been $1.1 trillion of outflow in 2016.
The only significant sign of China’s increasing integration with the world is outbound investment, but acquisitions of foreign assets, it appears, are primarily driven by a desire to minimize in-country risk. Many of the deals suggest money is permanently leaving China.
So outflows are increasing while inflows are decreasing. 

No wonder Xi Jinping is going to Davos. 

Like all Chinese leaders, he wants others to come to him, a sign of strength. 

So he surely thinks that his going to the foreign gathering is a humiliation, especially because he is on the hunt for cash.
The good news about Beijing’s new mindset is that the central government is being forced to grant market access, unilaterally. 

At the end of December, the powerful National Development and Reform Commission promised to liberalize rules for foreign participation in the financial, gas, and infrastructure sectors. 

The pledge followed a State Council announcement on increased access to certain types of manufacturing.
Yet it is not clear who would want to invest even if Beijing makes good on its market-opening pledges. 

For one thing, there is the slowing economy. 

The National Bureau of Statistics on the 20th of this month will report something like 6.7% growth for 2016, but in reality China was expanding in the low single digits. 

Slow growth poses the risk of a systemic financial crisis because China is now accumulating debt at least five times faster than GDP.
Moreover, China investments carry far higher political risk these days. 

For one thing, Xi Jinping’s Beijing is generally threatening to use its economic might to achieve expanding geopolitical ambitions. 

That jeopardizes China’s hard-won reputation for being a reliable member of global supply chains.
And then there is Donald J. Trump. 

The president-elect has announced the appointment of trade hawks—most notably Peter Navarro as the chief of the newly formed National Trade Council, Wilbur Ross to head the Commerce Department, and Robert Lighthizer as U.S. Trade Representative—signaling a far tougher line on China’s mercantilist practices. 

Beijing is bound to react poorly, and it has, according to a Bloomberg report this month, already threatened to scrutinize the business dealings of American multinationals, looking especially for tax and anti-trust violations.
Yet China is already doing that. 

On December 23, the Shanghai Municipal Development and Reform Commission announced it had imposed a fine of 201 million yuan ($28.9 million) on SAIC General Motors Corp., the joint venture of General Motors and Shanghai Automotive Industries Corp. 

The alleged sin? 

Setting minimum prices for dealer sales of Cadillacs, Chevrolets, and Buicks.
So someone at Davos should ask Xi, once he utters his last generalization on globalization, to explain why anyone should invest in his country.
Xi may look powerful, but he is going to Davos as a beggar—and he’s got a lot of ‘splainin to do.