G2 – US vs. China

1 Intro

This years topics of the DC Executive Club look attractive again. They are very much in line with the mission of the DC. They promise practical hands-on advice (How to ...) on how a local company can operate internationally.

• Franck Mathot on “Market Intelligence: Exploring and understanding markets”,
• Thomas Gronenthal on “Finding international customers via social media”,
• Melanie Prinz on “International Logistics”
• RA Andreas Neumann & Daniel McKee on “Business in the USA, that's how it works” and
• Irene Ho on “Business opportunities in Asia”

That's good.

However, we may be currently living in a phase of major upheaval these days. Some observers might look at it as minor hick-ups, just a big show or the “End of the world as we know it”, like former German Minister for foreign affairs recently called it.

In case we tend to lean towards the more extreme scenario, it could well mean that what was understood to be good practice yesterday may no longer be applicable tomorrow.

The issue I am talking about surely is obvious to all of us: the trade conflict between the USA and China, which has the potential of expanding into a veritable second "cold war". At least the signs are increasing.

But let me first set the scene in order to make clear, which force field we are acting in. Once this is done, we have to ask what consequences this development may have for internationally operating companies.

2. Drama - The US vs. China trade war

Before our very eyes a veritable drama is unfolding. It didn’t begin completely unexpectedly. And it started as a minor tit-for-tat exchange of blows:

As the graph of theRabobank shows …

• In March 2018 the US levied tariffs on steel (25%) and aluminium (19%)
• In April 2018 China responded with tariffs on aluminium, meat, fruit, and wine.
• In July 2018 the US implements tariffs on Chinese good worth 50 bn USD in 2 tranches: 34 bn & 16 bn mainly on electrotechnical goods.
• Nearly simultaneously China retaliates with the same amount on soybean, SUV’s an airplane parts.
• In September 2018 the US imposes tariffs of 10% on another 200 bn. worth of goods (electrotechnical products, rice, textiles, …)
• China immediately retaliates with 5% or 10% on goods worth 60 bn.
• In July the US raises tariffs von 10% to 25% for goods worth 200 bn. USD.
• China at the same time answers with 25% on goods worth 60 bn. USD
• In January 2019 the US another levied a lump of goods worth 200 bn. USD is with 25%
• This was responded by China with 25% on goods worth 60 bn.
• Recently these were followed by 25% on another 200 bn worth Chinese goods.
• The threat is to quickly follow with 300 bn. worth goods under the same conditions, if Xi Jinping fails to attend G-20
• Currently 35-40% of all imports from China are levied with hefty tariffs.
• The threat is out to apply this procedure to the other 60% as well and then even gradually raise the tariffs.

So, the economic struggle between the two heavyweights is in full swing.

How will it go on?

How will it end?

Will it ever come to an end?

Surprisingly China sanctions, unlike measures against Mexico or Canada, enjoy bi-partisan support in the US. So, there must be more to it than just the crazy idea of an exceptional political madman. Opinion Columnist, Thomas L. Friedman of the New York Times, widely considered as the voice of “liberal America”,quoted an unknown business man (or perhaps himself): “Donald Trump is not the American president America deserves, but he sure is the American president China deserves.” And “It took a human wrecking ball to get China’s attention.”

Interestingly financial markets so far seem not to be frightened the least. And as Enrico Colombatto summarizes: “The markets may be right in assuming that the U.S.-China trade crisis is only temporary. They may also be right in assuming that the crisis’ impact on global commerce will remain limited. If these assumptions are wrong, however, the resultant uncertainty could hurt global business”

These commentators all are considered as experts in this field, I suppose rightfully so. But - hmmm - are they really on the right track with their proposed measures, as they were with their, a bit one-sided, diagnostics?

Meanwhile optimism is fading that this conflict between the two major world powers will come to a resolution any time soon.

Observers close to either of the warring parties increasingly come to the conclusion that the U.S.-China Trade War Could Drag On For A Long Time still.

So, it is worth digging a bit deeper.

Before going on, one caveat: I am dealing here with a very controversial topics which will very likely draw heated emotion laden comments from either side of the frontier. Also finding reliable statistical data about the Chinese economy is notoriously difficult or, to be more precise, next to impossible. I therefore mainly restrict myself to asking questions and trying to extract answers from experts’ analyses of the scene. Their analyses of course and even the experts’ selection are not to be expected unbiased as well. So, I can only try my very best.

3 Megatrends - The end of globalisation?

Will this spell the end of globalisation?

In June 2019 McKinsey & Company published the article “Globalization’s next chapter” stating that Globalization in the sense of off-shoring manufacturing indeed is in retreat since the mid 2000s. And it did not recover after the financial crisis.

Internationally spanning value chains haven’t disappeared however, but have rather morphed into a different phenomenon.

Increasingly services are traded rather than goods. And trade relations spanning the globe are increasingly replaced by intraregional trade.

Underlying it all is the impact of automation on low-skill jobs—which will ultimately increase the need for innovation in operations, manufacturing, and supply chains.

Compelling, yet not proven is the assumption that the availability of cheap labour for about 30 to 40 years, aka China effect, caused general automation efforts to pause. Under the new auspices with global value chains increasingly being disrupted, ageing populations in some parts of the world, and rising wages in China, full-scale automation of manufacturing processes may have a furious come-back.

So true globalisation anyway is a thing of the past.

Hefty tariffs arbitrarily levied “over-night” will strongly enforce this anyway ongoing process. Even if taken back after some agreement has been reached, they will not strengthen confidence in the reliability and stability of the prevailing economic conditions. Rather regional self-reliance, completely domestic value chains and strategic autarky are on the rise.

4 Misconceptions – In the China trap?

Recent history of the West’s relationship with China is a story of repeated misunderstandings, misconceptions and outright beginner errors. With hindsight it is hard to understand, how governments, investors and the whole corporate world could have sleepwalked into an adventure, which in most cases turned out to become a disaster.

A quote attributed to Vladimir Ilyich Ulyanov, better known by his alias Lenin, comes to mind, when re-assessing this corporate frenzy: “When it comes time to hang the capitalists, they will vie with each other for the rope contract.” China however wasn’t that blunt, but up to today acted smartly in most cases.

4.1 The China dream – the illusion of 400 million customers

Since more than 80 years businesses around the globe with growing appetite eyed Chinas untapped market. In the 1937,Carl Crow, a Missouri-born businessman, wrote his most popular work “400 Million Customers”, triggering an unprecedented race for the best starting positions in the conquest of this apparently so attractive, huge market.

As Joe Studwell impressively describes in his brilliantly crafted book "The China Dream", this competition often overruled all the rules of commercial reason that had been painfully acquired over decades before. Neither the then low purchasing power of the Chinese population, even outright lack of demand, nor the restrictive regulations, which only allowed joint ventures, put the global crowd of investors off in the long term. China didn't even have to lure Western investors into the trap. They were already blinded by their dreamed-up returns and were seemingly willing to fall into the trap on their own.

Joe Studwell argues that since the days of Marco Polo, Western nations have seen the vast population of the Middle Kingdom as a fantastic opportunity for expanding trade, investing time and resources again and again in the hope to develop it, only to see, century after century, its economy crash and their dreams turn to dust. It only has to be added that Studwell expects another huge genuinely Chinese crash to occur rather soon.

In 2005 James McGregor too in “One Billion Customers” explains, that business in China was never quite what it seemed. Even hard-nosed US businessmen were not always up to the harsh conditions of Chinas dog-eat-dog business climate. Many foreign business executives were left with their pockets turned inside out in the end.

China is not alone playing this game either. The success stories of other Asian tiger states, as well as Japan, have also begun with well-shielded domestic markets, protected by high tariff barriers and state control and promotion of exports, as Joe Studwell lucidly describes his recommendable work "How Asia works".

So, we don't have to be as surprised as we pretend to be. We should have known long ago by what rules China intended or even had to play.

4.2 Why China failed to fail; a lesson for the West

The NY Times wrote on 2018-11-18: “China now leads the world in the number of homeowners, internet users, college graduates and, by some counts, billionaires. Extreme poverty has fallen to less than 1 percent. An isolated, impoverished backwater has evolved into the most significant rival to the United States.

During this time, eight U.S. presidents assumed, or hoped, that China would eventually bend to what were considered the established rules of modernization: Prosperity would fuel popular demands for political freedom and bring China into the fold of democratic nations. Or the Chinese economy would falter under the weight of authoritarian rule and bureaucratic rot.

But neither happened. Instead, China’s communist leaders have defied expectations again and again. They embraced capitalism even as they continued to call themselves Marxists. They used repression to maintain power but without stifling entrepreneurship or innovation. Surrounded by foes and rivals, they avoided war, with one brief exception, even as they fanned nationalist sentiment at home. And they presided over 40 years of uninterrupted growth, often with unorthodox policies the textbooks said would fail.”

Obviously there economic and societal truths beyond established business school orthodoxies.

4.3 Market vs. Strategy – who will prevail?

Recently James McGregor stated in an interview:

Xi, a number of months ago, gave a speech in which he said that China has a 15-year long march to take on the United States and overcome. That’s how they’re thinking: “How do we really work together to move ahead because of this?” Meanwhile, leaders in the United States are yelling at each other on cable news every day.

China is always looking for strategy and logic, and Trump never gets near either of those things.

As in global trade market forces favour the incumbents, those being strong enough to survive the lessons to be learnt and the cut-throat international competition, which is rarely purely played by the WTO textbook rules, some national champion nursery has to be set up first. Here those future contenders need to be nursed and raised carefully before releasing them into the wild of a global competition.

To succeed it needs long-term planning, strategies on state-level, economic regions, separated enough to serve as economic (like the Shenzhen Special Economic Zone) or political (like Hongkong) testbeds, and permanent adaptation. Obviously, it is less about the Art of the Deal, economic short-termisn and eying the next favourable election outcome.

To refer to McGregor again, to outcompete China again the US would need to treat this situation like a Sputnik moment, otherwise China will.

4.4 The ‘awakening’ – BRI & Made in China 2015

McGregor recently said that China had America in a really good position - and they overreached.

In 2013, Chinese President Xi Jinping announced the launch of both the Silk Road Economic Belt and the 21st Century Maritime Silk Road, infrastructure development and investment initiatives that would stretch from East Asia to Europe. The project, eventually termed the Belt and Road Initiative (BRI) but sometimes known as the New Silk Road, is one of the most ambitious infrastructure projects ever conceived. It refers to the original Silk Road, which connected Europe to Asia centuries ago, enriching traders from the Atlantic to the Pacific.

China’s Belt and Road Initiative could have welcomed as the most ambitious infrastructure investment effort in history, perhaps next to the great wall of China. But it also raised fears it could have the potential to rearrange the global balance of power.

Since the investments in China's neighbouring countries are to be financed largely through generous lending, the participating countries have to answer the question of profitability. Some of them fear falling into a debt trap. Ironically China here once again is proving to be an erudite student of the USA – however, and this still makes a difference, without taking recourse to violence as a means of last resort when “convincing” the participants.

The defining moment however, when the tide turned, might have been the proclamation of Chinas government’s ten year plan. It was released in 2015 titled “Made in China 2025” setting the goal to update China’s manufacturing base by rapidly developing ten high-tech industries. Chief among these are electric cars and other new energy vehicles, next-generation information technology (IT) and telecommunications, and advanced robotics and artificial intelligence.

Other major sectors include agricultural technology; aerospace engineering; new synthetic materials; advanced electrical equipment; emerging bio-medicine; high-end rail infrastructure; and high-tech maritime engineering.

Obviously, these plans were eye-opening as the US suspects that the policy relies on discriminatory treatment of foreign investment, forced technology transfers, intellectual property theft, and cyber espionage.

The U.S. should adopt a “wake up, grow up, compete with China” approach, he continues. And goes on: “It’s going to be a pretty hard proposition to make China change its system. To be really frank, the Chinese system is working for China better than the American system is working for America. And that’s a real threat, we’ve got to make our system work better.“

5 Hegemony - The underlying fabric

5.1 Is Chinas rise inevitable?

With the exception of the last 200 years Chinas economy was the largest in the world. The major shift originated with the industrialisation of western countries, boosting their capabilities by multitudes. As consequence of this relative weakening of the Middle Kingdom, China quickly became an easy prey of the Western colonial powers and Japan.

During the last 40 years however, the country was recovering to a formidable size and strength at a breath-taking speed. Meanwhile the International Monetary Fund last year proclaimed China could become the world’s largest economy by 2030.

Likewise, in 2018 Economists at HSBC Holdings Plc. projected China is on course to be the world’s biggest economy by 2030. The nation’s gross domestic product will stand at $26 trillion in 2030, while U.S. GDP will rise to $25.2 trillion, according to the HSBC projection.

According the world Bank the yearly per capita income in China (2017) was still 8,827.0 USD and at the same time 59,927.9 USD in the US, which is 6 to 7-fold. Hence China reaches just 15% of the US level. However, at the same time Chinas population ranged slightly below 1.4 bn and the of US hovering around 325 million. So, China has about 4.3 times the population of the US, which is to be considered a wealth as well as a burden at the same time.

Simple projection leads hence to the insight that those predictions are quite straightforward. With this expectation in sight however counter forces seem to be awakening. E.g. in an interview with Fox News, released on 19 May 2019, US president Donald Trump said he believes China’s intention is to “replace the US as the superpower” but this will not happen under his watch.

5.2 Power politics scenarios

John Mearsheimer in his classic treatise “The tragedy of great power politics” on the behaviour of great powers takes a penetrating look at the question likely to dominate the international relations in the 21^st century: “Can China rise peacefully?”

Following the concept of power politics Mearsheimer recognises no world hegemon and just one regional hegemon: The USA. According to the logic of the concept and supported by a rich collection of historical examples, he predicts that the US, determined to remain the world’s sole regional hegemon, will go to great lengths to contain China, including taking recourse to violence. China on the other side will attempt to dominate Asia as the best survival strategy in this concept is to become a regional hegemon like the United States in the Western Hemisphere and to make sure that no other hegemon emerges elsewhere.

This is exactly what we are most likely going to experience throughout the next two decades. Nevertheless, the theory’s weakness lies in the assumption that all actors will be driven by relentless yet stone-cold sober rationality. We have learnt from contemporary decision theory, that this cannot be expected in many cases.

We might also be tempted to seek comfort in the fact that, contrary to all logical inevitabilities, the first "Cold War" never turned into a hot war. Mearsheimer closes his considerations, admitting that he didn’t paint a pretty picture of what is likely to happen, but rather a downright depressing one. In closing he expresses his hope that Chinas rise may contradict his grim picture and proves his predictions wrong.

And indeed, it would not be the first time that the middle kingdom surprises western scholars and politicians.

5.3 Hegemony – learning from the US

We need to acknowledge that during the decades of American hegemony, the United States have developed a finely balanced set of tools to ensure its rule effectively, but mostly well camouflaged. Among all these activities short of war were covert intervention, client elites, psychological torture, worldwide surveillance, cyberwar, space competition, trade pacts, and military alliances.

It is safe to expect that China will become, or is already, an avid student of the hegemonial measures of the USA. In terms of generous loans to Third World countries for development projects and especially in the context of the BRI, China has proven to play no less skilful on the instruments of power.

Also we could expect China to develop and apply its own version of the Monroe Doctrine.

Besides all speculation one lesson can be taken for sure, regardless how the current trade war may turn out, there is a much stronger and much more compelling undercurrent to the contenders’ visible actions – the tragedy of power politics.

6 Consequences - The dichotomy of the world

Being a global think tank, the DC feels compelled to come up with an assessment of the situation in advance and point out the possible consequences for globally operating companies as well as for entire states, at least for the majority of them.

6.1 Manufacturers fleeing China

The trade war is already pushing businesses out of China - and it could be permanent. However, this trend begun before these dramatic events. The China impact on the world economy lasted about 30 to 40 years. During that period, driven by cheap labour costs and a huge potential of hard-working labourers to tap on, China became the manufacturing powerhouse.

As wages in China now rise and discussion on abandoning the '9-9-6' working habits signal different expectations, the window for this business model is about to close anyway. While China falls victim to its own success and it at a breath-taking speed crosses the line separating an industrialising country from a industrialised one, economic growth loses steam. Growth rates, which had been in the two-digit range for decades return to moderate and more sustainable ranges. Looking for cheap labour Chinese businesses themselves look for alternatives. So, widely unnoticed until recently now Africa becomes China’s new China. Sino-US-trade war is just accelerating this development.

6.2 No losing face

China will certainly be ready to engage in compromises as long it represents the least ugly choice to make. However, there will be a red line the country will never cross: agreeing to a humiliating trade pact. Losing face will definitely never be an option. Too deeply engraved into the collective consciousness is the haunting memory of Chinas great humiliation by the great colonial western powers, the plundering of its resources, the opium war. A president driven by predator instincts, like the current Donald Trump is not very likely to respect the Chinese people’s national pride but rather will try to kick them publicly.

Strategic thinking with history in mind clashes here head-to-head with deal making and quarterly reporting cycles.

6.3 Choosing sides

Most probably it is the Huawei story, which tells us, what is about to come. Huawei is certainly one of Chinas flagships when it comes to advanced technology. In order to contain the companies’ advance and / or to regain technological leadership in each important segment, the US threatens each one doing business with Huawei with severe consequences, as well as it discourages them in taking part in Chinas “Road and Belt” Initiative. By implementing toughest sanctions on China’s Huawei and declaring a national emergency on information security, the Trump administration made it clear that they are seeking to thwart ‘Made in 2025’, a blueprint for China’s developmental plans to become a manufacturing powerhouse with an emphasis on high-tech sectors.

The consequences, this development may have for internationally operating companies are pretty obvious. Just as the US, with its unilateral boycott of Iran, is forcing the world to do without a previously important trading partner, so the trade conflict in this much bigger case may lead to a division of the world into two spheres.

Indeed, we are likely to experience a division of the world into spheres of interest - just as we did during the Cold War. But this time it is by no means certain who will be the winner. The losers, on the other hand, can already been determined. It will be the smaller countries that have not been geared to one of the major economic blocs.

This time, however, we dwarf states (the EU is not to be taken serious here) will have to choose one side - the USA or China. For countries like Pakistan with its CPEC as the flagship project of Chinas $1-trillion global Belt and Road Initiative (BRI) or Singapore, whose Lee Kuan Yew’s advice likewise sought by Chinas Den Xiao Ping as by Henry Kissinger from the US this, will be almost impossible.

Germany like many other countries, including several European states, will then have to do without important markets - if the scenario does really materialise. This will mean serious losses of prosperity for entire regions.

6.4 China striking back

Considering that China ran a trade surplus of $420 billion with the United States last year, it is obvious that it can’t come close to matching the United States in terms of tit-for-tat tariffs.

But it does have other arrows in its quiver. Expert commentary and internet speculation have focused on three:

1. an embargo on imports of soybeans from the United States,
2. an embargo on exports of rare earth metals to the United States, and
3. the diversification of China’s currency reserves away from the dollar.

7 Conclusion

Although there is still a faint possibility that Trump and Xi will meet for talks during the G20 summit on June 28-29 in Osaka, we should be prepared to face the facts.

The damage is done. It can’t be undone anymore.

We most probably will experience the beginning of a total segregation of trade, technological development and all other economic activities including such unsuspicious activities like tourism.

According to an analysis by Nouriel Roubini a full-scale cold war thus could trigger a new stage of de-globalization, or at least a division of the global economy into two incompatible economic blocs.

The global consequences of a Sino-American cold war would be even more severe than those of the Cold War between the US and the Soviet Union. Whereas the Soviet Union was a declining power with a failing economic model, China will soon become the world’s largest economy, and will continue to grow from there.

Moreover, the US and the Soviet Union traded very little with each other, whereas China is fully integrated in the global trading and investment system, and deeply intertwined with the US, in particular.

What started as a trade war now threatens to escalate into a permanent state of mutual animosity. This is reflected in the US Security Strategy, which deems China a strategic “competitor” that should be contained on all fronts.

In this balkanized world, China and the US will both expect all other countries to pick a side. Their governments however are likely to try to thread the needle of maintaining good economic ties with both. After all, many US allies now do more business (in terms of trade and investment) with China than they do with America. Some of them may well be squeezed to an untimely death.

Authors, like Harvard University’s Graham Allison  even recognise the trade war as an inevitable pretext of a situation where the two contenders are destined for war. Others like Alfred W. McCoy in “In the Shadows of the American Century: The Rise and Decline of US Global Power”at least allow for 5 different scenarios by which the American century may prematurely end around 2026 to give way for some kind of Chinese century.

In fact I would like to agree with our former Minister of foreign affairs, Mr. Joschka Fischer, who stated in his Jun 3, 2019 post: From now on, the US will put might over market, as the message from the US is clear: technology and software exports are no longer just a matter of business; they are about power.

It will spell “The End of the World As We Know It”.