he US appears to be winning the battle for economic hegemony with China. Therein the US seems to have made the right choices, just in time, turning the tide against China.

Interestingly as we see broader the geopolitical clash for supremacy between the US and China the former’s (including the Obama, Trump and Biden presidencies) identification of China as an existential threat which has to be stopped has seen a combination of factors which seems to have braked and likely stopped China’s ascent to economic hegemony which had appeared inevitable only a few years back:

First, it has slowed Western investment into China and encouraged both a slowing in globalisation, perhaps de-globalisation, and on-shoring as companies, also post Covid, realise that security of supply chains is key. China was the big winner from globalisation over the prior 30 years and now it’s the big loser as all this goes into reverse. Countries globally and multinational companies are realising that they have to choose which side they want to be on in the clash of systems - Western Liberal Democracies vs Autocracies/Kleptocracies and many of the biggest global companies when pressed to chose, and realising the dominance of the dollar and the still primacy of G7 economies, are choosing the former. 

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Second, in response to US actions, China is making policy errors which seems to be accentuating its own problems and further slamming on the brakes on its own economic ascent.

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Some years back a consensus appeared to have formed that Chinese policy makers were geniuses, and could do no wrong. They were happy to play the long game, were pro market and orthodox in economic view, open to foreign investment and had accumulated a huge balance sheet to back development plans, buy influence and secure raw material supply chains (OBOR). They had better control on the levers of policy making and could act faster, and much faster than their Western counterparts.

But US and Western pressure now seems to be forcing policy errors on the Chinese side. Faced by what they view the US heightened security threat Xi has both concentrated power in his hands and also rolled out "Fortress China" economic policy settings with negative consequences for growth.

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Perhaps Xi would argue that faced by an existential security threat now from the US - they would argue aimed at regime change - a concentration of power was required to make decisive decisions in the best security interests of China. He might also argue that COVID also required similar stronger central leadership and direction. What is now clear though is the concentration of power might lead to quicker and more decisive decisions but that the lack of checks and balances means poor policy choices. This was seen during the extended Covid lock-down. We are also seeing this in Xi's approaches to the housing market, education, IT and market regulation, among others.

I was first to identify back in 2015 that President Putin had moved to introduce "Fortress Russia" economic policy settings in response to Western sanctions imposed because of his decision to annex Crimea, later invade Donbas and then in February 2022 embark on a disastrous attempted full-scale invasion of Ukraine. The idea was that Russia would build up economic defences, deleveraging and building up FX and reserve buffers. Economic policy was set on extremely cautious settings - much tighter fiscal and monetary policy was maintained than the growth and inflation mix would perhaps have suggested in a much safer security environment. Putin herein sacrificed growth for less balance sheet risk. It was about preparing for the inevitable clash with the West - that he knew was coming, even planned for.

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I would argue that the only thing that China has perhaps learned from Putin's wars on Ukraine has been that Fortress Russia economic settings have worked in that they have provided some durability to the Russian economy in the face of Western sanctions. And I think what we have seen in recent years is the adoption of Fortress China economic policy settings. This has meant accelerating efforts at deleveraging - trying to let down bubbles in the real estate, shadow banking, et al sectors. And on the growth front, it means accepting a much lower growth target which the hope is that it ensures fewer balance sheet vulnerabilities going forward to Western sanctions when they inevitably come.

Xi is also building a nationalist economic narrative - a more socially inclusive, almost socialist agenda, "levelling down" almost to ensure the support of the mass of the population both while he has embarked on the concentration of power around himself but as the geopolitical outlook darkens. I assume herein if there is a trade off lower real GDP growth for geopolitical insulation/security that Xi assumes its more important to take the majority of the population with him rather than the elites and middle class who have done best from the globalisation trend over the past 30 years. This explains his attack on private education, corruption and the affordability of housing.

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The combined impact of all the above has been a crisis of confidence in China both because of the slowdown in foreign investment but also the policy choices, and mistakes, being rolled out by Xi and his team. And with the focus on Fortress China there is less willingness, as on numerous occasions in the past, to deploy the huge sovereign balance sheet, and policy easing, to kick start/pump prime growth. Indeed, we have seen exactly the same trends in Russia, post 2015, with Fortress Russia. There is an assumption that in the greater battle for survival now with the US and the West that China and the Chinese population needs to tighten their belts and nationalism can fill a vacuum perhaps left by belt tightening back home.

The above suggests to me that the current China growth problems are structural, not cyclical, and there are presumably worries as to how the Xi team can manage a period of slower growth without the risk of systemic problems, even crises - problems in the housing sector appear dire. Interestingly therein as evidence builds as to just what a serious growth issue China now has we have seen the Biden administration appear to take their feet off China's neck - with recent Yellen et al visits to China suggesting a softening in approach, and a messaging that the US still sees the need for economic engagement between the US and China. The message is the two economies remain inter-twined but there has needed to be a reset by the US in its own security interests. I wonder here if for the US it is now a case of "be careful what you wish for" and that the economic statecraft deployed by the US against China has been a bit too successful. Therein perhaps the Biden team is now worried about the potential for a China crisis/collapse and its potential then to have global market impact this side of the US elections. Clearly they don't want to see anything which would damage the outlook for the US economy, playing into the hands of Trump and the GOP. Not saying here that the longer term goal of the US has changed - the desire to stop China's economic hegemonic ascent - but that they are aiming to ensure that this dovetails better with the US political calendar.

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Reprinted from @tashecon blog. See the original here.

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Comments ( 1)

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carlisle
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add Canada to the GDP pot w the USA, and it's no contest

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