Containment and engagement: drawing the line with China

President Macron’s high-flying interview on the way back from a visit to China attracted most comments, although not equally from both sides of the Atlantic: the Biden administration and the US media gave it much less attention than fellow Europeans. French foreign policy matters less these days, with the country being for two decades the G7’s growth laggard alongside Italy, and in a popular crisis of denial of this. In the United States, a major speech by Secretary of the Treasury Janet Yellen is also being underreported outside Washington. Yet it is clearly aimed at signaling to China and to American allies or partners a shift, at least a decision to contain the China policy drift in domestic politics and Congress. "Some see the relationship between the U.S. and China through the frame of great power conflict: a zero-sum, bilateral contest where one must fall for the other to rise. President Biden and I don’t see it that way. We believe that the world is big enough for both of us". Yellen explicitly cites President Biden’s support for this, which implies that this course correction was not so easy to decide. It is troubling that she echoes past declarations by Xi Jinping in 2012 and 2013, when Xi famously said "the vast Pacific Ocean has enough space for the two large countries of China and the United States".

In fact, another speech given by National Security Adviser Jake Sullivan, while recognizing that economic engagement is "still critical" to the relationship, adds the important provision that "China must be willing to play its part". Finally, James Cleverly, the Foreign Office Secretary of the United Kingdom, has made several statements urging the UK "not to pull the shutters over the relationship" with China, and declaring that a Cold War would be "against our national interest". This was capped by what is being billed as a major speech whose starting point is "the depth and complexity of Chinese history and civilisation, and therefore, by extension, of our own policy", and which ends with the following conclusion: "our approach to China must combine all of these currents, protecting our national security, aligning with our friends, engaging and trading with China where our interests converge, avoiding policy by soundbite, and always standing up for the universal values which Britain holds dear".

James Cleverly’s ornery speech, with policy spanning the whole range from strategic pushback to engagement and trade, captures best the Western dilemma and contradictions. In varying proportions, the United States and the United Kingdom subscribe in their own terms with the European Union’s March 2019 definition of relations with China: a cooperation & negotiation partner, an economic competitor, a systemic rival. Their public diplomacy must juggle these three balls in the air - at the risk of losing one, as the French president did on his way back from China, or as Spanish Prime Minister Sanchez did when he said that both China and Spain "believe in a strong, transparent multilateralism based on norms". Balancing one type of relation, or one issue, against another, is a difficult exercise. It is made even more difficult by the contrast between short-term and long-term: today’s remaining profits with China could be tomorrow’s vulnerabilities.

Literally all these recent speeches could be read as a plea to China to desist from its course of confrontation. China has agency, and it could do its part to avoid the "sleepwalking into conflict" thesis. Instead, the advocates of continuing engagement at the expense of containment are also re-emerging in the United States: to wit, the recent warning by former Clinton administration and China specialist Susan Shirk against "the fatalistic gloom about the future of China-U.S. relations". But there is no Chinese answer to this plea, especially to the United States.

"Decoupling", the hydra that European exporters and investors in China fear so much, is not more part of the American than European vocabulary. It is, however, a reality in China’s economic policy, which substitutes indigenous producers to foreign-made products as China’s technology matures in each sector. The combination of state-financed efforts and ingenuity (including with forced or illegal technology absorption) is yielding impressive results. After the known cases of the telecom and mobile phone industry, of solar and wind energy, of batteries, of shipyards and many others, it is China’s auto industry that is rising to the first rank - both in terms of domestic production and exports. While liberal economists want to reassure themselves that many Chinese-built exports are still foreign-owned (Tesla, and even BYD where there is a minority Warren Buffett stake), Chinese consumers are turning massively to Chinese models. Meanwhile, China is pushing back against any restriction on exports, technology transfer or investment into China: reportedly, Xi Jinping has told Ursula Von der Leyen that he was not naïve and saw "de-risking" as another term for "decoupling".

Meanwhile, China’s exports have increased by 30% in real terms compared to their pre-Covid 2019 level. The surplus in global manufacturing exports has again surpassed 10% of China’s GDP in the 4th quarter of 2022 - and that’s before the Q1 2023 surge. This was seen in the past as indicative of what some called "Chimerica": China’s trade surplus was America’s trade deficit. No longer is this the case. The European Union’s trade in goods deficit with China has more than doubled in size (from 165 to 395 billion euros) in the space of three years - from 2019 to 2022. And that is largely a deficit in manufacturing goods: even in 2022, the share of energy (for example LNG) in EU imports from China remains very low in value, and mining exports, although crucial, do not account for huge numbers in the trade balance. For some critical inputs, the dependency on China has increased: for example, the dependence of Germany’s industry on metal imports from China is larger than its former reliance on Russian gas, prompting the German economy to seek new mining resources at home. Margrethe Vestager has pointed out that the European market share of "non-trusted vendors" for infrastructure and connectivity has increased, not decreased. That is indeed the case for Huawei and 5G, except in France. Overdependence is not only an issue for critical materials - such as rare earths - where China has cornered, at home or abroad, much of the currently exploited resources. Neither is it limited to dual use technology. There are sectors or niches where China has carved out a dominant position, and not only because of price factors. From naval shipyards, harbor and airport equipment, solar panels, batteries, electric buses and increasingly automobiles, China is gaining the advantage that it already enjoyed in low end goods such as apparels, toys and consumer electronics. Such would also be the case for highly visible public goods such as fast trains, if domestic politics and public opinion did not intervene. In the civilian nuclear industry, China’s rise up the ladder and its consistent development plan over the years will make it a source of international expertise and skilled manpower, not to mention financing.

In short, "decoupling" may be real enough in a future geopolitical perspective, for example if a conflict breaks out around Taiwan with the ensuing interruptions of traffic, blockades and expected sanctions. And it is also a real prospect as China’s project to turn to domestic industry is implemented across new sectors: this is one key reason why companies silently diversify away from China. But in the short-term, balance sheet driven view of business, it is simply a scarecrow without actual foundation.

The only factor that may, in a very short-term perspective, slow down Chinese exports to the major industrialized economies is a major fall of consumer demand. And even that depends on the relative price trends for manufacturing and currencies. China’s manufacturing costs have risen faster than its consumer price index (CPI), because of low domestic demand for consumer goods. But the yuan has also fallen relative to the euro between September 2022 and April 2023, and is again level with the USD. Transportation costs are back to pre-Covid and Ukraine levels. That reality is coming into even sharper focus with the wave of consumer price inflation sparked in Europe and the United States by Russia’s Ukraine war. As has often been the case with East Asia in the past, its reliance on exports for growth implies low prices, and this may help reduce inflation in Western importing economies: that is a key target for political leaders subject to election. There are excellent short term economic reasons why a consensus around "de-risking" rather than "decoupling" is emerging across the Atlantic.

The rationale for these recent speeches could be an ultimate effort to separate economics (or trade) from politics (or geopolitics). Many long-term practitioners of China - whose careers essentially spanned the age of "reform and opening up" and the growing integration of China into the global economy - wish to resuscitate the past, when focusing on economic interests and on global issues with the hope to enlist China was the way of reason. Putting forward ideological and territorial issues and conflicts, focusing on the military dimension of China’s rise and its jingoism seems irrational, and perhaps a self-fulfilling prophecy that may bring us down the road to full conflict. Yet these trends do exist in China, and the chronology indicates that they preceded responses from the West and even more from Asian neighbors. While it may also seem wise to stay away from what could be described as a big power conflict over hegemony, it is utterly unrealistic to imagine that "bystanders" would be spared its consequences. Should a full blockade around Taiwan occur, a study has put its cost for the global economy at 2 trillion USD. In his recent speech, Jake Sullivan preferred to cite an Asia Nikkei estimate at 2,6 trillion USD, perhaps implying that the United States are the last to underestimate the global impact of what some would like to view as a "regional conflict".

Two observations should be made.
 
First, China’s official acts have  said strictly nothing in the area of foreign policy and geopolitics that could be a factor for a Western policy shift. On the contrary, links with Russia have seemed to intensify, the latest instance being a visit to Moscow by China’s minister of defense. This came after members of the Russian military and space establishment figured prominently among Xi Jinping’s hosts last month. Nor has the pressure around Taiwan abated, quite the contrary. And to cite ethical or environmental concerns, China has obscured research on the origins of Covid, and is again increasing its investment into new coal plants as we write. More broadly, the whole Xi era is characterized by subordination of economics to politics. What may seem irrational to others is a perfectly rational calculus for the CCP, whose top priority is political dominance at home, whatever the costs. Most dangerously, most information channels to the Chinese people have been cut, while the CCP’s disinformation media surround them at home.

Second, China’s economy, although improving after the two crises of Covid and real estate in 2021-2022, is far from buoyant. This is true particularly of imports – which are the major interest for Western exporters. China’s consumption rise in early 2023 is based on services and specifically on catering and entertainment, luxury goods, silver, gold and jewelry. Home appliances and auto sales are hurting – and this is even more true of foreign products. Round-tripping investment by Chinese firms is more important these days than foreign investment, and China seeks foreign firms and their technology based on specific needs, not out of a general open door. It is, or at least it shouldn’t be immediate gain on the China market that motivates new Western overtures.

We hazard a guess: the various Western moves are not coordinated, but they do echo each other in some ways. There is one common thread: in the new inflationary cycle that has started, China remains the only major manufacturing center with nearly zero inflation. U.S. Treasury (and Federal Reserve) heads have often pointed out that and come out against special tariffs that are passed on to American consumers. For Europe, the fear of losing access to logistical supply chains that originate in China is prevalent: the de-risking and industrial policy enterprise that is launched at the level of the European Union is not a short-term project, and it requires much coordination and more funding: an effort is underway, adding to the yearly budget several pluri-annual budgets covering the period 2021 to 2027. Assuming the amount was effectively disbursed (which is almost never the case with multi-year outlays), the total would represent 16,8 % of the EU’s GDP in 2021 – an important step forward.

The switch apparent in the speeches is also a competition not to miss out on China opportunities. Europe and the United States, for example, do not trust each other entirely over commerce. To their credit, President Biden and Commission President Von der Leyen are at the forefront of an effort to repair this: they each have to face their own administration in one case, Member States’ disunity or reluctance in the other. The US  fears that Europe will utilize American tech denials to China in order to improve its own sales. Europe fears that American subsidies to critical sectors will create unequal market conditions for European-based productions. The United Kingdom, before and after Brexit, has often sought to undersell the EU in negotiations with China. France and its president are in a competition for status and for contracts in China. The early flurry of government visits to China after the 20th Party Congress, initiated by Chancellor Scholz, has pushed others towards Beijing. Talk about China’s growth peaking, future population decline and authoritarian damage to innovation is reassuring and allows for short term opportunism. Remember the "after Putin" speculation that has been around since 2008, when Medvedev was substituted to Putin for one presidential term. These are on our part voodoo politics – a belief that a problem left unattended will go away by itself.

China, much maligned for its geopolitical, ideological, and human rights stand, is nonetheless among the winners in the international economic arena. The adoption by the United States of a developmental and industrial policy is a testimony to this reality. China’s economic breakthrough is despite the defensive measures and regulations adopted in Europe, the United States and Japan among others. The controversy over decoupling has obscured what Chinese strategists have all along assumed: we currently and for the near future need China as a supplier as much as it needs us as a customer.

What will be very important in this situation is to grasp and control the policy mix that this situation commands. De-risking, for example, is a necessary condition of decoupling should a major conflict occur. Decoupling in the short term is economically unwise and could indeed push further the Leninist and jingoist forces in China that thrive on "struggle" and conflict. Engaging China – in practice, Chinese non-elected leaders, as Chinese civil society have  receded into the shadows to protect themselves  – is useful on two conditions: that it is not wasted on oily praise, and that a verified record is kept of actual results, as opposed to pledges. On hard issues such as China’s military rise and its actions throughout the region, there is no telling when conflict may break out. But common sense dictates that China’s partners jointly practice deterrence, and that they be aware of even higher long term risks. It is by the simultaneous presence of these two components that we should evaluate politicians and experts’ formulation of China policies.

Copyright Image : LUDOVIC MARIN / POOL / AFP

China’s President Xi Jinping (C), his French counterpart Emmanuel Macron (L) and European Commission President Ursula von de Leyen meet in Beijing on April 6, 2023.