international analysis and commentary

The US-China economic link: high level diplomacy and structural problems

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Both the US and the Chinese leaders have what they evidently consider compelling strategic, economic, and political considerations in favor of cooling the simmering tensions that have escalated since the latter part of the Trump administration. The first steps have been for top US officials to travel to Beijing and at least give the appearance of constructive dialogue to address the many issues that separate them. Secretary of Commerce Gina Raimondo left Beijing on August 30 in the last of a choreographed sequence, with high hopes for concrete signs of progress. Unfortunately, expectations exceeded results.

Chinese vice premier He Lifeng, left, with US Commerce Secretary Gina Raimondo at the Great Hall of the People in Beijing

 

On the US side, a lukewarm economy, the approach of a presidential election year with the incumbent experiencing low approval ratings, and pressure from Wall Street and industrial and technology giants such as Boeing and Apple to reverse the protectionist tendencies of the Trump and Biden administrations, were the principal reasons for renewed dialogue with Xi’s China.

The hopes of progressives, led by climate envoy John Kerry, to win firm commitments from the world’s largest source of greenhouse gases for a less carbon-intensive future also provided a strong push to downplay the many problems in return for concessions on climate policy. An overriding consideration for the world’s two largest economies is the fear of inadvertent drift to a kinetic war over Taiwan.

For the Chinese leadership, the end of the traditional growth model propelling its economy since the era of Deng Xiaoping has resulted in a perceived need for at least a pause in the US-Chinese economic standoff, especially as the US slowly builds support for its China policies with East Asian and European allies. The indicators of China’s economic stasis and decline have become undeniable in 2023. The real estate bubble has caused not only massive bankruptcies in the property development sector, but also has undermined both local government finances and the personal wealth accumulation that drove the rise of a strong consumer culture. Deterioration of government finances, especially after the decade of massive credit growth ending in 2016, when China added $24 trillion to its banking assets, equal to one-third of global GDP, resulted in a total debt load of over 300% of GDP by 2022. 27% of bank loans were to the real estate sector. 30% or more of local government revenues originated in land sales and development. 70-80% of family wealth was tied up in real estate.

As capacity to borrow deteriorated, the ability of local governments to fund industrial development, improvement of social, medical and retirement services, and infrastructure expansion weakened progressively. The Covid lockdowns exacerbated this dynamic to the extent that many local governments had to cut back medical services, government salaries and payments to contractors.

In addition, Xi’s turn to tightening CCP control over the economy, symbolized by the takedown of Jack Ma’s Ant Financial and undermining of innovative education and health care firms, sapped the creative impulses of China’s private sector. New credit was directed increasingly to state owned enterprises (SOEs), whose productivity and returns on capital remain far behind those of private firms. Youth unemployment reached 21% in mid-2023 before Beijing ceased reporting updates on this and other economic statistics. Xi’s turn toward a statist economy contributed to a massive reduction in foreign direct investment in the PRC.

Due to the high levels of indebtedness and pressures on local government balance sheets, more than half of Chinese cities in 2023 lack enough incoming cash to meet current debt payments.

Xi’s regime now has few ways to stimulate growth without risking a serious financial crisis. The outlet of increasing exports is no longer available, as slow growth and mounting pushback to Chinese mercantilism has led to a drop of 24% in goods exports to the US and 13% to Europe this year. In the absence of export growth and the deterioration of government finances, Xi needs to reinvigorate Western investment and capital flows to maintain growth. In a more general sense he needs to avoid the decoupling he adduces as the long-term US strategy. The current charm offensive is the product of this dynamic.

The modest objective of lowering tensions by opening a new series of dialogues with regular meetings has clearly been met by the Raimondo visit. It remains to be seen of course if this marks a new period of constructive compromise on both sides and whether any of the more substantive US or Chinese objectives can be achieved with the new dialogues. Unfortunately, there is every reason to doubt that real progress that returns the relationship to anything resembling the years after Deng’s opening and the positive response of the Reagan through Obama presidencies can be expected.

One major reason for skepticism is that, even as the series of high-level US visitors to the Middle Kingdom unfolded, Xi was signaling that his longer term strategy is to free the Chinese economy as much as possible from dependence on the US and its close allies. There is no sign of changing his mercantilist practices, as exhibited by continued subsidization of high technology industries such as semiconductors, solar and EV production, artificial intelligence, and aerospace. In recent weeks Xi has enthusiastically and explicitly embraced expansion of the so-called BRICS (Brazil, Russia, India, China and South Africa) coalition to large economies such as Saudi Arabia, United Arab Emirates, Egypt, Argentina and Iran.

 

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This group expressly aspires to displace the US dollar in international finance, build alternative institutions to those of the Bretton Woods system, and solidify political coalitions to undermine the economic weight and geopolitical dominance of the West. Most of the members of the BRICS expansion network reflect the largely authoritarian governance nature of the founding members (except for India).

This suggests that Xi’s turn toward more centralized control of the economy, which distrusts both domestic free enterprise and foreign participation in the economy, is unlikely to see substantial change because of the new dialogue formula initiated during the Raimondo trip. Nor is it likely that China will cut back on its CO2 emissions as it benefits from below-market imports of fossil fuels from its new friends and builds new coal-fired power plants and chemical industries to take advantage of favorable energy prices relative to the West. Finally, as many commentators have noted, Xi’s deepest beliefs prioritize CCP control over economic efficiency.

One of the most telling revelations from Raimondo’s visit was her apparent discovery that Xi’s China is no longer hospitable to Western business. Xi’s crackdown on Ma and other innovators should have been a clue to this, but even more was the forced closure or restrictions on US-based due diligence and auditing firms, or the placement of CCP members on the management committees of foreign (as well as domestic) firms. These new measures simply add to the longstanding problems of IP theft, market access restrictions and regulatory burdens on foreign firms. After meetings with US executives in Beijing and Shanghai, Raimondo was compelled to observe that “…China is uninvestible because it’s become too risky.” She didn’t need to travel to China to know that most of the forfeitures on Chinese real estate debt are in dollar bonds. She also might have observed that Chinese equities have reached decades lows this year, harming the pension fund and other US-based investments in Xi’s economy.

 

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Apart from the opening of new dialogues, there were no notable announcements during the Raimondo visit signaling concerted will to meet the other side in substantive compromise. No lifting of the de facto ban on imports of Boeing aircraft, new grain purchases, renewed transparency in auditing of Chinese firms listed on US exchanges or issuing debt in dollars, much less new commitments on CO2 reduction, fentanyl exports and money laundering on the part of China. No pull back on export controls and investment restrictions, lifting of US tariffs on Chinese exports or backing down on criticism of human rights abuses in Xinjiang or Tibet on the part of the US. The optics of the Raimondo visit were characterized by both sides as positive, the political will to work for more substantive progress was lacking.