Arthur Kroeber - founder of China focused Gavenkal Dragonomics research service - outlines short and longer term challenges of China's economy given both domestic structural change and big geopolitical shifts. Arthur covers the implications for multinational corporations and what adaptation strategies they need to think about to maintain business continuity and supply chains.
Arthur R. Kroeber is a partner and head of research at Gavekal, a Hong Kong-based economic research firm, and founder of its China-focused Gavekal Dragonomics research service. Before establishing Dragonomics in 2002, he spent fifteen years as a financial and economic journalist in China and South Asia. He is adjunct professor of economics at the NYU Stern School of Business, a senior non-resident fellow of the Brookings-Tsinghua (Ching-Hua) Center in Beijing, a member of the Council on Foreign Relations, and a member of the National Committee on US-China Relations. His book China’s Economy: What Everyone Needs to Know (2nd edition 2020) is published by Oxford University Press
2. 2
Agenda
1. The Ukraine crisis: Xi’s big bet on Russia
2. Relations with the US: Strategic rivalry forever
3. Macroeconomy:
Short term: Headwinds are rising, and policy is constrained. Growth is
likely to disappoint in 2022.
Long term: Xi has a strong strategic vision of a more disciplined, self-
reliant China. But he could be leading the economy off the rails.
4. Implications for MNCs
4. 4
Xi’s strategic calculations on Ukraineand Russia
• Xi Jinping has made a strategic bet on alignment with Russia.
Core belief: the US is a) set on containing China and b) in long-term decline.
China and Russia share a core interest: erosion of US-led international order.
Xi-Putin February 4 statement on“friendship without limits”exaggerates, but is a clear
directional signal.
• Xi probably did not know about Putin’s invasion plans. China’s diplomatic
position is uncomfortable but manageable.
It will do the minimum needed to avoid secondary sanctions from the US/EU
Win-win: If Russia wins in Ukraine, the China-Russia agenda advances. If Russia loses,
China has a more pliant vassal state / resource supplier
• Risk: the Ukraine conflict has solidified cohesion of US and its allies around
liberal democratic values, and on technological self-reliance.
• Calculation: developed countries increasingly rely on China’s market, so
China’s room for maneuver is large.
• Incentives to create alternatives to the US-dominated order (e.g. in
payments) are on the rise; but practical obstacles remain immense.
7. 7
The viewfrom the US: Strategicrivalryforever
Trump
Economic nationalist /
opportunist. Unleashed
broad anti-China moves
after Covid. Replaced
“constructive engagement”
with“strategic competition.”
Economic Nationalists
Unilateral trade and industrial
policies to restore US
manufacturing base.
National security state
Maintain US tech/military
superiority; stem tech / financial
flows to China; strengthen
alliances.
Business
Build on US$250bn investments
in China; more market access +
protection from predatory
practices.
Short-term
No Biden administration
consensus on China;
little political space;
over-emphasis on
security and under-
emphasis on economy.
Policy outcomes
Medium term
Tech and financial
controls; partial and
slow‘decoupling’
Long term
Strategic rivalry
substantially constrained
by business interests
Values coalition
Oppose China’s spread of
authoritarian values and rising
global influence.
Political actors
Interest groups
Biden
Accepts“strategic
competition.” Aims at a
disciplined balance of all
four interests, with more
multilateral engagement.
Congress
A vector of bipartisan
anti-China sentiment
in all dimensions
10. 10
What tolook for in US Chinapolicy
• In 2021, minor re-calibrations:
Selective additions to the various sanctions lists
Possible new Section 301 trade action; but this will partly be for
technical reasons (rearranging tariffs)
Possible passage of investment bill (combining Senate’s USICA and
House’s COMPETES); mainly about domestic tech investment and R&D
but some restrictions on China trade and investment could be
tightened
• In 2022, more is possible with a hawkish Republican Congress:
Acceleration of timeline for delisting of US-listed Chinese firms
Screening mechanism for outbound investment
Selective controls on portfolio investment
18. 18
Long run: A new model of governance, and“the venture capitaliststate”
• Xi Jinping has a vision of a more disciplined, self-reliant China.
• The crackdown on tech platform companies and other private firms is part
of a long-brewing and more activist governance strategy:
“Rule of law”: more well-defined laws and regulations, more strictly enforced.
“Common prosperity”: More equal income distribution, support for families,
traditional morality.
“Dual circulation”: Greater self-sufficiency, especially in key technologies.
“Innovation-driven economy”: Technology-driven growth with a hardware bias.
• Long-term development plans amount to a “venture capitalist state”:
The state mobilizes big investments in technology-intensive sectors
Not all bets will pay off; but enough winners to pay for the losers
Foreign investment continues to be an essential catalyst
A supply-side strategy, not the hoped-for“rebalancing towards consumption”
• But there is rising criticism from technocrats that Xi’s political interference
is degrading the economy.
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Long-run outcomes: two scenarios
• ‘Leninist Germany’
State capitalist industrial policy succeeds, mainly by virtue of huge
financial resources and the big domestic market; China becomes a
technological leader in many sunrise sectors.
Annual growth around 3-5% in 2020-30, with stable leverage.
Economic success enables continued tight authoritarianism.
International tensions increase as China’s market power (and trade
surplus in high-value goods) grow.
• ‘Japan 2.0’
Entrenched political-economy bargains drive productivity growth to
zero; no obvious crisis but China is stuck in a low-growth, high-debt
trap.
Concern with social stability forces a retreat from foreign adventurism
and focus on domestic welfare and social control.
21. 21
Chinais indispensable, but tough
• Global companies have many reasons to be in China:
Large and fast-growing market
Ultra-efficient production base for which there are no substitutes
Global innovation hub (access to R&D talent and scaling opportunities)
US firms in China: for 75%, China is a top-5 global priority; 43% report profit margins
higher than the global average; and on a 5-year horizon 70% are optimistic
• The problem is balancing these commercial imperatives against political
pressure from US (and EU?), and challenges within China:
Covid restrictions
Domestic protectionism/industrial policy
Controls on data flows / cybersecurity
• Strategic options:
Double down:“The Plan B for China is China”
China + 1: retain capacity in China to serve China market, build elsewhere for other
markets
Localize more in China to maximize market access and minimize sanctions risk
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