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

1. MNCs and China:
Navigating Global Turbulence
Arthur Kroeber
May 2022

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

3. 3
Geopolitics:
The impactof the Russia-Ukraineconflict

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.

5. 5
Chinacannot afford to jeopardize its economicties withthe OECD

6. 6
Nopayments alternative: RMB not a threat tothe dollar

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

8. 8
The constraint:the Chinamarket is non-optionalfor MNCs…

9. 9
...andfew show signs of leaving

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

11. 11
Chinamacro outlook:
Short-term pain,long-term gain?

12. 12
Macrohurdle #1: Covid lockdowns mayhavepeaked…

13. 13
…but arestill hurting consumer activity

14. 14
Macrohurdle #2:The consumer internet has been hammered

15. 15
Macrohurdle #3: Propertyisn’tcoming back

16. 16
Macrohurdle #4:Debt constraintlimitsstimulus…
China’gross
debt/GDP is about
the same as for
the US, and lower
than that of some
other developed
economies.
China’s debt
level is high
relative to other
major emerging
markets

17. 17
…so creditgrowth is constrained

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.

19. 19
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.

20. 20
Implications for multinationals

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

22. 22
Contactand disclaimer
This presentation was prepared by
Arthur Kroeber, Partner and head of research
akroeber@gavekal.com
All research is available online at research.gavekal.com
Copyright © Gavekal Ltd. Redistribution prohibited without prior consent.
This report has been prepared by Gavekal mainly for distribution to market professionals and
institutional investors. It should not be considered as investment advice or a recommendation to
purchase any particular security, strategy or investment product. References to specific securities and
issuers are not intended to be, and should not be interpreted as, recommendations to purchase or
sell such securities. Information contained herein has been obtained from sources believed to be
reliable, but not guaranteed.

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