China and the West: the distance grows

The model of growing economic interdependence between the West and the emerging world (especially China) was built on assumptions that no longer hold. The West assumed that keeping high-value production at home would create wealth that would stimulate growth, and that this wealth would be shared to keep the middle class prosperous. However, while multinationals have generally benefited from globalization, the middle class in the developed world, especially in the United States, has lost purchasing power as manufacturing jobs have moved abroad. In addition, tax bases in the developed world have shrunk as multinationals have moved to low-tax jurisdictions, encouraged by a shift to supply chains that create gaps in profit allocation.

The global financial crisis of 2008, which began as a subprime crisis in the United States, clearly demonstrated that the Western economic model was flawed and needed to be fixed. One of the unforeseen consequences of the crisis was the collapse of world trade, which ended up being a structural trend. Since 2008, global value chains have contracted, trade in intermediate goods has slowed, and foreign direct investment (FDI) has fallen globally.

Why does economic interdependence decrease?

The reasons for these changes range from increased geopolitical tensions to environmental risks. The trade war that President Donald Trump launched against China in 2018 hurt US-China relations. In addition to the massive tariffs imposed on US imports from China, the Trump administration implemented a series of measures to contain China’s technological rise.

This has clearly influenced the prospects of American and European multinationals. Companies from the European Union and the United Kingdom have increasingly weighed the advantages of accessing the Chinese market against the perceived lack of equal treatment for foreign investors and less attractive growth opportunities in China compared to a few years ago. years.

«The main focus of European policies on China is no longer the Chinese market, but the way in which China influences European markets, societies and political systems»

Furthermore, both the EU and the UK are wary of China’s influence on their economies, given the rapid increase in Chinese acquisitions of high value-added companies and critical infrastructure. Both the EU and the UK are more open than other developed economies to Chinese takeovers (not only the US, but also Japan and South Korea, and more recently Australia, have acted to limit China’s reach in their economies). Beyond China’s appetite for strategic assets, European policymakers are increasingly concerned about China’s influence in the media, education and other sectors. They are also concerned about misinformation and even political influence. The main focus of European policies on China is no longer the Chinese market, but the way in which China influences European markets, societies and political systems, directly and through Europe’s neighbours. The thorny issue of China and Russia agreeing to “endless cooperation” is a case in point.

However, despite growing mistrust on both sides, trade flows between the US (and the EU) and China continue to grow. This includes FDI inflows to China, which spiked until 2020 but have since declined, indicating the growing difficulties Western companies are experiencing in China.

Looking at the future

The centrifugal forces are stronger than those that push to increase codependency. Here are some reasons.

China has pushed for self-reliance since President Xi Jinping came to power with the landmark Made in China 2025 industrial strategy and, more recently, the dual-circulation strategy. China’s import growth has been disappointing for several years, especially since the start of the COVID-19 pandemic. This has been the case, in particular, for imports of manufactured goods that China now produces itself; this is particularly hurting exporters of high-end intermediate/manufactured goods, including Japan, South Korea and Germany. China is also pushing its own rules to guard against technological decoupling. Finally, China is also promoting the use of the renminbi as an international currency, especially among like-minded countries seeking alternatives to the dollar, notably Russia.

“Europe must ask itself what it can do to mitigate the impact of the slow but steady separation from China”

There is also a growing disillusionment in the West about what can be expected of China as a responsible actor in the world order. China is doubling down on its state-driven economic model, with many sectors still closed to foreign competition and a lack of reciprocity. Major events have further weakened Western confidence in China, such as a lack of cooperation during the pandemic, with a major supply chain disruption centered on China, which has increased inflationary pressures. Beijing’s stubborn application of zero-COVID-19 policies has had negative consequences for a world trying to control inflation; China remains the factory of the world, but with increasing difficulties due to these restrictions. Other reasons for growing distrust are the ambiguous role of China in relation to the Russian invasion of Ukraine, and the increase in belligerence over Taiwan, with military exercises around the island. It seems highly unlikely – if not impossible – that relations between China and the West will return to their previous course of increasing co-dependence.

If this is the way forward, Europe must ask itself what it can do to mitigate the impact of the slow but steady separation from China. First of all, Europe must find alternative trading partners so that its integration into global value chains does not suffer. European economies must eliminate possible over-reliance on strategic inputs from China. This is especially problematic for the inputs needed for the digital and energy transitions. The episodes in which China has tried to pressure Australia and Lithuania point to the risks of not securing other sources for inputs in supply chains.

Second, China’s rise in third markets where European exporters operate is supported by a state-driven model with which European companies can hardly compete, at least in the short term. Europe also has to accept Chinese support for Russia, at least in terms of narrative, if a narrative matter. China’s drive to build global influence – a “global south aligned not only with China, but also with Russia” – constitutes a threat to the liberal international order.

Article originally published in the Web of Bruegel.