Yellen and China — Reality and Illusion

National Review Online, April 22, 2023

Although the “rules” that governed the Cold War were never so clearcut as many now imagine, they were a model of clarity compared with how America’s relations with China are currently run. The frank acknowledgment that the U.S. and the USSR were enemies made that contest easier to “manage”— and so, thanks to determination, luck, and the courage of one Soviet lieutenant-colonel, here we still are.

Our relationship with China, by contrast, is an updated version of pre-1914 great power rivalry that has evolved into something that may be more dangerous, not least because our tangled economic relationship makes it hard to say aloud how things really stand. And so it is to Treasury Secretary Yellen’s credit that in a speech at Johns Hopkins School of Advanced International Studies on April 20, she attempted to do just that. Her talk was an interesting mix: combining realism with an attempt to cling to older illusions that went, I suspect, beyond mere politeness.

Yellen:

[I]n recent years, I’ve also seen China’s decision to pivot away from market reforms toward a more state-driven approach that has undercut its neighbors and countries across the world.

Some mean-spirited types might point out that some U.S. allies have viewed the Inflation Reduction Act in precisely the same way, but I won’t do that. Instead, I’ll move onto Yellen’s next sentence.

This has come as China is striking a more confrontational posture toward the United States and our allies and partners — not only in the Indo-Pacific but also in Europe and other regions.

Those two sentences describe two sides of the same coin. Despite the governing party’s name, China’s ruling regime has adopted an essentially fascist model economically and politically. It has harnessed capitalism to work for the interests of the state, and those interests have been redefined to include “common prosperity” (any resemblance to the “common-good capitalism” being peddled in this country is, of course, an unfortunate coincidence) and an explicitly nationalist agenda. .

The regime may loosen the harness, but it will never remove it. The reappearance of tech mogul Jack Ma is case in point. It is a propaganda stunt, not a sign that China is returning to its earlier more easygoing economic ways. His company, Alibaba, is to be split into six units. They will eventually be spun off into separately listed entities, designed to attract new capital in their own right. In the end, some may be divested by their parent company. Ma’s offense was in becoming too powerful and too opinionated for the Communist Party to accept. The CCP’s actions then devastated Alibaba’s market value. The prospect of dismemberment merely confirms that Alibaba and Ma have been cut down to size.

CNN’s Laura He, writing at the end of March:

In a policy shift, Chinese leader Xi Jinping recently urged the government to support private businesses, while calling on entrepreneurs to play a role in boosting growth and tech innovation, so that China can better counter what he called “containment” and “suppression” from the West led by the United States.

Premier Li Qiang, a trusted ally of Xi who was confirmed as the country’s No 2 official this month, followed up by rolling out a series of measures intended to repair ties between the government and the private sector.

“For a period of time last year, there were some incorrect discussions and comments in the society, which made some private entrepreneurs feel worried,” Premier Li said at his first news conference earlier this month.

Shift? Not so much. Yes, entrepreneurs should feel free to develop their businesses, but a central part of their role is to help China push back against the West. Westerners might want to consider that before investing in China or its companies.

Meanwhile, JP Morgan has been saying that investors are looking to cut risk in China more than any other market. If that’s the case, then they are doing the right thing unless (moral and patriotic issues aside) they are confident in their ability both to time the market and understand the internal dynamics of the Beijing regime. There are also encouraging signs of caution on the corporate side too. Although some U.S. consumer goods companies are increasing their activities in China as it reopens after Covid, many businesses appear to be more wary, as they should be.

Yellen described America’s economic approach to China as having three objectives. The first is to:

secure our national security interests and those of our allies and partners, and we will protect human rights . . . And we will not hesitate to defend our vital interests. Even as our targeted actions may have economic impacts, they are motivated solely by our concerns about our security and values. Our goal is not to use these tools to gain competitive economic advantage.

Hopefully that last sentence is there for diplomatic reasons, something that Yellen feels obliged to say but does not mean. Hopefully.

Yellen’s second objective:

[W]e seek a healthy economic relationship with China: one that fosters growth and innovation in both countries. A growing China that plays by international rules is good for the United States and the world. Both countries can benefit from healthy competition in the economic sphere. But healthy economic competition — where both sides benefit — is only sustainable if that competition is fair. We will continue to partner with our allies to respond to China’s unfair economic practices. And we will continue to make critical investments at home — while engaging with the world to advance our vision for an open, fair, and rules-based global economic order.

“Seek” is doing a lot of work here, as is “healthy.” As things currently stand, there is no compelling reason for Americans to want China’s economy to flourish. A richer China is a richer adversary. And there is no reason for Americans to welcome Chinese innovation. As noted above, Xi Jinping’s encouragement of innovation is intended to strengthen China’s effort to combat supposed “containment” and “suppression” by the West.

Yellen’s third objective:

[To] seek cooperation on the urgent global challenges of our day. Since last year’s meeting between Presidents Biden and Xi, both countries have agreed to enhance communication around the macroeconomy and cooperation on issues like climate and debt distress. But more needs to be done. We call on China to follow through on its promise to work with us on these issues — not as a favor to us, but out of our joint duty and obligation to the world. Tackling these issues together will also advance the national interests of both of our countries.

The question of debt distress (in the emerging markets) is for another time, but the notion that there can be genuine cooperation between China and the West over climate policy is delusional. China’s leadership sees climate change as less of a priority than do their counterparts in the West. They do, however, regard Western fear of climate change as both a business and geopolitical opportunity. Not only is the West progressively hobbling its economies in the name of the climate, but it has also allowed China to establish a dominant position in the market for solar panels (and their supply chain), a key energy resource in a decarbonizing West. And the self-harm does not stop there. Something similar may occur with wind turbines, where Chinese manufacturers have yet to replicate an impressive domestic showing, but may now be well positioned to take on the leading Western manufacturers, who have been struggling of late.

And then there are electric vehicles (EVs). For a century, the internal combustion engine has given the West’s automakers an edge, whether technologically or flowing from their long incumbency. But that could be about to change. EVs are well-established in China (accounting for around 20 percent of car sales in the country in 2022), and the country has also gained a dominant position in the EV supply chain. Now, China’s manufacturers may be poised to use these advantages to achieve an international breakthrough. Meanwhile, the U.S. is trying to head off that effort with generous subsidies for production here, an approach not normally associated with success.

Having said that, there may be a decent argument on geopolitical grounds in support of Washington’s effort — which Yellen refers to in her speech — to assist in rebuilding U.S. semiconductor manufacturing capacity. This is an argument — perhaps to Yellen’s surprise — that Adam Smith would probably have backed in principle. As I discussed in a recent Capital Letter, Smith recognized the need to support a “particular sort of industry . . . necessary for the defense of the country.” An awareness of the vulnerability of America’s semiconductor supply chain lies behind the CHIPS Act, which is why that legislation can thus be defended on those grounds despite its appalling flaws.

But no credible justification exists for ploughing billions of taxpayer dollars to develop an EV industry. Doing so is not only inessential — the impact of the switch to EVs on the effects of a changing climate will be minimal at best — but will also benefit Beijing.

Better news comes when Yellen talks of imposing additional controls on the flow of American technology to China:

As in all of our foreign relations, national security is of paramount importance in our relationship with China. For example, we have made clear that safeguarding certain technologies from the PRC’s military and security apparatus is of vital national interest.

We have a broad suite of tools to achieve this aim. When necessary, we will take narrowly targeted actions. The U.S. government’s actions can come in the form of export controls. They can include additions to an entity list that restricts access by those that provide support to the People’s Liberation Army. The Treasury Department has sanctions authorities to address threats related to cybersecurity and China’s military-civil fusion. We also carefully review foreign investments in the United States for national security risks and take necessary actions to address any such risks. And we are considering a program to restrict certain U.S. outbound investments in specific sensitive technologies with significant national security implications.

Good.

This, however, is not:

But we do not seek to “decouple” our economy from China’s. A full separation of our economies would be disastrous for both countries. It would be destabilizing for the rest of the world. Rather, we know that the health of the Chinese and U.S. economies is closely linked. A growing China that plays by the rules can be beneficial for the United States. For instance, it can mean rising demand for U.S. products and services and more dynamic U.S. industries.

As Yellen recognizes (how could she not?), the American and Chinese economies are deeply interconnected. In 2022, the U.S. imported Chinese goods worth some $536 billion and exported $154 billion worth of goods to China. In terms of imports, that number is significantly higher than the figures for Canada, Mexico, or the EU. It is also higher than it was in 2021, despite the deteriorating relations between Beijing and Washington. In 2015, U.S. imports from China were worth $462 billion, and its exports to China were worth $115 billion. The story of Sino-American trade relations has not so far been one of decoupling.

But it should be. Although the economic relationship is too deep to be cut overnight, Yellen and other U.S. officials should be working toward (in Gwyneth Paltrow’s memorable phrase) a “conscious uncoupling” from China. Any such effort will involve identifying key areas in which uncoupling should occur first, a process that should be shaped by recent supply chain disruptions as well as more conventional definitions of strategic goods.

This does not mean that the U.S. should move towards some sort of “autarkic lite” regime. China can, for instance, continue to sell us plastic toys. And not all production of essential goods needs to be re-shored. For instance, it could be “friendshored” — an idea that Yellen refers to — although only to countries relatively safe from Chinese disruption. Nor does it mean that U.S. companies (except in certain sectors) should be banned from locating production facilities in China. Although shareholders should be aware that every dollar invested in fixed capital in China will be high risk.

Yellen claims to believe in the possibility of a “China that plays by [our] rules.” Once again, one can only hope that she was just being polite, because it’s not going to happen. A frank acknowledgement of that by Yellen and other U.S. officials would help us move forward more effectively.

Extracted from the Capital Letter for the week beginning April 22, 2023