China is not a superpower nor will she ever seek to be one … If one day China should change her colour and turn into a superpower, if she too should play the tyrant in the world, and everywhere subject others to her bullying, aggression and exploitation, the people of the world should identify her as social-imperialist, expose it and work together with the Chinese to overthrow it.
Deng Xiaoping
If we go back to the economists’ theory that growing trade is a winwin for all concerned, when the West let China join the World Trade Organization (WTO) in 2001, it seemed like everyone would be a winner. Never mind that the theory allegedly holds between similar free-market economies, which China was and is not, or that the theory assumes trading between countries according to their comparative advantage in production, not absolute advantage. These details were perhaps expected to be worked out over time
The opening of China to Western investment and international trade shocked the West’s labour market with a vast expansion in the global supply of labour of over one billion new workers between the 1980s and 2010. As we’ve seen, together with the deregulation of labour markets and technological change, this development significantly undercut Western workers’ ability to bargain for higher wages.
China became the new workshop of the world, with Western companies taking advantage of the country’s lower absolute costs of production. Some of these savings were passed on to the consumer in the form of cheaper prices, but plenty was also retained from the higher profits for senior management to award themselves bumper pay and retirement packages. In the West the balance of forces and rewards tilted inexorably away from the workers as the share of income going to labour shrank from 64 per cent in the 1970s to below 60 per cent in the 2010s. In a nutshell, most Western workers took a relative pay cut but the return on capital rose.
Chinese workers however prospered. Over 600 million Chinese were lifted out of poverty by moving from farms to factories. China’s economy took off, its GDP per head soaring from 1.8 per cent of the level of global GDP in 1979 to 9.3 per cent by 2010.1 This is illustrated in Figure 10.1, which charts the explosive growth of Chinese real wages between 2005 and 2016 in inflation-adjusted terms, compared with the stagnation experienced by other countries, including Portugal, a member of the EU. Euromonitor International reported in early 2017 that Chinese hourly wages now exceeded those of every country in Latin America, save for Chile, and had reached 70 per cent of wages in poorer European countries.
In fact, Chinese wages in some areas have been overtaking some European countries. Writing in 2017, Kenneth Rapoza reported that median monthly wages in Shanghai ($1,135), Beijing ($983) and Shenzhen ($938) were higher than in the newest European Union member, Croatia, which had joined in 2013. Croatia’s median net salary was $887 a month. Shanghai wages were also higher than two of the newest Eurozone members, Lithuania ($956, joined in 2015) and Latvia ($1,005, joined in 2014), with Estonia (joined in 2011) recording a median income of $1,256 per month in 2016, according to government figures. The situation was summarised by Rapoza: ‘Over the last 10 years, Europe has sought to incorporate the skilled, lower cost labour pool from Eastern Europe into the fold of the European Union. In 2001, China became more fully integrated into the global labour force when it joined the World Trade Organization. The combination of these two massive labor pools into the workforce set the stage for wage stagnation among lower skilled and assembly line labor worldwide.’2
According to the International Labour Organisation (ILO)’s 2016/17 Global Wage Report, the average real wage index for the USA, Canada, France and Germany rose by 5–9 per cent, well short of 1 per cent per annum from 2006 to 2015; Italy, Japan and the UK experienced contractions of their real wage indexes of around 6, 2 and 7 per cent respectively. Over the same period Chinese real wages increased by around 125 per cent.
Between 1990 and 2014 income per person in China increased thirteen times in real terms. In a delicious irony China’s nominally socialist society went from being one of the most equal in the world to one of the most unequal, with a Gini coefficient of 0.49, compared to 0.4 and 0.3 for the capitalist bastions of the US and Germany. China’s top 1 per cent could make their Western equivalents pale with envy, controlling around a third of the country’s assets, often thanks to hidden or undeclared income. At the same time, President Xi, as far back as 2013, was worried that China was losing its moral compass, bemoaning the numerous food contamination scandals, graft or dereliction of duty by government officials and the country’s obsession with money.3 The Economist reported the same lamentation by the official China Daily in July 2016, and that trust had become a ‘scarce commodity.’4
This was not how it was meant to be. Developing countries should grow relatively fast as they catch up, but that should not be at the expense of their trading partners. Otherwise trade becomes a zero-sum game, whereby one party’s economic gain becomes the other’s pain. Unfortunately, all the evidence points solidly in this direction. Even before its accession to the WTO, China’s economy had been growing rapidly since Deng Xiaoping’s reforms in the late 1980s. By 2000, China was already stacking up a trade surplus with the US of $84 billion per year.
In a fascinating 2001 paper Nicholas Lardy questioned the rationale for China agreeing to abide by the WTO’s stringent rules and conditions in order to become a member, given how well it had fared so far outside. It was already one of the top ten trading countries in the world by 1995, and to join the WTO, China had to be prepared to suffer short-term pain in the form of higher unemployment in industries opened up to unprotected foreign competition. Lardy found this hard to understand, given that politicians are loath to inflict short-term pain for long-term gain. The protocol governing its accession was clear that China would accept
significant reductions in tariffs; the introduction of a tariff-rate quota system that brings the tariff rate for key agricultural commodities, such as wheat, almost to zero for a significant volume of imports; the gradual elimination of all quotas and licenses that have restricted the flow of some imports; a substantial reduction in the use of state trading as an instrument to control the volume of imports of agricultural and other key commodities; and the opening of critical service sectors such as telecommunications, distribution, banking, insurance, asset management, and securities to foreign direct investment. In addition, the protocol governing its accession sets forth China’s commitment to abide by international standards in the protection of intellectual property and to accept the use by its trading partners of a number of unusual mechanisms that could be used to reduce the flow of Chinese goods into foreign markets.5
Lardy speculated that one of the reasons that China was willing to sign up to the WTO and its conditions was that the Chinese regime had staked its legitimacy on being able to deliver rapid growth and rising consumption. These were perhaps tailing off in the 1990s, and China’s leaders had calculated that to maintain high growth the country would have to become more integrated into the supply chains being formed through globalisation. Membership would also force China’s state-owned banks and enterprises to reform themselves and become more efficient. All this implies that the Chinese understood and accepted the need to develop a market economy even if that meant some short-term pain.
In fact, what we have learned since then, and the Trump administration has been the first to attempt to rectify, is that the Chinese simply indulged in having their cake and eating it, failing to follow through on any of the conditions they supposedly accepted.
However, Lardy dismissed China’s large and growing trade advantage with the US as evidence that it was not playing by the rules, using the frequent non sequitur that America’s trade deficit is caused by America’s too low savings rate compared to investment rate. Why is this defence weak? Putting aside the government sector for a moment, it is true by definition that, for one country, consumption + investment + exports = consumption + savings + imports = GDP (where investment spending and export revenue boost GDP while savings and imports take money out of the system).
If these are the only broad categories in the economy, they must balance. So, as consumption equals itself on both sides, if imports exceed exports, this implies logically that savings must be less than investment, hence the country needs to borrow from overseas, and overseas countries will oblige since they are earning surpluses from the trade. The mistake or dishonesty of those who defend China is to equate a logical relationship with a necessary one. In fact, any of these variables can change as long as others adjust to preserve the equality of the sides. It is because China is not playing by the rules that imports from China to the US, for example, are about four times exports to China. If trade became balanced, then, necessarily, savings would equal investments. There is no law that says that savings must remain lower than investments.
This disingenuous argument is economic rubbish of the first order. A rise in American exports, or a fall in imports, closing the trade deficit, would increase American income and reduce the savings deficit. And by the same token, China’s chronic trade surplus exists because the Chinese save too much, rather than invest or buy more American imports. Nothing prevents the Chinese authorities from encouraging their citizens to spend more and save less, thereby reducing their trade surplus.
This is what is now being negotiated between the Trump administration and China’s President Xi Jinping. The Chinese will be happy to oblige and buy more American soybeans and high-tech equipment, but they will not budge on their long-term game plan of overtaking the decadent West politically and economically. It is highly unlikely that China will undertake true structural reforms, opening up its economy, phasing out government funds for ‘national champion’ companies and ending the acquisition of Western know-how and intellectual property by fair means or foul.
The reasons why America spearheaded the West’s welcome of China into the WTO, according to Lardy, were threefold. First, the prospect of easier access by American companies to one of the largest potential markets on the planet was mouth-watering. To be able to sell to the world’s most populous nation proved irresistible. Second, American company profits would benefit from the transfer of production to cheaper China. The gains from this switch would be shared out between producers, consumers (lower prices) and Chinese workers (higher wages). In practice, as we have seen, most of the gains were shared between Chinese workers and the global top 1 per cent. Third and perhaps crucial, whether or not US CEOs believed that globalisation would create winners and losers rather than the much touted win-win situation, they were aided and abetted by politicians who either didn’t understand the economics of trade or had a naive view of history. This was a colossal strategic blunder, and the West’s belated realisation that this was the case is now paving the way for confrontation.
As a result of accepting the notion of the free market in their country, the West assumed the Chinese would adopt a rules-based political system, thereby solidifying the dominant world order devised by the West since the Second World War. Bringing China into the global trading fold was the missionary equivalent of spreading Christianity into Africa in the nineteenth century. Nearly two decades on, America and its allies are recognising that they have been played. Far from living up to its commitments and following the West’s playbook of rules-based integration, China has continued to play by its own rules and trade on its own terms. Generations of Western politicians have been forced to look the other way in the hope that their naivety would eventually come good, even as Beijing abused the system. Meanwhile, Beijing has proved masterful at playing for time, with repeated promises of reform and change just around the corner.
The Western strategy of tolerance, patience and hope is no longer tenable. US workers have woken up to their loss of earnings growth at the same time as some big business is switching from appeasement to criticism of its increasingly unfair and predatory treatment by China. The plight of American workers was a significant factor in Trump’s rise to power, but their interests conflict with those of his corporate backers who cling to the status quo for their own short-term pecuniary ends. It remains to be seen how forcefully Trump favours the former and the long term, over the defenders-to-the-end of the free market.
Perhaps the most flagrant case of China not playing by the winwin rules of international trade is its controlled currency. If good trade rests on free and open markets, then Beijing’s strict control of the yuan, which is not allowed to float or be exchanged against the world’s currencies, should have been a deal-breaker by now. The West gave up fixed exchange rates nearly fifty years ago in favour of market-determined rates that move to bring trade into balance. If China is running a large trade surplus with the US, that means, other things being equal, that the US dollar is too high and the yuan too cheap.
In a freely exchangeable currency system, the excess demand for yuan (needed to buy more Chinese goods and services than the Chinese want to buy of American goods and services) would push up its exchange rate. Chinese products would then become more expensive for Americans and vice versa for American products in China, so trade would even out. Fixing the yuan’s exchange rate enables China to set the terms of its trade with the US to its own advantage. Those interests in America who have profited from this situation have prevented every administration, until recently, from pronouncing China a currency manipulator, even though it has clearly acted like one.
Rather than complying with the terms of fair trade enshrined by the WTO, China has continued to abuse the international trading system in four ways: by protecting its domestic champions through tariffs, administrative measures and subsidies; by extorting intellectual property (know-how and technology) from foreign companies by forcing them to set up joint ventures in China with local partners, and by stealing it through hacking; by barring foreign competitors in several sectors including technology and banking; and by buying up strategic Western companies while not allowing reciprocal access.
Not content with the dominant share of global manufacturing it has taken, China now wants to move up the food chain and compete in cutting-edge industries where the West still has an edge and something to sell. Now that it has extracted the high-growth benefits from developing its manufacturing base, it needs to move on to new sources of growth to maintain the social contract it has agreed with its citizens: delivering rapidly increasing living standards in exchange for witholding political freedom.
A few examples illustrate the four ways in which China exploits its trade partners.
Tariffs vary by type of product and are only one tool that countries use to discourage imports. At a simple level, we can compare the average tariff level between countries. According to IndexMundi, using World Bank staff estimates, China comes in around the middle of the pack globally, with average tariffs on goods of 7.76 per cent, compared to 2.79 per cent for the US and 1.92 per cent for the countries of the EU. Even between WTO members, it is far from a level playing field. However, tariffs are not the main barrier to entry into the vast Chinese market.
In the 2018 edition of the US National Trade Estimate, produced by the Office of the United States Trade Representative, the section on China provides stark reading:
China continued to pursue a wide array of industrial policies in 2017 that seek to limit market access for imported goods, foreign manufacturers and foreign services suppliers.
For example, in technology, China’s 2016 cybersecurity law imposed: ‘severe restrictions on a wide range of US and other foreign information and communications technology (ICT) products and services with an apparent goal of supporting its technology localisation policies by encouraging the replacement of foreign ICT products and services with domestic ones.
Contrary to its undertakings, the NTE notes that, while China agreed to de-link indigenous innovation policies at all levels of the Chinese government from government procurement preferences … by December 2011 … this promise had not been fulfilled.
When challenged, China plays for time and makes promises it has apparently no intention of keeping:
China reiterated many of these commitments at the November 2016 JCCT [US–China Joint Commission on Commerce and Trade] meeting, where it affirmed that its ‘secure and controllable’ policies are not to unnecessarily limit or prevent commercial sales opportunities for foreign ICT suppliers or unnecessarily impose nationality-based conditions and restrictions on commercial ICT purchases, sales or uses. China also agreed that it would notify relevant technical regulations to the WTO Committee on Technical Barriers to Trade (TBT Committee). Again, however, it appears that China does not intend to honor its promises … China’s measures do not appear to be consistent with the non-discriminatory, non-trade restrictive approach to which China has committed.6
Contrary to its undertakings, China continues to provide substantial subsidies to domestic companies, which have caused injury to US industries. Some of these subsidies also appear to be prohibited under WTO rules.
Studies have shown that China has come to dominate certain industries thanks to state subsidies. These are often provided by local authorities, in cash as well as in the form of cheap loans, cheap land and subsidised utilities. In return, the authorities receive enhanced tax revenues as subsidised companies expand, sometimes to global significance. Laila Khawaja of consultancy Fathom China believes that since local government is controlled by the Communist Party, one path to rapid rise in the party is through being associated with high-growth projects.7
China’s state direction of key industries, which are set growth targets as well as domestic and international market share targets, aided by state capital (equity, loans and subsidies), distorts market prices and creates excess capacity. The steel industry is one of many where the consequences include excess product being dumped on world markets, threatening to bankrupt foreign competitors.
A 2013 study by Usha and George Haley showed that China, until recently a net importer of steel, glass, paper and auto parts, has turned into the world’s largest manufacturer of such products in spite of having no overall comparative advantage in these capital-intensive industries, where labour costs represent a paltry 2–7 per cent of costs. This can only have happened because of state subsidies. And yet no one in industry or government in the West took any notice, blinded by the glittering short-term profits of trading, whatever the long-term cost.8
From 2000 to 2014, China accounted for more than 75 per cent of global steelmaking capacity growth, even though China has no comparative advantage with regard to the energy and raw material inputs that make up the majority of costs for steelmaking. Currently, China’s capacity represents about one-half of global capacity and twice the combined steelmaking capacity of the European Union (EU), Japan, the United States and Russia. Meanwhile, China’s steel exports grew to be the largest in the world, at 91 million metric tons (MT) in 2014, a 50-per cent increase over 2013 levels, despite sluggish steel demand abroad. In 2015, Chinese exports reached a historic high of 110 million MT, causing increased concerns about the detrimental effects that these exports would have on the already saturated world market for steel.9
The story is the same for aluminium and in other industries, causing huge damage to swathes of industry in the West.
China’s trade practices do not derive from an adherence to Ricardo’s theory of comparative advantage and a belief in the benefits of free trade. The Chinese system is structurally incentivised to maximise growth, even to the point of overcapacity (which then has to be dumped cheaply abroad). It is all but impossible to imagine how it could reform itself while the one-party state system endures. It appears equally inevitable that such a dynamic must propel China along a collision course with the West, as it cannot back down without disappointing both the ambitions of Communist Party members and the bargain with its citizens of fast growth in exchange for living in a totalitarian surveillance state.
Chinese domestic car companies have also benefited handsomely from subsidies, a fact which did not prompt the European competition authorities stopping the takeover of Volvo cars by Geely in 2010. Geely is a privately held Chinese automotive group although more than 50 per cent of its profits came from subsidies. In contrast, woe betide any European government that provides aid to an ailing domestic company. With friends like the European Commission, mechanically adhering to a mantra which belongs to a time long before China erupted on to the scene, who needs enemies?
The US National Trade Estimate notes,
In its WTO accession agreement, China committed to adopt a single official journal for the publication of all trade-related laws, regulations and other measures, and China adopted a single official journal, to be administered by China’s Ministry of Commerce, in 2006. More than 10 years later, it appears that some but not all central-government entities publish trade-related measures in this journal, and these government entities tend to take a narrow view of the types of trade-related measures that need to be published in the official journal.
Lack of transparency makes it difficult to keep track of transgressions of the WTO rules, let alone prove them. The US and other World Trade Organization members have continued to press China to notify all of its subsidies to the WTO in accordance with its obligations. However, ‘China has not yet submitted to the WTO a complete notification of subsidies maintained by the central government, and it did not notify a single sub-central government subsidy until July 2016.’ Nor is China complying with its commitment to the WTO Government Procurement Agreement (GPA), which would open up its government procurement market to the United States and other GPA parties.
Although the US actually runs a trade surplus in services with China (amounting to $38 billion in 2017), this would probably be much larger if the services market were open rather than being constrained by ‘case-by-case approvals, discriminatory regulatory processes, informal bans on entry and expansion, overly burdensome licensing and operating requirements, and other means to frustrate the efforts of US suppliers of services to achieve their full market potential in China’.10
In banking, foreign banks’ share of the Chinese market has actually declined – not surprising given that China imposes asset and capital requirements on foreign banks that it does not apply to domestic banks and is notoriously slow to act upon the applications of foreign banks to set up new branches. It also restricts the activities that can be conducted by foreign banks, while discriminatory and non-transparent regulations also limit the potential of foreign banks to take full advantage of China’s capital markets.
In 1994 China introduced a rule forcing foreign automobile companies to set up joint ventures with Chinese companies in order to manufacture and sell their products in China. This served the twin purposes of providing a captive source of revenue and profits for the Chinese partners and ensuring rapid technological transfer. Furthermore, Beijing imposed a rule whereby joint ventures with state companies were required to set up internal Communist Party cells to be involved in decision-making. In April 2018, under pressure from President Trump, China promised to phase out the joint venture requirement by 2022. Whether Western companies actually take advantage of this change remains to be seen. Their statements so far suggest few planned changes in their structures. As has been pointed out, this relaxation is probably too late given that the Chinese car market grew from about 4 million to 20 million sales between 2003 and 2018, so the costs and logistical complications required for foreign companies to buy back their Chinese partners’ stakes and go it alone may be prohibitive.
When it comes to technology that China judges to be of prime importance for the future, Beijing aggressively pursues its own interests. For example, requests by Seat, part of the VW group, to use its name on electric vehicles produced under a joint venture with Chinese car maker JAC were rejected by the National Development and Reform Commission, even though Seat sells conventional cars under that name. China intends to lead the world in advanced manufacturing (see below), including electric vehicles, so does not want foreign brands to gain recognition in this area.
The US Trade Representative’s (USTR) office has investigated the various direct or indirect practices that put foreign firms at a disadvantage in China, including the theft or extortion of intellectual property. It has identified four categories of reported Chinese government conduct for investigation including but not limited to:
• the use of a variety of tools to require or pressure the transfer of technologies and intellectual property to Chinese companies
• depriving US companies of the ability to set market-based terms in licensing negotiations with Chinese companies
• intervention in markets by directing or unfairly facilitating the acquisition of US companies and assets by Chinese companies to obtain cutting-edge technologies and intellectual property
• conducting or supporting unauthorised intrusions into US commercial computer networks or cyber-enabled theft for commercial gains
In March 2018 the USTR issued a report stating that the four categories of acts, policies and practices covered in the investigation are ‘unreasonable or discriminatory and burden and/or restrict US commerce’.
Famously, China forces foreigners to transfer intellectual property in exchange for access to its market.
China seeks to protect many domestic industries through a restrictive investment regime, which adversely affects foreign investors in key services sectors, agriculture, extractive industries and certain manufacturing sectors … evidenced by the continued application of foreign equity caps and joint venture requirements … In addition, foreign enterprises report that Chinese government officials may condition investment approval on a requirement that a foreign enterprise transfer technology, conduct research and development in China.
If China cannot obtain technology and know-how to accelerate its ability to compete with the West further up the value chain, it may resort to theft or take-overs: ‘the protection of trade secrets and IP more broadly represents yet another area where China has failed to comply with its promises for a more market-oriented system, particularly to the extent that the state itself sponsors the theft of trade secrets or actively frustrates the effective protection of trade secrets’.11
China’s cybersecurity law gives the government control over encryption and the flow of data. Hanna Müller, head of the German business lobby BDI has said, ‘You have to disclose a lot of data, and there is the risk that commercial secrets are just no longer protected.’
Foreign companies reported to the USTR various forms of pressure to share technology; if they resisted, permits to operate were withheld. Often, the pressure came through private channels with no paper trail, a violation of WTO rules. Companies that comply with demands are likely to have their competitive advantage rapidly eroded as local players master the technology. Foreign cloud service companies, for example, have had to share their know-how with Chinese partners.
Hacking is also a problem. US Steel was on the receiving end when Ugly Gorilla, allegedly a Chinese hacker, broke into 1,700 of the firm’s computers and mobile devices in 2010. One year later, the computer of a researcher at the company was hacked and details of how to produce ultra-high-strength steel were stolen. China’s Baosteel was rolling out such products two years later using techniques US Steel took a decade to develop.
Most legal systems and international institutions such as the WTO were not crafted to cope with the digital era. Cyber theft is difficult to prove, making it difficult to bring a case through conventional channels. This is one reason President Trump is circumventing such avenues of redress (which are also slow) in favour of executive orders, using the justification of threats to national security.
There has long been a problem with knock-offs made in China, including pirated videos and movies. Allegedly, factories in southern China produce components for iPhone or iPad imitations alongside the manufacture of the real thing, and the quality of knock-offs is now in some cases as good as or better than that of the real products. Local versions of GoPro cameras, for example, are as good as the originals and cheaper. Chinese drones are said to be the best available. Innovators such as GoPro are teetering on the brink of extinction due to their failure to realise the dangers of availing themselves of a cheap Chinese manufacturing base. Ironically, even Chinese manufacturers of high-quality products are complaining that they are being undercut by cheap imitations. Lei Jun, founder of Xiaomi, has griped that 30–40 per cent of supposedly Xiaomi phones on the market are in fact fake.
In the all-important technology sector the Chinese government has mandated that local information technology firms purchase Chinese products and use Chinese service suppliers, has imposed local content and research and development requirements, designated the location of R & D as a cybersecurity risk factor and required the transfer or disclosure of source codes and other intellectual property. China has nurtured its domestic Internet companies through cheap loans and land, access to the state-run banking and payments infrastructure and crucially by effectively barring Google, Facebook, Twitter, Instagram and YouTube using the so-called Great Firewall of China.12 Amazon operates in China, but can’t compete effectively with its Chinese rivals for locally sourced products and so enjoys only a modest 6 per cent market share. eBay and Walmart sold their unsuccessful operations.
China’s censorship rules and the Great Firewall have allowed its domestic tech companies like Baidu (search engine), Alibaba and JD.com (e-commerce) and Tencent (Facebook equivalent) to grow and thrive in the world’s most populous market, safe from foreign competitors. Tencent has 1 billion users in China, and Alibaba’s online platforms reported 654 million active users in the first quarter of 2019, probably more than Amazon and eBay put together.13 Chinese online companies work with the state’s artificial-intelligence-enabled censorship apparatus, scrubbing their services for undesirable content.
Their protected profits enable them to reinvest in new start-ups, such as ride-hailing Didi Chuxing. At the end of 2017, according to Chinese brokerage outfit CICC, China boasted half the world’s billion-dollar start-ups. The Chinese tech industry is graduating from copycat to innovator and will undoubtedly use its protected domestic customer base as the foundation for an eventual push abroad. Richard Liu, founder of JD.com, openly boasts that his company and its Chinese peers will one day challenge Google, Facebook and Amazon.
But protection is also a double-edged sword. Chinese companies have struggled to gain traction even next door in Hong Kong, let alone the US, where Tencent app WeChat operates. Perhaps this has something to do with the fact that people outside China do not trust the privacy settings on Chinese apps and services. Whatever the eventual outcome, China’s ambitions are plain to see, but it may have overplayed its hand.
According to Bloomberg, China has bought at least $318 billion-worth of companies in Europe alone over the last ten years, and over $900 billion globally.14 This is probably an underestimate since it excludes companies taken over by foreign subsidiaries of Chinese companies. The US was the single largest target country, representing $175 billion of acquisitions.
These are often businesses that own key infrastructure. In Europe alone this category includes at least four airports, six sea ports (including Piraeus in Greece) and wind farms in nine countries. Iconic industrial brands such as Pirelli have been taken over, and the Zhejiang Geely Holding Group has struck at the very heart of German industry and pride by taking a $9 billion stake in Daimler AG, parent of Mercedes-Benz, which has a large development budget for electric vehicles. Li Shufu, founder of Geely, is said to want to cooperate in the area of e-mobility – vehicles powered by electricity. As we have seen, Geely also owns Volvo and has used Volvo technology in its own cars. Bill Russo, CEO of advisory firm Automobility Ltd, says Chinese carmakers are ‘hungry for partners to help build capabilities to improve the[ir] competitiveness’. Speaking on Chinese State TV channel CCTV, Li Shufu explained this was to ‘support the growth of the Chinese auto industry … [and] serve our national strategies’.
Li Shufu built up his 9 per cent stake in Daimler AG by stealth, exploiting loopholes in German financial rules that require investors to inform the authorities once their stake exceeds 3 per cent of the voting rights of a company. He used a combination of bank financing, share options and complicated derivative contracts. Such tactics are hardly those of a partner with pure and transparent motives. Unsurprisingly, the banks were as usual happy to aid and abet transactions that evaded the spirit and the letter of the rules.
The suspicion is that this is a piece in the jigsaw of the Made in China 2025 plan (see below) for world domination in the key industries of the future. As Thorsten Benner, director of the global Public Policy Institute in Berlin put it, ‘If Made in China 2025 succeeds, German industry might as well pack up and go home.’15 The Daimler acquisitions, the Chinese purchase of Kuka, Germany’s largest maker of industrial robots, for €4.5 billion in 2016, and other deals that have been stopped just in time, plus the centralisation and increasing assertiveness of power in China and the refusal to open its own markets, have combined to flip the mood among the Western elite. China is seen less as a partner and more as an adversary, moving in on high-end manufacturing. If the plan succeeds, what will the West have left to sell to China?
In the UK, Chinese interests have bought about a dozen office towers in the City and Canary Wharf. Pin Ang Insurance group has taken a $10 billion stake in HSBC. In Switzerland, the China National Chemical Corporation paid $44 billion for agribusiness Syngenta and all the knowledge it possesses on plants, seeds, herbicides, pesticides, fungicides and fertilisers. In Portugal, China’s State Administration of Foreign Exchange (SAFE) bought a 5 per cent stake in EDP, the national electricity company. China Three Gorges (CTG) acquired a 23 per cent stake in 2011, and another Chinese entity, CNIC, majority owned by SAFE, also owns 5 per cent. Tim Buckley, a director at the Institute for Energy Economics and Financial Analysis, commented, ‘I see this as China going global. They are building a global network not by military adventurism, but by economic imperialism.’16
Chinese direct investment in Europe has jumped from €2.1 billion in 2010 to €37.2 billion in 2016, but declined to €17.3 billion in 2018. Around 60 per cent of takeovers have come from state-controlled groups who enjoy subsidies from the Chinese government.17
Western politicians such as David Cameron, who as UK prime minister welcomed Chinese investments with open arms, have done so from a position of weakness. With huge public debts racked up since the GFC, low growth and increasingly angry electorates, Western governments have seen Chinese capital as an easy short-term source of funds for infrastructure projects. And in the private sector, corporate management and shareholders are happy to take the short-term gain from selling shareholdings at a premium. In contrast, China is playing a long game to which the West has been blind.
China has set self-sufficiency targets in technology-related industries. For example, in telecommunications and aerospace the government has mandated that at least 70 per cent of key components be sourced from domestic companies by 2025, and seeks dominance in world markets by 2049, the hundredth anniversary of the foundation of the People’s Republic of China. That does not bode well for the West.
Made in China 2025 is a ten-year plan spearheaded by the Chinese Ministry of Industry and Information Technology (MIIT) which targets ten strategic industries including, among other things, advanced IT, automated machine tools and robotics, aviation and space-flight equipment and new energy vehicles. According to the 2018 US Naional Trade Estimate, Made in China 2025 is ‘emblematic of China’s evolving and increasingly sophisticated approach to indigenous innovation, which is evident in numerous supporting and related industrial plans. Their common, overriding aim is to replace foreign technology, products and services with Chinese technology, products and services in the China market through any means possible so as to ready Chinese companies for dominating international markets.’
The initial goal of Made in China 2025 is to ensure that Chinese companies develop, extract or acquire their own technology, intellectual property and know-how and their own brands. The next goal is to substitute domestic technologies, products and services for foreign technologies, products and services in the China market. The final goal is to capture much larger worldwide market shares in the ten targeted industries.
Many of the policy tools being used by the Chinese government to achieve the goals of Made in China 2025 raise serious concerns. These tools include a wide array of state interventions and support mechanisms designed to promote the development of Chinese industry in large part by restricting, taking advantage of, discriminating against or otherwise creating disadvantages for foreign enterprises and their technologies, products and services.
The digital economy already represents about one third of China’s GDP.18 No longer content with being a supplier of components or hardware, China is moving up to compete at the highest level. Payments using smartphones and Alibaba’s Alipay or Tencent’s WeChat are making cash obsolete. Yahoo and the Japanese Softbank were the largest initial shareholders in Alibaba, until founder Jack Ma told them that the Chinese government would not allow foreign investors to control a part of the country’s payments system. When Ma carved out Alipay, Yahoo was told the susidiary was no longer included in its investment.
China is currently aiming to raise over $30 billion through its state-backed China Integrated Circuit Industry Investment Fund to invest in domestic computer chip companies, an area where it is still overwhelmingly dependent on foreign producers. China represents a large proportion of global demand for semi-conductors, yet produces only a small fraction of the supply.19 Only 16 per cent of chips used in China are produced domestically and only half of those by Chinese-owned firms.20 China’s aim is to reduce its reliance on chip imports for national security reasons but also to become a global leader in the design and manufacture of sophisticated products to maintain its high economic growth rate. Increasingly squeezed by lower-cost Asian countries at the bottom end of the manufacturing food chain, and having achieved rapid growth during the period of migration of the labour force from fields to factories, China cannot stand still if it wants to avert the fate of Japan, mired in stagnation since 1990.
Chinese labour costs have risen so fast, the country is in danger of becoming uncompetitive in basic manufacturing. In order to preserve market share, some companies are replacing workers by robots, but as China’s manufacturing moves up the sophistication spectrum, it ceases to complement the West’s, and the notion of division of labour and specialisation by country creating the basis for mutually beneficial trade completely falls by the wayside.
China published a separate development strategy governing artificial intelligence in 2017, in which it set out its plans to dominate the ‘fourth industrial revolution’. It expects to be at the level of the most advanced countries by 2020, and according to a government statement issued in July 2018 will be the world’s primary AI innovation centre by 2030. In 2018 the AI market in China expanded 52.8 per cent to 33.9 billion yuan and is projected to pass 70 billion by 2020.21 Industry output is targeted to explode towards 1 trillion yuan by 2030. As well as nurturing home-grown talent, China is importing foreign talent, such as Lu Qi, hired from Microsoft in 2016 to head up its AI effort. The Berlin-based Mercator Institute for China Studies described the plan as ‘the building blocks of an overarching political program … In the long run, China wants to obtain control over the most profitable segments of global supply chains and production networks.’
Russian president Vladimir Putin is said to have remarked that the country that takes the lead in AI will rule the world, and China has declared AI superiority a strategic goal.
President Trump has ordered a probe into what he considers China’s unfair trade practices. As well as the first set of tariffs effective on up to $250 billion of Chinese goods, with further tariffs to follow if the Chinese do not change their ways, the US administration is also looking at enforcing reciprocity of access for foreign investment. The idea is that America will only permit Chinese takeovers in sectors where the Chinese allow similar US companies access.
America is strengthening the mandate of its Committee on Foreign Investment in the United States (CFIUS) to investigate and block deals. Similarly, Germany, Italy and France are tightening up their laws on overseas takeovers, introducing tougher screening and enhancing powers to block transactions; these initiatives are not, it should be noted, at the EU level. Meanwhile China has been caught flat-footed in its response to the pushback against its practices. This is perhaps not surprising given the decades of appeasement by the West. China’s meteoric rise to challenge the US for the title of the world’s top economy has encouraged a hubristic reinflation of national pride and the reinforcement of the notion of the superiority of its centralised, controlled, closed and undemocratic system as the most effective state model for the twenty-first century. Why should it compromise, faced by a weak, craven, divided and decadent West unable to follow a consistent course through the swings and roundabouts of the electoral pendulum?
But rather than heeding the wise advice of Deng Xiaoping, China’s success has gone to its head. It has let the proverbial cat out of the bag with its Made in China 2025 plan, presuming that it was already too late for anyone to block its path to global domination of cutting-edge industries and hence the world.
Ironically, as the prospect of realising its revanchist agenda finally comes into view, the very rigidity and closed characteristics of China’s system appear to have tripped it up. At home, with power concentrated at the top in the hands of a leader with no term limit, there are no checks to its exercise, as long as power continues to deliver rapid increases in living standards. That means there is only risk and no reward for anyone in the entourage of Xi Jinping who expresses a divergent opinion, in other words, who speaks truth to power. In particular, would any of his entourage have dared warn him of the provocative effect of the Made in China 2025 declaration or the AI manifesto? Did Mr Xi not consider the possibility that Western companies would tire of the inhospitable conditions for doing business in China? Last, but not least, did his contempt for the West’s democratic system blind him to the ability of the system to self-correct at the base.
For all the talk of win-win and the universal benefits of globalisation, ordinary people in the West are beginning to realise that they have been tricked by the actual winners’ self-serving propaganda and have lost badly. As some wag noted a few years back, the United States lost millions of jobs, indebted itself to China by $1.4 trillion and received in return a host of consumer goods, many of which now reside in landfills across the country.
Sigmar Gabriel, a German politician, has said that China is the only country with a truly global, geostrategic idea, and the West has no strategy of its own to offer in response. In 2017 the German security services revealed that Chinese intelligence agencies were setting up fake profiles on social networks such as LinkedIn to establish contact and potentially recruit German politicians and officials. These are not the actions of a friendly partner without ulterior motives. Meanwhile China apologists and Western beneficiaries of a system that reached its sell-by date at the time of the GFC and now smells rotten try to hold back the rising tide of change by disparaging it as ‘populism’, implying that its leaders are ignorant of economics and exploiting the masses’ base nationalistic instincts for their own cynical political ends.
There are also fatalists who realise what is happening but have given up trying to prevent it. According to this point of view, China’s rise is inevitable and we might as well accept it gracefully rather than shoot ourselves in the foot with a futile attempt to halt the Chinese bulldozer via a trade war. It is exemplified by declarations such as: ‘There is a legitimate argument that Daimler will ultimately survive by becoming a little less German and a little more Chinese,’ the opinion of one German official.22
China’s self-proclaimed return to the glories of the Middle Kingdom, around which the rest of the world rotates, coincides with the establishment of President Xi as its modern emperor for life. As James Stavridis eloquently noted, if Western democracy lives by following the short-term policies of the revolving door, what happens to a system where there is no mechanism for changing the leader, if the going gets tough?23 And it will get tough in a country that is ageing, has a huge gender skew in favour of males and will not be able to keep its high-growth show on the road to justify the absence of freedom.
Machiavelli provided an answer centuries ago: distract the masses’ attention from their domestic problems by channelling their frustrated aspirations into nationalism, if necessary to the point of conflict. It is no accident that China has siezed control of huge swathes of the South China Sea by enlarging small atolls into military bases equipped with runways, ignoring the ruling of an international tribunal against its claims. Defence spending is rising sharply, and China has built the first of several planned aircraft carriers which will enable it to project its military power well beyond its shores for the first time in modern history, thereby increasing the risk of a clash with the US in the Pacific. Reneging on its international commitments, in 2017 China’s foreign ministry casually declared the Sino-British joint declaration guaranteeing political autonomy for Hong Kong a ‘historical document’ that no longer has any significance.
Trade negotiations between China and the US to de-escalate the developing trade war are at an advanced stage at the time of writing and are likely to conclude with some sort of deal. Even if an agreement is sealed in time to suit Trump’s re-election calendar, it is likely to be cosmetic and will probably not alter China’s behaviour. This is because of the powerful deep structural forces at play within China that have been outlined above. Its business model – high growth, state and local government sponsorship of business, monopoly of power by the Communist Party – does not permit any slowdown in growth that would result from adherence to an open economy and abandoning its pursuit of foreign intellectual property. China is more likely to put up with tariffs than slam the brakes on its drive for domination of the key industries of the future.
Alibaba boss Jack Ma has remarked that war starts when trade stops. Ominously, he warned: ‘The first technology revolution caused the First World War, the second technology revolution caused the Second World War – and now we have the third.’24
If he’s right, the world needs wise leaders. Instead we have rulers with an inadequate understanding of history and a dangerous excess of personal vanity and national pride. In short, everything but the wisdom of Deng Xiaoping.