Trump and Xi made progress at the G20, but are the US and China still destined for war?

  • Aidan Yao says the US’ fundamental disagreements with China’s industrial policy and trade practices haven’t changed. Both sides, and the world, still need to worry about Thucydides’ Trap leading to worsening conflict
PUBLISHED : Wednesday, 05 December, 2018, 1:12pm
UPDATED : Wednesday, 05 December, 2018, 10:32pm

Between 431 and 404BC, the two major Greek powers – incumbent power Sparta and the rising Athens – waged war. This is recounted by the Athenian historian Thucydides in The History of the Peloponnesian War: “It was the rise of Athens and the fear that this installed in Sparta that made war inevitable.”

The dangerous dynamic of a rising power that threatens to overthrow the ruling one has been dubbed the “Thucydides’ Trap” by American political scientist Graham Allison, whose study famously reveals that, in 12 of the last 16 encounters in which a rising power confronted the ruling one, the result was war.

This was true with Athens vs Sparta and for Germany vs the UK/France more than 100 years ago. Even though the tussle between the Soviet Union and the United States did not end in an all-out military clash, it did result in an antagonistic “cold war” which lasted decades.

That prompts the critical question of today: is the emerging tension between the US and China doomed to end in a grand conflict, or can they find a peaceful way to coexist?

The experience since the second world war has been encouraging, as the power transitions Allison identifies since then have occurred without outright conflict. Hopefully, the eventual handover of global power, whenever it happens, can occur in a peaceful manner.

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But even without catastrophe, the path to the endpoint is likely to be bumpy. As can be seen in the past year, the rising conflict between ruling and emerging powers can create turbulence for the world.

Luckily, the battleground is not yet in military fields, but conflicts are clearly rising in trade, investment and technology, whose impacts will continue to manifest in economic and market terms in the coming years.

This is why investors should be cautious about the outcome of the G20 meeting in Buenos Aires between Chinese President Xi Jinping and US President Donald Trump, which amounted to nothing more than an agreement to resume trade negotiations. In substance, Beijing has not really budged much with respect to its offer of buying more US goods, opening up its market and “working on” issues, such as technology transfer and intellectual property rights protection, which were all part of its previous list of offers.

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Instead, the core issues that have led to the trade impasse surrounding China’s industrial policies – known as Made in China 2025 – plus the role of the state vs the market and China’s “non-reciprocal” trade practices, remain unresolved and it is not clear that the US will be willing to relent for a smaller trade deficit (at least temporarily).

Therefore, what follows in the coming 90 days will be key for financial markets. After their initial positive reaction, the markets are nervously watching every step of the negotiations.

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For now, the G20 outcome has not fundamentally changed our view on the US-China economic tussle and its impact. The shifting effect of the trade war – from a market shock to a growth shock – is the key driver of the economic slowdown expected for China in 2019. The base case remains that the tariff rate will eventually rise to 25 per cent, covering US$250 billion in Chinese goods, although the odds of non-escalation, with levies staying at their current levels, have risen after last week’s meeting.

To counteract the trade shock, Beijing is expected to stick to “cautious” policy easing, which focuses on fiscal support for households and private-sector businesses. In addition, policymakers also have to “walk the talk” with structural reforms in 2019, likely to focus on strengthening intellectual property protection, liberalising financial markets, opening up the capital account and reforming the corporate sector.

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Many of these things have been on Beijing’s to-do list since the Third Plenum, but rising trade/tech conflicts with the US have added a sense of urgency. If executed properly, these actions will benefit China in the long run but, in the near term, they can also help alleviate tension with the US.

Whether these actions permanently halt the trade war and avoid the Thucydides’ Trap is impossible to tell. What we do know from history is that failure could lead to multiple disasters for the world, such as a worsening global economic downturn, financial market turmoil and an unstable global order that leads to geopolitical, economic and military conflict.

Aidan Yao is senior emerging Asia economist at AXA Investment Managers