With US-China tensions rising over Taiwan, the global economy must brace for geopolitics trumping economics

The Taiwan crisis has deepened the divergence between China and the US-led West
While markets might believe that trade is the new mutually assured destruction, history tells another story

Andy Xie

Published: 3:30am, 26 Aug 2022

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The global economy has become more dependent on China since the pandemic began, while the geopolitical climate has become more confrontational as tensions rise between the US-led West and China. The divergence seems to be deepening over the question of Taiwan.

That raises the risk of geopolitics suddenly overwhelming economics. This is likely to be the biggest risk to the global economy in the coming years.

Then US president Donald Trump declared a trade war on China in July 2018, and reshoring became a talking point around the world. The perception was that China’s export machine would fall apart. While that narrative still remains popular in the international media, the facts on the ground have moved in the opposite direction.

China’s exports of goods and services rose from US$2.26 trillion in 2017 to US$3.36 trillion in 2021, while the US’ exports inched up from US$2.33 trillion to US$2.53 trillion in the same period. In the first half of 2022, China’s exports of goods rose 13 per cent, despite the high base of comparison from last year.

Instead of reshoring, “friend-shoring” is the new buzzword among Western politicians. It essentially means shifting production to friendly countries. This begs the question of why it hasn’t happened yet. What has changed in the past few years to make friend-shoring more viable now? “Friend-shoring” is a talking point that seems destined to be forgotten.

The hard truth is that most factories generate little profit, create jobs that are demanding but not well-paying, and require a capable and supportive government. After Trump said he would bring manufacturing jobs back to the US, American comedian Dave Chappelle joked, “For what …? So iPhones can be $9,000? … I wanna wear Nikes, I don’t wanna make them … Stop trying to give us Chinese jobs.”

Maybe politicians should consult comedians before they draft policies.

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In addition, a manufacturing economy requires a lot of capital, which only countries with high savings rates can stomach. It means that people should have a strong preference for wealth accumulation rather than having a good time, that is, tolerance for a low discount rate, where present benefits are only slightly more valuable than future benefits.

East Asian countries have used manufacturing to boost their economies and become wealthy because they were suited to this path. Countries elsewhere have not displayed the same characteristics. Vietnam has exhibited traits that would allow it to become an East Asian story, but it is the size of some Chinese provinces. At best, it is a mini-China, not a candidate for replacement.

China’s domestic demand is in trouble. A hard landing is likely for the property market, and the zero-Covid policy is weighing down the service sector.

The country is becoming more dependent on exports than at any other time in the past two decades. The Chinese government will put as much effort as possible into export promotion, with the global economy offering a favourable environment for this.

Unless something drastic occurs, China’s exports could exceed US$6 trillion by 2027, more than the US, the European Union and Japan combined.

Globalisation has made the world economy more vulnerable to trade disruption, because economies of scale drive production concentration at every step of the supply chain. A major disruption would spell catastrophe for the global economy.

By now, the impact of supply chain disruption is well known. Shanghai’s zero-Covid lockdown had a cascading impact on the global automobile industry. The electronics, automobile and pharmaceutical industries are all highly dependent on China for basic materials and components. They could well shut down if China trade is disrupted.

No danger of China losing its supply chain supremacy to India or Vietnam

Less well known is the importance of mark-up gross domestic product for developed economies. You may have heard of import-driven economies. These really hinge on massive mark-ups on Chinese imports.

From souvenirs at tourist spots to trainers promoted by sporting stars, mark-ups of over 10 times support a vast service economy. Without supplies from China, this mark-up economy wouldn’t exist.

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As geopolitics and trade move further apart, it begs the question which side is mistaken. The market may think that politicians are bluffing, that the terrible consequences would deter politicians from pulling the plug on China trade, that trade is the new mutually assured destruction (MAD).

This view, however, goes against history. In past conflicts, geopolitics has tended to trump economics. That would imply that the market is mistaken, drifting to its own destruction.

Beijing is betting on the new MAD. Its diplomats are sounding the inevitability of Taiwan reunification around the world. Repeating the message is intended to blunt the psychological impact of the real thing. But, if history is any guide, the real thing would feel very different, and there will be drastic reactions.

Beijing has come too far to back down on Taiwan. A decisive moment is likely to occur within five years. When it does happen, the West will feel helpless at first and then lash out. Numerous sanctions would be imposed. Global trade would probably collapse. And the global economy could crash dramatically, accompanied by high inflation.

As societies are already so divided around the world, an economic depression would open many Pandora’s boxes. The market is in for a rude awakening.

Andy Xie in an independent economist