Economic cold war between China and US inevitable

Both sides will find it hard to step back in the confrontation over trade and the result will be a world divided in a deja vu of the old cold war days

PUBLISHED : Tuesday, 25 September, 2018, 7:01am
UPDATED : Tuesday, 25 September, 2018, 10:28am

It is inevitable that a trade war between China and the US will escalate into a new cold war, and the confrontation will press Beijing and Washington to form their own alliances and divide the world into their spheres of influence – a deja vu of the old cold war days when the US and the former Soviet Union vied for global dominance.

The US is using tariffs as a tool to pressure Beijing to alter its state-led economic model and “unfair” trade practices. At the heart of US policy is the issue of China’s state-owned enterprises – they are implementing China’s Made in China 2025 strategies, they are the vanguard of expanding Chinese influence in Asia and Africa, and they are the main beneficiaries of technology “transfers” from the US and EU.

But these are exactly the reasons why Beijing will only enhance its state-owned sector – even though doing so could hurt the private economy at home. Meanwhile, those bearing the brunt of a trade war in China are mainly the private exporters, which Beijing cares less about.

China is also economically much stronger than the former Soviet Union, which may embolden Beijing to engage in a cold war. While the Soviet Union’s planned economy model achieved relatively rapid economic growth in the 1960s and early 1970s – the Soviet share in the global economy peaked at 13 per cent in 1970 – the former Communist empire is no match for China’s economic might of today.

China’s GDP output is about two-thirds of the US in nominal dollar terms and accounts for approximately 15 per cent of the world economy. China’s GDP growth is slowing to a level of around 6.5 per cent but it is still faster than that of the US. More and more people in the US believe China is strong enough to challenge the US-led international system, and so do the elites in Beijing.

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The Chinese government will find it hard to step back in the trade confrontation.

On one hand, giving up a state-owned economy means the ruling Communist Party has to give up the benefits which come from control of the economy. In Taiwan, the Kuomintang regime, defeated in 1949 by the Communists on the mainland, went on to give up ownership of the economy on the island and quickly lost power. It is a good lesson for the mainland China.

On the other hand, Beijing is more willing to stretch the timing of confrontation. Beijing has experienced worse times than the current trade tensions. From the great famine in the early 1960s to a decade of chaos in the Cultural Revolution, and then to international sanctions following the crackdown on the pro-democracy movement in Tiananmen Square, these were far worse situations for China than the trade war. So, at least for the ruling elites in Beijing, the attitude may be that if China can overcome those difficulties, why not today’s challenges also?

At the same time, the US will also find it difficult to compromise because doing so would only give Beijing more confidence in the Chinese model and a willingness to be more aggressive in challenging the US.

A trade war will firstly spill over to the foreign investment field. China became a net capital exporter in 2014, and China’s state-led investment is more easily accepted by developing countries where rule by man is more important than rule of law. The EU and the US have been strengthening investment restrictions on China since last year, encouraging China to transfer more investment to Asia, Africa and Latin America.

An economic cold war could also weaken the role of the Chinese economy in the world.

The importance of China’s market is reflected in two aspects. One is a strong manufacturing capacity thanks to its cheap labour force, and the other one is a big potential consumer market due to rapid economic growth. The former is being replacing by India and Southeast Asia, the latter may be weakened by a zero tariff trade zone of the EU, the US and Japan.

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As China’s market becomes less important than before, which in turn would prompt Beijing to further close access for the US and its allies, the world trade market may be divided into two parts. The separation of foreign investment plus trade markets means the separation of capital flow, which will bring monetary and financial confrontation. Russia was looking forward to stopping the US dollar for a long time.

The economic exchanges between China and the US are far closer than they were for the two camps in the old cold war. That’s why the new trade war will bring more economic damage than ever. Sadly, in every process of national confrontation, rationality always retreats to the second line, for each side believes it will be the winner.

Zhang Lin is a Beijing-based independent political economy commentator