Destructive Decoupling
Policymakers in both the United States and China seem to have fully accepted, and even embraced, the logic of economic decoupling. But what exactly will decoupling entail, and what will its consequences be?
This approach might have met resistance, including in
Europe, were it not for the war in Ukraine. The conflict seems to have
re-solidified transatlantic relations, after a few fractious years. And
while China has remained officially neutral in the war, it has remained
committed to its “no-limits partnership” with Russia, which Chinese
President Xi Jinping reaffirmed on his recent three-day visit to Moscow
. At the heart of Xi’s partnership with Russian President Vladimir Putin
is the shared belief that the US-led West is determined to keep their
countries down – to impede their development, thwart their territorial
ambitions, and constrain their international influence. This conviction –
seemingly vindicated by recent US policy – is also central to the
latest iteration of China’s domestic economic agenda.
The beginning of
Xi’s unprecedented third term in power brought a flurry of documents
illuminating China’s economic plans, not least its strategy to restore
rapid GDP growth. Having concluded that the world economy will be less
open and more hostile, and thus a less reliable growth engine, China’s
leaders are seeking to reduce their dependence on export demand. So,
despite continuing to tout multilateralism and economic openness,
Chinese leaders’ highest priority is now stability and self-reliance in
trade, investment, and technology.
The economic logic is sound. With an
economy roughly 80% the size of the US, China has a huge internal
market for goods and services, and for factors of production. By
improving the integration of its domestic market, China may be able to
take fuller advantage of its growth-enhancing potential, thereby
insulating itself to some extent from foreign pressures, including
challenges to its centrality in global supply chains.
In fact, diversification of supply chains – such as through so-called friend-shoring – is already well underway, and not only because of the US-China competition. Frequent shocks – from climate-related extreme weather to pandemic and war – and the growing use of economic sanctions as a foreign-policy tool have also given businesses and governments incentive to strengthen resilience.
For many countries, greater resilience would ideally include less dependence on the US dollar. While the greenback’s global dominance is not in immediate danger, given the absence of a viable alternative, several Asian countries are trying to create mechanisms for settling trade that avoid reliance on the dollar. Tactically, this would make it harder for the US to track transactions and identify sanctions violations.Make no mistake: the economic
consequences of this lurch toward confrontation are as far-reaching as
they are severe. As global supply chains become less elastic, less
efficient, and more costly, their ability to counteract inflationary
pressures will decline. Central banks will thus be left to manage price
growth alone, by suppressing excess demand.
All of this generates
powerful growth headwinds. Moreover, as we have recently seen, rapid
monetary-policy tightening, after years of ultra-low or negative (in
real terms) interest rates, produces financial stress and bouts of
instability, especially when debt levels are substantial.
The
combination of higher interest rates and heavy sovereign-debt burdens
will compound fiscal pressures. Though lower inflation could ease those
pressures, interest rates are likely to remain elevated for a while,
especially if suboptimal global economic trends and secular forces like
population aging cause supply-side conditions to deteriorate. Nor is the
downward trend in productivity growth – which has become particularly
pronounced in the last decade – likely to be reversed in a fragmented
global economy with barriers to technology development and diffusion.
These barriers will also jeopardize progress on the sustainability
agenda, which requires free and frictionless flows of existing and
emerging technologies. Likewise, the green-energy transition will
require capital to flow to where it will have the most impact, including
to lower-income countries. The incremental capital investment needed
for the global energy transition – estimated at about $3-3.5 trillion
– simply will not be mobilized without international coordination. To
crowd in private investment, the international financial institutions
need increased capitalization and support from all the major
shareholders, which is not likely in the current environment.
Many
people on both sides of what might be called the “mutual distrust
equation” know that decoupling is a distinctly suboptimal and perilous
course. But in both the US and China, dissenting voices are either
ignored or stifled, whether through political pressure or outright
repression.
Many emerging and developing economies recognize that a
fragmented global economy – let alone one where they must choose between
two competing blocs – is not in their interest. But they currently lack
the power to change the major players’ incentives. India may be able to
play such a role someday, but not yet. And while Europe is big enough
to resist the decoupling pressure, it is not fully integrated, and is
hamstrung by its energy dependence. As for multilateral institutions,
they are too beholden to their major shareholders in the developed world
to advocate strongly for cooperation, openness, and an adaptive
rules-based system that promotes efficiency, growth, and inclusiveness.
That leaves no obvious off-ramps from the current trajectory. The future is partial decoupling and fragmentation.
Michael Spence, a Nobel laureate in economics, is Professor of Economics Emeritus and a former dean of the Graduate School of Business at Stanford University. He is Senior Fellow at the Hoover Institution, Senior Adviser to General Atlantic, and Chairman of the firm’s Global Growth Institute. He serves on the Academic Committee at Luohan Academy, and chairs the Advisory Board of the Asia Global Institute. He was Chairman of the independent Commission on Growth and Development, an international body that from 2006-10 analyzed opportunities for global economic growth, and is the author of The Next Convergence: The Future of Economic Growth in a Multispeed World (Macmillan Publishers, 2012).
MILAN – Over the last year, the trajectory of Sino-American relations has become indisputable: the United States and China are headed toward a substantial, though not complete, decoupling. Far from resisting this outcome, both sides now seem to have accepted that this will play out as a largely non-cooperative game, to the point that they are embedding it in their policy frameworks. But what exactly will decoupling entail, and what will its consequences be?