The Economic Costs of America’s Conflict with China
In a wide-ranging speech on the US-China
relationship, US Treasury Secretary Janet Yellen reversed the terms of
engagement with China, prioritizing national-security concerns over
economic considerations. The US case, however, rests not on hard
evidence but on the presumption of China's nefarious intent.
NEW HAVEN – Five years into a once-unthinkable trade war with China, US Treasury Secretary Janet Yellen chose her words
carefully on April 20. In a wide-ranging speech, she reversed the terms
of US engagement with China, prioritizing national-security concerns
over economic considerations. That formally ended a 40-year emphasis on
economics and trade as the anchor to the world’s most important
bilateral relationship. Yellen’s stance on security was almost
confrontational: “We will not compromise on these concerns, even when
they force trade-offs with our economic interests.”
Yellen’s view is very much in line with the strident anti-China sentiment that has now gripped the United States. The “
new Washington consensus,” as
Financial Times
columnist Edward Luce calls it, maintains that engagement was the
original sin of the US-China relationship, because it gave China free
rein to take advantage of America’s deal-focused naiveté. China’s
accession to the World Trade Organization in 2001 gets top billing in
this respect: the US opened its markets, but China purportedly
broke its promise
to become more like America. Engagement, according to this convoluted
but widely accepted argument, opened the door to security risks and
human-rights abuses. American officials are now determined to slam that
door shut. There is more to come. President Joe Biden is about to issue an
executive order
that will place restrictions on foreign direct investment (FDI) by US
firms in certain “sensitive technologies” in China, such as artificial
intelligence and quantum computing. The US rejects the Chinese
allegation that these measures are aimed at stifling Chinese
development. Like sanctions against the Chinese telecoms giant Huawei
and those being considered against the social-media app TikTok, this
one, too, is being justified under the amorphous guise of national
security. The US case rests not on hard evidence but on the
presumption
of nefarious intent tied to China’s dual-purpose military-civilian
fusion. Yet the US struggles with its own security fusion – namely, the
fuzzy distinction between
America’s under-investment in innovation and the real and imagined threats of Chinese technology.
Significantly, Yellen’s speech put both superpowers on the same page.
At the Communist Party’s 20th National Congress last October, Chinese
President Xi Jinping’s opening message also stressed national security.
With both countries equally fearful of the security threat that each
poses to the other, the shift from engagement to confrontation is
mutual. Yellen is entirely correct in framing this shift as a tradeoff.
But she only hinted at the economic consequences of conflict.
Quantifying these consequences is not simple. But the American public
deserves to know what is at stake when its leaders rethink a vitally
important economic relationship. Some fascinating new research goes a
long way toward addressing this issue.
A just-published study by the International Monetary Fund (summarized in the
April 2023 World Economic Outlook)
takes a first stab at identifying the costs. IMF economists view the
problem through the lens of “slowbalization”: the reduction of
cross-border flows of goods and capital, reflected in geostrategic
strategies of “reshoring” (bringing offshore production back home) and
what Yellen herself has called “
friend-shoring” (shifting offshore production from adversaries to like-minded members of alliances).
Such actions result in “dual bloc” FDI fragmentation. The IMF estimates
that the formation of a US bloc and a China bloc could reduce global
output by as much as 2% over the longer term. As the world’s largest
economy, America will account for a significant share of foregone
output. European Central Bank President
Christine Lagarde recently
stressed a different channel through which an escalating US-China conflict could adversely affect economic performance. Drawing on
research
by ECB staff, she focuses on the higher costs and inflation resulting
from supply-chain disruptions implied by conflict-driven FDI
fragmentation. The ECB study concludes that geostrategic conflict could
boost inflation by as much as 5% in the short run and around 1% over the
longer term. Collateral effects on monetary policy and financial
stability would follow. Collectively, these model-based calculations of
the costs of conflict imply a stagflationary combination of lower
output and higher inflation – hardly a trivial consideration in today’s
fragile economic climate. And they dovetail with economic theory.
Countries trade with others to reap the benefits of comparative
advantage. Both inward and outward flows of foreign investment seek to
achieve similar benefits, offering offshore efficiencies for
multinational corporations that face higher costs in their home markets
and attracting foreign capital to support domestic capacity expansion
and job creation. Regardless of their different political systems and
economic structures, this is true for both America and China. It follows
that conflict will reduce these benefits. Yet there is an important
twist for the US: a chronic shortfall of domestic saving casts the
economic consequences of conflict with China in a very different light.
In 2022,
net US saving
– the depreciation-adjusted saving of households, businesses, and the
government sector – fell to just 1.6% of national income, far below the
longer-term 5.8% average from 1960 to 2020. Lacking in saving and
wanting to invest and grow, the US takes full advantage of the dollar’s “
exorbitant privilege”
as the world’s dominant reserve currency and freely imports surplus
saving from abroad, running a massive current-account and multilateral
trade deficit to attract foreign capital. As such, the economic
interests of saving-short America are tightly aligned with its outsize
imbalances of trade and capital flows. Barring a highly unlikely
resurgence of domestic US saving, compromising those flows for any
reason – say, security concerns over China – is not without meaningful
economic and financial consequences. The research cited above suggests
those consequences will take the form of slower economic growth, higher
inflation, and possibly a weaker dollar. This is hardly an ideal
outcome for a US economy that is already at a precarious point in the
business cycle. The tradeoff for national security should not be taken
lightly. Nor should the US penchant to over-hype the security threat be
accepted on blind faith.
Stephen S. Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China (Yale University Press, 2014) and Accidental Conflict: America, China, and the Clash of False Narratives (Yale University Press, 2022)
NEW HAVEN – Five years into a once-unthinkable trade war with China, US Treasury Secretary Janet Yellen chose her words carefully on April 20. In a wide-ranging speech, she reversed the terms of US engagement with China, prioritizing national-security concerns over economic considerations. That formally ended a 40-year emphasis on economics and trade as the anchor to the world’s most important bilateral relationship. Yellen’s stance on security was almost confrontational: “We will not compromise on these concerns, even when they force trade-offs with our economic interests.”