Something is rotten in the Middle Kingdom

October 28, 2024

This week in The Red Report

From Zhongnanhai: This week in Chinese Politics

What has stimulus achieved?

Despite announcing the largest stimulus package since the pandemic, markets–and consumers–appear unconvinced that China’s economy can overcome its embedded structural issues. Foreign businesses should take note of the potential diminishing returns associated with continuing business engagements in China.

Analysis

China’s recently announced stimulus package–a much-touted move by CCP leaders to reenergize the flagging economy–appears to have spurred little improvement in consumer and investor confidence. Aimed at strengthening domestic demand and consumption as a boost to stalling economic growth after the pandemic, the stimulus packages announced in the past few weeks met with more of a whimper than a bang both at home and in global markets, Measures to improve bank liquidity, cut rates, boost the housing sector, and stabilize local government debt are important and helpful measures, but are arguably more about plugging holes in the economy, rather than adjusting deeper structural issues that created these problems. Industrial profits in China, for example, posted their steepest decline of the year after the stimulus announcement, and the Hang Seng Index dropped as the IMF downgraded their forecast for China. An announcement that economic policy leaders would meet in the coming weeks in Beijing similarly did little to nudge market confidence in a positive direction.

Yet at the same time as China’s stimulus tries to attract private investment from abroad (albeit on the party’s terms), foreign companies should still exercise extreme caution with the Chinese economy. Even as some companies, like HSBC, reorient their China and Hong Kong operations, these moves appear to be more about insulating and separating China-based operations from other business operations, rather than reflecting an excitement about the Chinese economy. This cautiousness about engaging with China is prudent. Concurrent with stimulus announcements, for example, China’s Ministry of State Security accused an “unidentified foreign company” of conducting “illegal mapping” that amounted to unsanctioned data collection. Foreign companies and investors should therefore not be swayed by promises of short term returns amid the CCP’s broader securitization of its economy. Ignoring the CCP’s clear messaging that foreign entities will be regarded with increasing suspicion will likely result in damages to company reputations, ability to engage other global partners, and ultimately bottom lines.

On the Hill: Developments in US China policy

What are China’s hopes for the US elections?

Regardless of November’s victor, US-China relations look unlikely to improve, with potentially damaging consequences for businesses that continue to engage with Chinese partners.

Analysis

Will US-China relations continue to deteriorate, regardless of who is in the White House come January? Trends suggest that improved relations are in neither the US nor China’s short-term interest, with both sides benefiting from promoting the other as an adversary that demands attention from across the political spectrum. 

For the CCP, Trump presents a catch-22. On the one hand, Chinese disinformation campaigns overwhelmingly promote Trump and his positions with the intent of spreading the most socially divisive messaging to provoke distrust and social unrest in the US. On the other hand, Trump is a much less predictable candidate compared to Harris, which is a problem for the CCP and its love of predictability on the world stage. Trump’s imposition of tariffs and trade wars against China, for example, appears to have caught the CCP largely off guard, and there are fears that Trump could impose even more punitive measures against the Chinese economy if he wins the election. While US economists have largely debunked Trump’s proposals as potentially damaging to the US economy, 

One issue for both US and Chinese policymakers is that the US public is increasingly receptive to messaging from both Democrats and Republicans that China is an adversary, a position that was unaided by recent news that Chinese hackers have targeted both Harris and Trump on the campaign trail. This makes it increasingly difficult–and unpopular–for an administration of either party to de-escalate or to be seen as cozying up to Beijing. It also heightens the pressure on the executive branch to continue to restrict imports and exports of Chinese goods and services, particularly in the tech sector, as a sign that economic security is increasingly viewed as a function of national security. Notably, in a sign that engagement with China will be viewed with suspicion by the next administration–whoever that might be–McKinsey was recently berated by Congress for allegedly lying about their past engagements with the CCP, which suggests that the US is trending towards a future questioning of any corporate engagement with China as suspicious. Companies with China engagements should therefore both consider how to redirect operations elsewhere–although this comes with its own security concerns–or at the least to ensure that they have conducted thorough diligence on these engagements.

Business Matters

Why you don’t want China’s economy to fail

Recent Red Reports have brought attention to the declining state of the Chinese economy and cautioned businesses to insulate their bottom lines and supply chains from related instabilities. While this remains true–making informed decisions about engaging with China has never been more important–it is also incumbent on us to remind readers why, despite current tensions, you do not want China’s economy to fail.

Analysis

As the world’s second largest economy and the second largest foreign holder of US debt, at US$859.41B or 2.6%, the Chinese economy is a critical lynchpin in the global economy. Although China previously threatened to call in a significant portion of its US debts during the COVID-19 pandemic, when Sino-US tensions were also high, this is not the reason for worry (the US economy could survive such a move and debts cannot be called en masse anyway due to maturation periods). If the Chinese economy fails so spectacularly that Beijing needs to call in its debts, then the world is in trouble. A 2020 inventory of Chinese debt discovered that China is the largest global creditor, “surpassing traditional, official lenders such as the World Bank, the IMF, or all OECD creditor governments combined.” Among developing countries receiving Chinese aid, at least a dozen owe 20% of their annual GDP to China, with 50% of the relevant loans going unreported via official, document channels. Altogether, the world owes China 5-6% of the global GDP. While the US economy might survive, lesser economies will sputter and fail, endangering supply chains and the opening of new markets. In short, the collapse of the Chinese economy would trigger a series of cascading implications that will ultimately wreak havoc on the US economy.

Still, supporting continued economic engagement on mutually advantageous terms is not the same as going back to the 1990s and 2000s. That is neither possible nor desirable. Massive IP theft and other anti-competitive practices remain as crucial obstacles to cooperation. The safest and most productive path for Western economies is neither blind engagement nor complete disengagement, but rather engaging smartly on terms that benefit the West and do not crater the world’s second largest economy.

Tech Futures

Why China’s quest for critical metals hints at the CCP’s AI ambitions

Rare earth metals are increasingly at the frontline of the race for global AI superiority. Watching how this critical market evolves and adapts to the CCP’s tightening grip will be vital for those interested in the future of tech in US-China relations.

Analysis

Those interested in the future of AI in China should look at how the CCP is securing critical metal resources as a key indicator of the party’s tech ambitions. Critical metals, including rare earth metals like lithium used in batteries, and gallium used in brilliant mirrors, are vital for chip and semiconductor manufacturing needed to produce the necessary hardware for AI and other new technologies. Unlike other states, China is heavily interventionist in metals markets both at home and abroad through its directing of state-owned enterprises and sidelining of private mining ventures, which aims to secure the party’s control of the entire supply chain in hardware manufacturing from raw materials to the final product. China’s recent moves to seize global critical metal supplies, the majority of which are already under the CCP’s control, therefore indicate that the CCP prioritizes Chinese-made tech systems as crucial for its national security.

For the US, China’s seizing of global metal resources has triggered a growing understanding that economic security is integral national security. Exploration of lithium deposits in Nevada and Australia, for example, present an opportunity to secure vital metals beyond China’s grip. This means that Western states, including the US, will likely become increasingly interventionist in the mining industry and the securing of key elements, as a function of technological innovation. Besides companies in the mining industry, many of which will likely face aggressive competition from Chinese entities, tech and other industries will also be heavily affected by growing governmental intervention in private sector deals on the basis of national security. These interventions will produce dramatic consequences for industries like chip making. Monitoring rare earth metals will therefore be a vital canary in the coalmine for the tech sector in the coming years.

Espionage Alert

European and U.S. officials note that the world has never seen an intelligence war like the one China wages on the the advanced economies

China’s intelligence operations against the West are so vast and include so many different nontraditional targets, including private companies and critical infrastructure, that Western governments simply cannot contain the problem.

Analysis

U.S. and European intelligence and counterintelligence officials are publicly warning both individuals and businesses that governments cannot effectively respond to China’s actions. This situation is unprecedented. Although private companies in advanced economies occasionally resort to stealing trade secrets to gain advantage over competitors, the legal systems in democracies limit this activity. The Chinese party-state-economy operates under no such constraint. China combines all the resources of the second largest economy in the world with the centralized direction of a dictatorship to siphon off vast amounts of private wealth, degrade Western economies, and attack Western infrastructure.

China’s successes in this regard stem not only from its intent and organization, but the range of national resources, its position in global supply chains, the way technology has altered how much spies can steal, and the increased economic value of intangible assets like data and trade secrets. No other state in history has done what China is doing now. Beijing by one estimate fields as many as 600,000 intelligence officers to steal Western economic information. This figure likely does not include proxies and the private companies and individuals compelled to assist China’s professionals. Moreover, avoiding China is impossible because it is integrated into global supply chains. Additionally, modern information technology has turbocharged China’s spying; whereas spies in the 1990s could make off with the equivalent of a few megabytes of data at best, today, China’s hackers can steal petabytes, or a billion times the amount of information in the same amount of time. Finally, knowledge today accounts for a much greater portion of economic value than it did thirty years ago, and so the benefits of espionage are much greater. 

Because governments lack the resources and authorities to counter China’s attacks, private firms in the advanced economies must play a role in their own defense. China has created a world in which counter-espionage is as much a requirement as any other component of a sound business operation.

One more thing…

A BRICS breakthrough between Beijing and New Delhi?

An expanded BRICS highlights how “neutral” investment destinations will likely continue to be deeply involved with China, with all the associated risks that come with these engagements.

Analysis

BRICS summits often produce words with few actions. The most recent BRICS meeting, however, displayed a demonstrable effort for member states to forge an alternative to the Western-led global order, expanding the group to include 13 “official partner countries” alongside the 9 full members. Several of these new additions are either allies or partners of the US–like Thailand and Turkey–or countries that had previously opted for a more neutral stance between the US and China, most notably countries in Southeast Asia like Malaysia, Vietnam, and Indonesia. A major focus of the summit, hosted by Russia, is to promote cooperation among countries of the Global South, particularly in exerting more influence over price setting and in developing an alternative to the US-controlled SWIFT payment system. Yet in an ironic twist, concurrent with the BRICS meeting, both Indonesia and Vietnam reported confrontations with Chinese coast guard vessels in the South China Sea over contested territories. The ideal of BRICS as what China and Russia deem a multipolar alternative to US alternative to US hegemony therefore appears to be a work in progress because of the tensions that persist among members. These tensions and other obstacles to creating an alternative to the current economic order are not trivial.

Relations between China and India illustrate the complexities. The two states have engaged in a military confrontation along disputed border regions since the 1960s, with recent flares in tensions in the past few years seeming to push India closer to the US and the “Quad” as a balance to China’s aggression. At the most recent BRICS meeting, however, Beijing and New Delhi appeared to have reached an agreement for how to de-escalate their conflict, with tangible results already apparent along the border. While this agreement provides for peaceful methods for dispute resolution, it does not resolve all contested territorial claims. Moreover, India noticeably refused to endorse China’s Belt-Road Initiative at the summit. Still, overall, India is showing that it may increasingly prioritize Global South solidarities over its relationships with the West. 

These shifting geopolitical tectonics have potentially dramatic consequences for businesses looking for alternative destinations as they relocate or “friendshore” operations out of China. Where many corporations are increasingly looking to India or Southeast Asia, the BRICS expansion demonstrates that these destinations are not insulated from the same security considerations that are driving many global companies out of China. As the US and China both push for “clean networks” of technology and supply chains that do not rely on components from the other side, geopolitical alignments, like those on display through BRICS, are therefore important stages for assessing how global shifts will continue to shape business decisions.

Book Recs

What we’re reading to better understand China

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