Crouching Dragon
Last December, I wrote a piece in these pages entitled China: Not Rising But Stalling. My sense was that the re-opening of China after two years of a Zero-Covid policy was not necessarily a resumption of service as usual. And over the course of this year, the view that China is not inevitably on course to overtake the USA has gained traction.
In his book Unrivalled: Why America Will Remain the World’s Sole Superpower (2018), Michael Beckley challenged those who assume that China will inevitably surpass the United States in both economic and then military terms in the course of the next decade or so. Michael Beckley is a fellow in the International Security Program at Harvard Kennedy School’s Belfer Center. His perspective is based on historical and economic analysis.
When the founder of the People’s Republic of China, Mao Zedong died 47 years ago, China was still a poor and backward country with most of its colossal population living on subsistence wages in the countryside. Today, China has the second largest economy in the world after the USA. According to the IMF World Economic Outlook Database published in April, the USA has an economy with $26.854 trillion of output while China’s figure is $19.373 trillion. So, China’s economy is currently about 72 percent as large as America’s.
But China, as we know, while roughly the same geographical size, is much more populous than the USA. China has a population of just over 1.4 billion (recently exceeded by India), while the USA has a population of about 335 million. Therefore, on a GDP-per-capita basis Chinese people are still poorer than their American counterparts. In fact, Americans enjoy GDP of $80,035 per head – the eighth highest in the world, according to the IMF – while Chinese people manage on $23,382 of GDP each – 73rd in the global ranking.
That level of income means that now, technically, China is a “high income” or “developed” country. When Mao died China was a low income – in fact a desperately poor – country. So, the first thing to note is that China’s industrial, economic and technological progress in less than half a century has been remarkable. Indeed, the word “remarkable” does not do the achievement justice. China’s rise out of poverty to prosperity is without precedent, and a lot of the confidence of the Chinese Communist Party – and the reason why probably most Chinese still owe their fealty to it – is that the country has been totally transformed in a historically short space of time.
That was possible because China was able to sustain extraordinary rates of economic growth – often over 10 percent per annum – over successive decades. China became a hugely important manufacturing hub and, after the country’s accession to the World Trade Organisation in December 2001 – became the favoured location for the outsourcing of manufacturing activity by western corporations which could profit from its light-touch regulation, relatively low labour costs and low corporate taxation. There are literally thousands of well-established western companies which either entirely moved production to China or outsourced part of their manufacturing process there.
But the exceptional rapidity with which China transformed itself should give us pause. The extraordinary tailwinds that propelled China upwards have now subsided. As China grew richer, so labour wages rose, thus eroding the differential in wage rates with more developed countries. China’s economic growth rate was already on a downward trend even before the epidemic of Covid-19 first manifested itself in the provincial capital of Wuhan at the end of 2019. China’s draconian Zero-Covid policy, under which millions of people were confined to their homes for over two years, had a negative impact on economic growth. And since President Xi Jinping desisted from his Zero-Covid stranglehold, China’s economy has struggled to rebound.
Cracks in China’s economy are now emerging. There is mounting evidence that the country’s massive infrastructure programme, much of which has been financed by debt, is of variable economic benefit. There are entire ‘ghost cities’ with high-rise apartment blocks – and no people.
Moreover, under President Xi, who acceded to the office of head of state in March 2013, and who has signalled no intention of relinquishing office in the medium-term, the Chinese state apparatus has adopted a heavy-handed approach to China’s burgeoning tech sector and those who own and invest in it.
Many young entrepreneurs have left China at a time when the USA makes such people welcome. The Financial Times reported last week that Microsoft is seeking visas to move some of its top experts in AI from Beijing to its research institute in Vancouver, Canada. Jack Ma, the founder of Alibaba Group, has reportedly returned from exile in Japan but is still officially teaching at the University of Tokyo. He never discusses politics, and no longer proffers his personal opinions on economic policy, no doubt wisely.
Further, with the USA’s more robust approach towards the deployment of Chinese technology in western countries (a case-in-point is Huawei) and now the restriction on the export of microprocessors to China, the outlook for China’s tech sector looks more uncertain. But there is another reason why China analysts foresee that Chinese growth may slow even more.
China’s population peaked last year and is now in fairly rapid decline. There will be 800,000 fewer Chinese citizens by the end of this year. This is due to an ageing population and plummeting birth rates. By 2035, China will have lost about 70 million working-age adults and added 130 million retirees. The country’s total population in 2100 will be 766 million, according to the UN; but it could fall to as low as 488 million, according to other estimates. If the latter forecast is correct then the USA might well be more populous than China by the end of the century, at which point one in three Chinese citizens will be over the age of 65.
President Xi Jinping’s initiative to end China’s one-child and then two-child policies have failed to reverse declining birth rates, seemingly because many young people don’t want to have children. As they have become more prosperous and middle class, so people prioritise careers over starting families. This is not unique to China – Japan is already experiencing this demographic deflation.
And demographic deflation means price deflation. The most dangerous environment for debtors is when asset prices fall but the debt used to acquire them must still be repaid at face value.
Geopolitical Encirclement
China has hugely extended its global reach as it has grown richer since Mao’s death. Many countries in east Asia and in Africa have become client states which supply China with raw materials and agricultural products in return for soft loans. Countries such as Sri Lanka have become de facto dependencies.
And yet it is not all going China’s way. As China has become more aggressive under President Xi with territorial incursion in the South China Sea and a habitually belligerent attitude towards Taiwan, so powerful neighbours have begun to coalesce. Japan and South Korea are ramping up their defence spending. Taiwan is growing more defiant. The Quad (USA, Australia, Japan and India) and AUKUS (Australia, UK, USA and possibly Canada soon) are overtly anti-Chinese coalitions. Relations with India have worsened with China’s aggressive stance on the Himalayan border with Arunachal Pradesh. About 10 countries have recently withdrawn from China’s flagship Belt and Road Initiative.
China’s only allies are not a good-looking bunch. Russia is on the back foot as its invasion of Ukraine unravels. Pakistan is entrenched in a permanent omni-crisis – significantly, Bangladesh which once called itself East Pakistan, has overtaken the Islamic Republic on nearly all economic and social metrics. And North Korea? Let’s just say it is a basket case with vicious intentions. Eritrea? Forget it. China’s path to global mastery will be a lonely one. And the economic consequences of de-globalisation aka re-shoring will only damage China’s geopolitical clout.
The Case For China’s Continued Rise
On the other hand, no economist expected that China would persist with double-digit growth indefinitely. Families can go from dirt poor to modestly prosperous quickly; but it takes a few generations for them to attain the highest social status. The truth is that China will most likely continue to grow faster than the USA over the next decade and will therefore continue to close the gap.
China has a vibrant technological base and is investing heavily in AI, quantum computing, space technology, robotics and life sciences. (I’ll have something to say about that virology laboratory in Wuhan shortly). Arguably, it is ahead of the USA in EV battery technology.
In terms of China’s demographic challenge, it’s not all bad news. China, like many nations which were developing ones until recently, has a high degree of what I call demographic slack.
I mean by that firstly that the traditional retirement ages reflect those of a largely agricultural economy. Men retire in China at 60 and women at 50-55 – just as in Russia until recently. As longevity and healthspans increase, so China will raise the retirement age as in western nations, thus bringing millions more people back into the workforce. Secondly, a huge number of Chinese people still live in the country and work on the land – something like a quarter of the population. In the US, the figure is about 2-3 percent. China has a huge untapped reserve of labour that will enter the industrial labour force as farming is modernised and mechanised, even if its overall population declines. France managed to sustain double-digit rates of economic growth in the 1950s and 60s as its rural population moved to the towns and cities.
Demographic slack also arises where in traditional societies gender roles confine women to the home and discourage them from doing “men’s work”. As China’s rural population becomes urbanised, so the female participation rate will increase. Also, educational standards appear to be improving for both men and women; thus, China can expect further improvements in productivity.
China has invested heavily in building up a huge diplomatic corps – some of whom are sophisticated and multi-lingual. They cultivate opinion leaders in developing countries and project a united message that the best way to prosper is to work with China. As I say, China has few friends but many clients.
The Chinese economy will continue to grow over the next decade, if at a more leisurely pace than hitherto, though still faster than the USA. In the medium term, however, their growth rates will converge such that the USA will remain the sole superpower and global hegemon.
Hidden Tiger: The USA Powers Away…
Looking from this side of the pond, what is most striking about America is what is wrong with it. The federal government is caught in a worsening debt trap – as I discussed last week. There is a vicious culture war underway which is de-stabilising the middle class, and which entails restrictions on US’s great tradition of tolerance of free speech. Stating the truth is often designated hate-speech. Many young Americans are addicted to TikTok. There is an epidemic of fentanyl addiction, much of which is allegedly trafficked across the border from Mexico. Nominally a pain killer, it is many times more toxic than heroin.
Some US cities are becoming hell holes – a recent article in the Financial Times Weekend magazine painted an implacably ugly picture of San Francisco. The FT thinks the ‘City of Love’ is in a “doom loop”. Conspiracy theories abound, amplified by social media. Anglo-Jewish commentators like Melanie Philips claim that anti-Semitism is on the rise in the Land of the Free. In a country with the best universities in the world and possibly the best educated elite, the 2024 presidential election is likely to be a contest between a confused octogenarian and an obnoxious 78-year old who is the subject of criminal charges.
The homicide rate is off-the-charts by European standards – even if the murder rate in New York is running at about one fifth of what it was in 1990. Millions of Americans feel compelled to stash guns at home to protect themselves. The income and wealth gaps are widening. Well-off, well-educated Americans are thriving; but there are millions of semi-literate Americans living in poverty.
A number of critically strategic countries such as Saudi Arabia are now pivoting towards China and are moving tentatively towards de-dollarisation. The fact that, until now, the US Dollar has been the world’s favoured reserve currency and the currency in which most major commodities, including crude oil, were traded, has given a massive competitive advantage to the United States. That could now change. No wonder there is a narrative in the liberal-inclined US and European mainstream media about American decline.
Yet for all that, on the economic front, the USA continues to outperform the UK and much of Europe on almost every metric. In the first quarter of this year growth was running at 1.3 percent. Unemployment is low. Business formation continues apace – despite the increase in interest rates. And inflation in the US is down to just over four percent as compared to over eight percent in the UK and six percent in the eurozone. The US equity indices continue to generate stellar returns for investors. The London stock market is losing listings to New York at a worrying rate.
The dynamism of the US economy is likely to be perpetuated by the country’s unrivalled stable of leading corporations. Simply put, US companies dominate most industries globally. In particular, US tech companies are not only global monopolies but are also driving lifestyle changes across the globe. Companies like Apple and Meta have changed the way we live. True, China has cultivated something similar – Alibaba and TikTok have global reach. But there is no prospect that the digital dominance of the USA will be challenged by China, India or Europe in the foreseeable future. American companies spend more on R&D and own more patents than their European or Chinese counterparts.
The sudden explosion of AI into our lives in the form of Bard and ChatGPT arises from the titanic rivalry between Google and Microsoft – two of the most consequential corporations in the history of capitalism. China is trying to catch up; but so far America is way ahead, albeit with the UK having pockets of unrivalled expertise.
Perhaps most importantly of all, the USA enjoys broad and deep capital markets with the result that brilliant business ideas can almost always secure adequate finance. About half of all the venture capital in the world is invested in US start-ups every year.
Again, America is dominant in aerospace and space technology. If it was an American who first trod on the surface of the Moon, an American is likely to be to be the first man or woman on Mars – possibly as soon as the mid-2030s. NASA, a US federal agency, orchestrated the Apollo moonshot programme in the 1960s and 70s; but it will most probably be US private corporations such as SpaceX (backed by Elon Musk) and Blue Origin (Jeff Bezos) which will roll out the next phase of Moon exploration and which will conquer Mars.
The US remains far and away the overarching military superpower. It is the only country that can send soldiers, sailors, and military hardware to every corner of the world at short notice. China doesn’t even come close. America’s military budget this year will be $768 billion compared with China’s $270 billion.
According to the geopolitical analyst Ian Bremmer, America’s role in the global security order today is more essential – and more dominant – than it was a decade ago. China is expanding its military and could become a regional hegemon in the Indo-Pacific region, hence the geopolitical containment described above. Russia has extensive military assets, not least more nuclear warheads than anyone else, but it is likely to emerge from its war against Ukraine weaker, having already lost as many as 200,000 troops and huge quantities of materiel.
In the 1980s, American sceptics foresaw that the USA would fall behind the then rising power, Japan. Yet, as we know, the Japanese bubble burst in the early 90s. The Nikkei-225 Index has never regained its all-time high achieved in December 1989. The US still accounts for about one quarter of global GDP – down from nearly half at the end of World War II. But the US has been outpacing the other democratic free-market economies for decades. In 1990, the USA accounted to 40 percent of the nominal GDP of the G-7 economies. Today, it accounts for 58 percent. That is partly explained by demographics. As my friend Swen Lorenz (late of this parish) points out in a recent must-read piece in Undervalued Shares, the US working-age population has risen by 38 percent since 1990. In the EU, the figure is just nine percent.
The US stock markets account for about 60 percent of global stock market capitalisation. Of the roughly 100,000 listed entities across the globe, around half are domiciled in the US, about one quarter in Europe and a quarter in Asia. Investors cannot manage an international equity portfolio without exposure to the USA.
The USA is hugely blessed by nature. Its river system enables goods to be transported cheaply by barge. It has long coastlines on the Atlantic and Pacific oceans which are ice-free all year round. Further, The USA has the largest area of prime farmland of any country and is essentially self-sufficient in food. Canada, Russia and China also have huge expanses of land but much of theirs cannot sustain agriculture.
The country has amongst the largest oil and gas reserves in the world – and the oil sector is not stymied by a chattering class intent on shutting it down completely as in the increasingly dystopian UK. Its consumer market of 330 million people who all speak the same language (OK true, quite a few Americans have Spanish as their first language), and who have considerable spending power, is unrivalled.
Outlook
Despite all the talk about a new Cold War with China, the US and Chinese economies remain in an intimate embrace. Bilateral trade between the two powers continues to reach new highs. True, before World War I, the received wisdom was that the great European imperial powers would not go to war because they were too deeply entangled by trade. Yet, in August 1914, they did.
From a strategic point of view, China will not risk war with the USA until it has a reasonable chance of winning it. That calculation can only be made after it has overtaken America economically, and then militarily – which, if Michael Beckley is correct, as I believe he is – is not going to happen.
There is ample possibility that one side or the other will make a key strategic mistake, perhaps instigated not because of skilful poker but by a joker in the pack such as a North Korean thinking it can attack Japan.
On the other hand, the balance of probability still favours a continued Pax America for the foreseeable future.