Media  International Exchange  2017.04.20

A New Flash Point for U.S.-China Economic War -North Korea Risk and Growing Pessimism in the U.S. Business Community over the Chinese Market-

An article published in JBpress on March 21, 2017

The United States and China are increasingly dependent on each other economically. If the two countries should start an economic war, they would both be severely damaged amid the escalation of retaliation they would impose on each other.

That would create a greater impact than the 2008 financial crisis not only on their own economies but, in the worst case, on the world economy as a whole, with the significant likelihood of a global great depression.

With such serious damage anticipated from an economic war between the two, Washington and Beijing would both fully recognize the great risk they would assume in launching a war in the economic field, and so each would strive to avoid such a situation.

This is the key point I presented last month in the February issue, where I stated that between the U.S. and Chinese economies, there seemed to be a relationship similar to mutual assured destruction (MAD), which applies between nuclear superpowers.

Visiting the United States in early March, I presented such views to several researchers of international politics. They generally agreed with me.

At the same time, they suggested some valuable viewpoints, referring as a risk they could not completely rule out, for instance, to the possibility that any serious confrontation between the United States and China on diplomatic issues, and the consequent deterioration of their bilateral relationship, might compromise their pseudo-MAD arrangement, drawing them into an economic war.

Here I would like to introduce these different viewpoints and examine them.

North Korea Risk

In the article I posted last month, I focused on the economic relationship between the United States and China. The international politics researchers I met in the United States pointed out some diplomatic issues that should be taken into consideration as they may entail risks to their economic relationship.

For the Donald Trump administration, the greatest problem at the moment in diplomatic relations with China lies in the risk of intensifying confrontation over North Korea.

It is reported that in response to North Korea's missile launches in its attempt to contain the United States, the Trump administration is exploring all possible options, including military action, to take a firm stance.

One of the main issues President Trump is expected to discuss with Xi Jinping, the President of China, at their first summit meeting, to be held in April at the earliest, is how they should deal with North Korea.

It is believed that President Trump will demand of his Chinese counterpart that China also act more sternly to its neighbor.

However, given their bilateral relationship which has already become extremely chilled, any sanctions China might impose on North Korea, with some greater level of severity, is unlikely to lead Pyongyang to lend an ear to Beijing, most people believe.

Under such circumstances, the only option China could exert as a sanction against North Korea would be the suspension of energy and food supply to the country, the ultimate hard-line measure. That would cause an economic crisis in North Korea, with a huge number of refugees expected to flood into the northeastern region of China.

That part of China is already congested with structurally-depressed industries with a great deal of overcapacity, having already suffered prolonged economic stagnation. A flood of refugees there would carry a great risk of creating a serious negative impact on the political and economic stability of China.

It is highly unlikely that Beijing would take any action that involves such a great risk to its internal affairs on behalf of the United States.

Therefore, it is believed that there is little chance that China would respond to the strong demand from the United States in a manner that could satisfy Washington. The two countries would then fall into more intensified confrontation, with the greater likelihood that the United States would take a more hard-line stance against China.

What specific measures Washington would adopt as a consequence is still unknown. If the United States takes any tougher measures that involve military operations in the South China Sea, or suggests reconsidering the "One-China" policy, their bilateral relations would quickly deteriorate.

Such a hard-line stance from the United States might stir up anti-American sentiment among the Chinese people, who might then boycott American products and/or hold anti-U.S. demonstrations, against which Washington might name China a currency manipulator and/or impose higher tariffs on Chinese imports, an escalation that might end up in an economic war, which nobody can fully rule out.

This is, however, an extremely pessimistic scenario presented by international affairs experts close to the Democrats, who you could not deny might assume the worst to emphasize faults in the foreign policy of the Trump administration.

Meanwhile, experts close to the Republicans or those who are neutral do not think the probability of such serious situations taking place is so high.

At the moment, it is believed that the China policy of the Trump administration is led by Rex Tillerson, Secretary of State, James Mattis, Secretary of Defense, Gary Cohn, Director of the National Economic Council (NEC), and Kenneth Juster, Deputy Assistant to the President for International Economic Affairs at the National Security Council (NSC). They are among the moderates in the government.

The hawks who insist on taking a hard-line against China include Steve Bannon, Chief Strategist, Peter Navarro, policy advisor to the president in charge of the National Trade Council, and Wilbur Ross, Secretary of Commerce, who seem to have exerted only limited influence on the China policy so far.

As long as the moderates lead the China policy in the administration, the collision presented in the scenario above could well be avoided.

However, what you should keep in mind is that there are some who suppose that, in addition to the risk of any change in the balance of power between leading members of the administration, the effect of President Trump's own mood swings on the policy would appear to be another risk factor.

As I have described so far, the Trump administration still leaves a great deal of uncertainty and unpredictability in its diplomatic policy toward China. If Beijing refrains from overreacting, and instead keeps cool and calm, acting prudently, the risk of the two powers colliding could be mitigated.

Risk of someone other than the governments acting as the main player

While the diplomatic issues I have described above are at the moment the major factors that may deteriorate the relationship between the United States and China, another element that may accelerate any induced aggravation is the attitude of the market participants, or ordinary people, who act as the main player in the field of economics.

For national security, the original concept of MAD assumes the governments of the two countries as the main players who should underpin the relationship. In the field of economics, however, pseudo-MAD is played primarily by the market participants, or ordinary people, who are unlikely to control themselves as well as the governments.

In a country, once strong frustration or anger at another country is shared broadly among its people as a national sentiment, the government would then have difficulty controlling them.

That is, even when the governments of two countries find their countries in a pseudo-MAD condition, they might be unable to halt the momentum that would draw them into a collision.

Specifically, once boycott campaigns against American products or anti-U.S. demonstrations start to spread around the country, Beijing would find it quite difficult to subdue them quickly. In turn, anti-China sentiment growing in the United States among workers and ordinary people would also be hard for Washington to control.

That's easy to understand when you recall how quickly people in China changed their attitude toward Japan after the issue of the Senkaku Islands came to the surface.

Lower controllability over the main players stands as one of the factors that hinder pseudo-MAD.

Impact of growing pessimism among U.S. companies on business in China

Another thing the experts pointed out is recent changes in the attitudes of U.S. companies toward investment in China.

In China, U.S. companies, such as Apple Inc., General Motors (GM), Ford Motor Company, Pfizer Inc., Procter & Gamble Co. (P&G), McDonald's and Starbucks Corporation, have so far acquired a large market share in their various sectors, earning enormous sales and profits.

Nowadays, however, as typically seen in the frustration expressed by the American Chamber of Commerce in Shanghai, dissatisfaction is growing among U.S. companies over infringements of intellectual property rights, difficulties in recovering payment, abrupt changes made by the government to its regulations, and discrimination in the treatment of Chinese and foreign companies.

For the last year or two, these problems have led more people to see the Chinese market as being less attractive than before to U.S. companies.

In addition, with the slowdown of the Chinese economy which feeds pessimism even about the future of the Chinese market, I often hear people talk about greater caution being observed in terms of investment in China. However, in fact, direct investment by U.S. companies in China has yet to decrease, and instead, has shown some growth.

Japanese companies have been faced with the same problems as those mentioned above for years, and I have not heard of anyone in Japanese companies who says that concerns about such problems have recently started to rise further.

What lies behind the recently increasing concerns among U.S. companies should be examined in more depth.

Pessimism growing among U.S. companies about business in China, and the consequent caution they have shown in investment there should change the way they perceive the economic impact they would suffer in a collision of the two countries.

Those who used to worry about serious damage, and strongly hope the two countries would avoid an escalated confrontation would not feel as desperate as before.

That is another negative factor that hinders the establishment of pseudo-MAD.

As shown above, pseudo-MAD in the field of economics is made fragile by its three inherent factors.

This should be among the key points that the United States and China both consider carefully, while hopefully making persistent efforts to avoid going to economic war.

(This article was translated from the Japanese transcript of Mr. Seguchi's column published by JBpress on March 21, 2017.)