Summer Essays 5 and 6: China

So this is how I am spending my summer vacation: daily reviews of essays from the current edition of Foreign Affairs as the United States barrels towards the most consequential election in decades, with US global leadership very much on the line.? Looking forward to the conversations this may spark.

When two essays in Foreign Affairs address the same topic (China), it only makes sense to review both essays together.? Together, and independently, they illustrate why every corporate leader must pay attention to international relations.? The dividing line between economics, the role of the state in the economy, and geopolitics remains razor thin.

Addressing the China challenge will remain at the top of the policy agenda for years to come. These policy debates matter today to corporate America, particularly small and medium-sized companies.? The unit economics of many small firms run on razor thin margins and often depend on components sourced from China.? Re-tooling manufacturing systems will create costs which will impact the bottom line in the near-term. Political pressure to offset those costs with subsidies (“industrial policy”) may insulate qualifying firms but at a cost to fiscal sustainability, the fixed income markets, and over time exchange rates.?

Every firm and every tradeable security is impacted by policy responses to China's growing economic and military heft. The risks are expressed verbally, but business requires that the risks be measured quantitatively. These two essays use the language of economics and trade policy to scope the points of vulnerability and possible responses.

The Cold War may have ended decades ago, but a fundamental truth remains undisturbed by history: centrally planned economies are inefficient.? Both essays provide plenty of examples of how government decisions in Beijing have resulted in suboptimal allocations of capital.?

Today’s language eschews yesterday’s ideological terms in favor of technical economic terms, of course.? The current favorite buzzwords (“overcapacity,” “supply chain resilience/security”) identify the negative externalities and pressure points in the geopolitical debate with China in the language of economics.? Friedberg’s essay revives a less politically charged, 19th century term to describe China’s economic model (“mercantilism”) but the bottom line is the same:? the core debate avoids addressing directly the cause for overcapacity -- a centrally planned economy whose output targets are set by government officials.

The mismatch between cause and effect creates real hurdles for reaching agreement internationally.? The West’s capacity to influence outcomes may be hampered because arguments based on economics will not resonate among policymakers in Beijing.? Zongyuan’s detailed, fact- based analysis shows that Chinese domestic political stability is bolstered by (i) “embedding the party hierarchy into every economic sector”, (ii) guaranteeing high quality manufacturing jobs for the large domestic labor force, and (iii) ensuring market dominance for all strategic economic goods important to the global economy in general and the energy transition in particular.?

When the government and the private sector are so intertwined, strategic and geopolitical priorities will always trump economic reality.? Arguments focused on internal economic weaknesses (Zongyuan) or adverse economic impacts in the global economy (Friedberg) are doomed to fail.? Indeed, Friedberg notes that China’s CCP dismisses the economic arguments “as a deflationary trap of the sort that it claims the United States sprung on Japan in 1985.” At its worst, arguments about overcapacity tacitly validate economic central planning by focusing the debate on the "right" amount of capacity to be produced domestically and then exported abroad.

Neither essay contemplates the possibility that Beijing might actually celebrate the economic pressures that their exported overcapacity creates for advanced economies around the world.? ?Nor do the essays highlight the fact that diversifying away from Chinese-produced goods creates real costs on consumers and businesses, creating a set of creeping inflation pressures as supply chains re-route from China.

Instead, both authors recommend more forceful action. Both agree that a debilitating trade war should be avoided and that?the United States should be using the World Trade Organization more strategically.?

• Zongyuan argues for strategic alignment with Chinese business elites paired with initiatives to encourage China to abandon the coveted “non-market economy” status that provides Beijing with favorable trade treatment.
• Friedberg argues for the creation of a “trade defense coalition” among like-minded market economies.? Think of it as a more formal version of “friendshoring,” where sourcing strategies prioritize friends and allies, as recently championed by US Treasury Secretary Janet Yellen.? Friedberg indicates that such frameworks may not be compatible with the existing WTO framework.? However, this is not strictly true.? Side-deals among a subset of countries have always been part of the trade framework, from the GATT to today’s WTO.? They are called “plurilateral agreements” and can be crafted to be WTO-legal.

The economic and strategic challenges posed by China’s centrally planned economy will persist and will be one of the top 5 issues that advanced economies will have to address in 2025 and over the medium-term.? Their responses will impact the planning horizon for every company and market.? While Zongyuan and Friedberg focus on trade policy, the reality is that policymakers have a more robust set of tools to deploy, including regulatory policy, investment policy, and securities regulation.?For a deep dive on the trade policy issues, please see my recent paper for the Mercatus Center HERE.

Policy volatility is set to increase in 2025, driven in part by the geostrategic imperative to meet the China challenge.? It has never been more important for corporate leaders to have their finger on the pulse of the policy process.

Barbara C. Matthews is a globally recognized public policy and quantitative finance leader.? Her track record of successful innovation and leadership spans five continents in both the private and public sectors, including service as the first US Treasury Attache to the EU with the Senate-confirmed diplomatic rank of Minister-Counselor.? She has consistently been the first executive to forge new paths that add lasting value with durable, high-performing teams. ?She is currently the Founder and CEO of BCMstrategy, Inc., a company that delivers ML/AI training data and predictive analytics that provide ground-breaking transparency and metrics about government policy globally.? The company uses award-winning, patented technology to measure public policy risks and anticipate related reaction functions. Ms. Matthews is the author of the patent.