Caveat Emptor

At an event hosted by the School of Foreign Service (SFS) Asian Studies Program on November 1, Fred Neumann, co-head of Asian economic research and managing director of global research at HSBC in Hong Kong, discussed the U.S.-China trade war and its potential effects on the Chinese economy. The discussion was moderated by SFS Professor Evan Medeiros.

Neumann began the presentation by contextualizing the U.S.-China trade relationship. He pointed out that U.S. exports are not as important to the Chinese economy as is claimed by many. On the flip side, Neumann also noted that exports as a percentage of Chinese GDP are falling, which points to a burgeoning consumer class domestically. He specifically referred to the Chinese economy as becoming increasingly “close,” meaning that domestic production is being matched by domestic consumption.

Neumann’s research predicts that, as a result of the 25 percent tariff imposed on $250 billion worth of Chinese goods by the Trump administration, Chinese annual GDP growth would fall approximately 0.9 percent. He further predicts that, if the Trump administration continues with mooted plans to impose a tariff on all Chinese exports to the U.S., the maximum effect on Chinese GDP growth would be a 1.8 percent decline (i.e. 6.9 percent growth would become 5.1 percent growth).

Despite being an economic analyst, Neumann underscored the importance of calculating political risk when giving advice to investors. In regard to President Donald Trump, Neumann said researchers have been focusing on the likelihood of the trade war continuing if the Democrats take back the House and Senate in tomorrow’s election.

In the case of President Xi Jinping and the Chinese Communist Party (CCP) leadership, Neumann believes that there is a low tolerance for economic strife and stagnation. As a result, he predicts that the Xi administration may promote further investment in construction and real estate, which have traditionally bolstered the Chinese economy, in an effort to offset the effects of increased U.S. tariffs. However, this may prove difficult for Xi, because under his leadership, crackdowns on corruption and implementation of reforms have proven paramount to the perpetuation of his power. The reforms have specifically targeted the shadow banking system at the municipal level, where unregulated lending practices have resulted in high levels of debt, poorly-conceived construction projects, and local corruption. Also, the assumption by local governments and state-owned enterprises (SOEs) that the Chinese national government would bail them out has created a system plagued by moral hazard. However, Neumann feels that the CCP’s economic reforms could be halted as a result of the tariffs.

Nevertheless, Neumann felt confident that Chinese leadership could manage the short-term disequilibrium caused by the tariffs, especially when the Chinese high-tech manufacturing sector is roaring. What concerned him more, however, was the long-term sustainability of the Chinese economy. He pointed to how, under Xi’s leadership, the Chinese government has been increasingly catering to the interests of SOEs and clamping down on private investment. At a symbolic level, given that 2018 is the 40-year anniversary of the beginning of Deng Xiaoping’s liberalization reforms, Neumann felt that it should strongly concern potential investors that Xi is increasingly touting SOEs. He pointed to the inefficient allocation of capital under SOEs as a potential contributor to long-term problems with the Chinese financial system. Furthermore, according to Neumann, decreasing productivity within the Chinese economy could dampen future GDP growth.

Finally, Neumann pointed to the potential for the Chinese economy to post an annual current account deficit for the first time since 1993. Given that domestic consumption is becoming a larger portion of GDP, fewer goods are being exported abroad, which has been a large component of the longtime Chinese current account surplus. Moreover, increases in borrowing domestically have driven down the surplus in savings, resulting in a lower capital account deficit which balances out the current account surplus in the balance of payments model. Stay tuned for continuing coverage from Compass Money on the U.S.-China trade war and its economic consequences.

(Anti)trust No One

In an October 11 Open Markets Institute event at the Marriott Metro Center, Senators Shelley Moore Capito (R-WV), Mark Warner (D-VA), and Cory Booker (D-NJ) and Securities and Exchange Commissioner Rob Jackson grappled with the issue of antitrust law in a new and dynamic business landscape defined by high-tech firms, disruptive innovation, and globalization.

Capito focused her remarks on how the brain drain is affecting rural America, including her home state of West Virginia. Citing the state’s poor performance on the Kauffman Foundation’s rating of business startup activity, the senator argued that new policy tools were needed to foster innovative business ideas and create the sort of jobs that will draw back West Virginia’s youth. Capito—and each of the other senators that spoke—praised the Opportunity Zone (OZ) legislation included in the 2017 tax code overhaul. The OZs provide tax incentives for new business development in America’s rural areas and second- and third-tier cities.

Several speakers cited the statistic that approximately 85 percent of venture capital (VC) investment goes to startups in California, New York, and Massachusetts. Responding to this, Capito told investors not to “give up on rural America,” praising her state’s hard-working culture, strong institutions of higher education, and low cost of living.

Warner, a telecoms executive before he became governor of Virginia and then senator, took aim at big Silicon Valley tech firms like Facebook, Google, and Twitter. The senator argued that recent statements from technology company CEOs on issues like bias, radicalization, and the spread of misinformation show an industry that is falling out of touch with reality. He praised the work of the German Marshall Fund, which has set up a program to research the extent to which social media-based misinformation is shaping American politics.

Warner noted that eight of the top ten apps in the Apple App Store were developed by Google and Facebook and called this a troubling sign of brewing oligopoly. The senator urged the Federal Trade Commission (FTC), which is partly responsible for antitrust enforcement, to investigate these big tech platforms to ensure that a healthy, competitive market can exist that allows for new entrants and in which no tech firm becomes too-big-to-fail.

Booker, a fierce opponent of the consumer welfare standard of antitrust enforcement used by the FTC and Department of Justice, called for new research to assess the standard’s shortcomings and propose enforcement solutions. The consumer welfare standard favored by America’s antitrust enforcement officials is based on the idea that the sole criterion for approval when evaluating a proposed merger is whether that merger will improve outcomes for consumers—either by lowering prices or improving quality, convenience, availability, or variety. European competition regulators, meanwhile, have historically favored the market concentration model of antitrust, which is primarily concerned with ensuring all entrants have a fair shot at competing in the market. Booker argued for a middle-road approach to balance the welfare of consumers with other stakeholders like employees and suppliers.

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Jackson tended to agree with Booker’s assessment of antitrust policy, arguing that the Securities and Exchange Commission (SEC) must refocus on ensuring competition in the markets it oversees. He called for the creation of an SEC Office of Antitrust Economics and cited concentration in the investment banking sector as the prime factor in stifling price competition for initial public offerings (IPOs) services. Jackson’s research shows that the average price of these services have stayed constant since the 1990s despite massive improvements in technology and efficiency, which should have resulted in fierce price competition and a greatly reduced IPO fee. However, the commissioner claimed that a corresponding fall in the number of investment banks offering these services prevented price competition.

The OMI event touched on many different facets of the economy, but the driving force behind all the debate was that healthy and competitive markets have been the bedrock of American economic advancement since the country’s independence and the fall of Britain’s tea monopoly. However, all the speakers expressed worry that if current economic trends are not reversed, the American economy is on its way toward unhealthy markets that stunt competition, raise prices, lower product quality, and drive inequality by ensuring that established players make a healthy return and new entrants are choked in their infancy. As Jackson said, “Wall Street needs to be put back in its place.”

A Growing Waistline

This September, China celebrated five years since the unveiling of its ambitious Belt and Road Initiative (一带一路). Encompassing special industrial zones in Ethiopia, railways in Britain, and many more projects, the initiative aims to bring the world closer together, literally and figuratively bridging continents across land and sea.

Formerly known as One Belt One Road, the Belt and Road Initiative (BRI) has often been cloaked in vague, amorphous language. It is simultaneously a national vision, global development project, and foreign policy guide. In September, Chinese Foreign Minister Wang Yi described it as the “largest platform for international cooperation,” while President Xi Jinping called it a path to peace, prosperity, and innovation. But to understand the BRI in its evolution, it is necessary to first go back to its creation.

The BRI was first established in September 2013 when Xi introduced the concept of a a new, overland Silk Road Economic Belt in Kazakhstan. In Indonesia the following month, he proposed the construction of a 21st century Maritime Silk Road to connect the region. Just like that, the two components to the BRI were born.

In the five years that followed, the BRI has grown to “biblical” proportions; according to Forbes, the project is predicted to affect 60 percent of the world’s population. It includes 76 participating countries across Asia, Africa, and Europe, and a half dozen more in Latin America have signed Belt and Road Cooperation Agreements with China. A Center for Strategic and International Studies report finds that the $1 trillion (at least) project includes Chinese investment in both hard infrastructure—roads, ports, and railways—and soft infrastructure like trade deals and transportation agreements. It has also come to encompass tourism and people-to-people cultural exchange.

While the overland “belt” reaches across Eurasia and the maritime “road” extends from Asia to Europe via India and East Africa, the initiative also includes “the Arctic, cyberspace, and outer space.” All in all, it promises to fill long-standing infrastructure gaps around the world, boost global development, and promote trade, economic growth, and employment in participating countries.

Growing consistently in ambition and scope, the BRI has been deeply institutionalized in the Chinese political system; it is overseen by a permanent working group of the State Council and was formally included in the constitution in 2017. The Asian Infrastructure Investment Bank—established in 2015 and often referred to as China’s own World Bank—is tasked with lending to fund BRI projects, while the Silk Road Fund, established in 2014, is set to invest in businesses that can contribute to the BRI.

Since Xi abolished presidential term limits in fall 2017, effectively ensuring his position for life, the BRI has become the hallmark of his legacy. Despite significant variation in projects from country to country, it has evolved to become the catch-all for Xi’s foreign policy. The BRI is used to frame ongoing and future infrastructure projects, as well as those that predate the birth of the vision itself. BRI represents a clear departure from China’s foreign policy under Deng Xiaoping, who led China from 1978 to 1989. Although Deng is remembered for opening up the economic giant’s markets and catalyzing three decades of stunning growth, he argued that China should “hide [its] capabilities and bide [its] time.”

The BRI’s dramatic expansion shows just how far Xi has strayed from Deng’s advice. Even Latin American countries, far removed from the historic Silk Road but eager to accept Chinese cash, welcomed Xi’s assertion at the Belt and Road Forum in 2017 that the BRI is “open to all countries.” According to the Inter-American Dialogue, many “proposed infrastructure projects...already resemble BRI initiatives,” from the trans-Pacific fiber-optic cable in Chile to the Bi-Oceanic Railway in Peru and Brazil.

This expansion, however, has often come at a price. The Chinese-funded Standard Gauge Railway in Kenya revitalized a colonial-era railroad but has recently sparked controversy over alleged discriminatory labor practices at the China Roads and Bridges Corporation. In Sri Lanka, the government’s failure to repay Chinese creditors of the new Hambantota port resulted in the government agreeing to hand it over to China for 99 years, intensifying global concern over Chinese “debt traps.” This August, Malaysian Prime Minister Mahathir Mohamad shelved $22 billion of Chinese-backed projects, citing concerns over a “a new version of colonialism.”

These controversies highlight the uncertainty surrounding long-term Chinese intentions. From a practical standpoint, the BRI is a way for China to overcome barriers to greater and freer trade and to address its excess industrial capacity.

From a political standpoint, however, and much more concerning to the United States, the BRI is a tool with which China can extend its influence. Emphasis in Chinese government statements on “policy coordination” and the internationalization of the renminbi (人民币), China’s currency, reveals that China intends to accumulate both financial and political power. Its willingness to lend to historically risky and underdeveloped regions of the world may represent its attempt to shape the interests of developing countries and align them with Chinese policy.

The debate between the positive externalities of regional and global connectivity and the specter of a new Chinese-run world economic order has captured the attention of journalists and scholars alike. Regardless whether China is driven by one goal or the other, the future impact of the BRI remains uncertain.

Experts at CSIS estimate that costs will range from $1 trillion to $8 trillion, but a recent slowdown in the Chinese economy and rising domestic concerns over risky state investments may slow Chinese ambitions. Furthermore, the BRI’s impact on particular regions and countries will depend heavily on the specific details of each project and agreement. Though many agree that the project’s scale earns it the title of “project of the century,” the long-term success of the BRI and the effects of its many social, economic, and environmental consequences will only become clear with time.

Writing contributed by Louisa Christen and Jackson Gillette.

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