Hoping for the best is no longer an option; we need instead to be preparing for the worst.
Back in the day, the hope was that China, with its turbo-charged economic growth, would eventually become more like us – a kind of giant version of Singapore that gladly accepts the Western designed rules-based order governing international trade and cooperation that grew out of the ashes of the Second World War.
Politicians in Britain and beyond spoke of a new “golden age” of economic integration with China, greedily eying the supposed opportunities of its fast-growing markets.
These hopes have been dashed by Beijing’s tacit support for Putin’s invasion of Ukraine, its repudiation of the “one country, two systems” settlement in Hong Kong, its disregard for the principles of fair trade, its abuse of human rights, its refusal to cooperate over the origins of Covid, and its increasingly bellicose rhetoric, matched by ever more threatening behaviour, over Taiwan.
Far from wanting to grow more like us, China today claims an innately superior, alternative form of governance – free from the short-termist compromises of electoral democracy – which it does not intend to change and aims to spread around the world. Its approach to the West is confrontational, rather than cooperative.
Exactly who is to blame for this deterioration is hotly disputed, and no doubt the West is partly culpable. What seems unarguable, however, is that we’ve passed the point of no return. Companies and governments are responding accordingly by re-engineering supply chains and rethinking globalisation.
Conventional economic wisdom is that this is a retrogressive step, if also an inevitable one as the emerging superpower of China increasingly faces off with the US incumbent.
But is it really such a disaster? Globalisation has brought major rewards to China and many other developing economies; beyond lower consumer prices – which are admittedly not to be sneezed at – its benefits to the West look much more questionable.
As we have learnt to our cost with Putin’s invasion of Ukraine, it has also endangered our security, in that economic integration with potentially hostile regimes makes it more difficult to take a principled stand when required.
At this stage, the idea of “deglobalisation” – or to use the jargon, “geoeconomic fragmentation” of world trade and financial flows into competing blocs – is more a case of imagination than reality. Both in Europe and the US, trade with China last year surged to record levels.
All three are still highly dependent on each other, which is one reason why an imminent invasion by China of Taiwan seems unlikely. The economic consequences would be as devastating to China as it would be to the West. Such considerations didn’t stop Putin, but it must be assumed that President Xi Jinping is more pragmatically minded.
The direction of travel is nevertheless undeniable. Already, foreign direct investment flows are increasingly concentrated among countries that are geopolitically aligned. The US Treasury Secretary, Janet Yellen, speaks of “friendshoring” of supply chains to trusted countries.
In Britain, the Chancellor, Jeremy Hunt, is similarly focused on reducing the country’s economic dependence on China in strategically important industries – derisking the economy by diversifying supply chains, rather than outright decoupling.
In so doing, G7 nations have belatedly begun reaching out to the “global south”, where decades of Western neglect have allowed China to extend and consolidate its influence.
In large parts of the world, Putin’s war is regarded as a European affair of little or no interest to their own countries, except insofar as Western sanctions have harmed them by putting a rocket under global food prices.
Such is the degree of resentment that, as strongly advocated by the UK, a new package of IMF assistance to Ukraine was last week balanced by similar aid to low income countries and another big push on debt relief. Finally, something is being done to counter China’s growing monopoly of the global south.
All the same, it’s a tricky process. Today’s friend can rapidly become tomorrow’s enemy. All too frequently, moreover, apparently trusted nations with similar values turn out not to be so friendly after all.
The reshoring intent of a number of US industrial policy initiatives, including the Creating Helpful Incentives to Produce Semiconductors, the Science Act, and the Inflation Reduction Act, and the weakening of state aid rules in the EU so as to encourage an overtly “Made in Europe” approach, are all essentially protectionist measures which are not at all helpful to Britain’s own attempts to rebuild its own industries.
China, too, aims to replace imported technology with local alternatives, so as to reduce dependence on geopolitical rivals.
All these developments are regarded with horror by the International Monetary Fund, whose globalising, free trade principles look ever more out of touch with the geopolitics of today’s world. “Change through trade” as applied to China self-evidently hasn’t worked.
At the IMF’s spring meeting last week, the fund’s managing director, Kristalina Georgieva, said that as a Bulgarian she had experienced the Cold War first hand, together with its impact in cutting off talented people from the world economy, and didn’t want to see that repeated.
She warned strongly of the dangers as nations ramped up efforts to make themselves more resilient and their supply chains more secure.
Estimates of the cost of fragmentation vary widely. The longer-term impact on trade alone could range from 0.2pc of global output in a limited fragmentation scenario to almost 7pc in a severe scenario, according to the IMF, or roughly equivalent to the combined annual output of Germany and Japan.
If technological decoupling and restrictions on cross border capital flows are added to the mix, some countries could see losses of up to 12pc of GDP.
So much for the modelling. Believe it if you will; yet it needn’t necessarily be the case if fragmentation is pursued in an orderly and constructive way. There will undoubtedly be inflationary consequences, in that some of the key benefits of unfettered free trade, in terms of specialisation, competition and efficiency, might be lost.
Yet once Chinese mercantilism has been curbed, these downsides could be more than made up for by enhanced onshoring of investment and therefore economic growth.
It is striking how much Western growth in output and productivity has slowed since the fall of the Berlin Wall in 1989, marking the start of the era of unrestrained globalisation. This was meant to be the final triumph of democratic capitalism, the end of history and all that. Yet there doesn’t seem to have been much in the way of an economic dividend.
The subsequent malaise in many Western democracies cannot of course be wholly attributed to globalisation; there are many factors at work here.
But globalisation has played some part in nearly all of them, including the financial crisis, whose origins lie in no small measure in political pressure to compensate for lacklustre income growth with expanded credit.
The fact is that we have nothing to fear from geo-economic fragmentation, provided it is done in a considered way for mutual benefit among friendly nations. Done well, it might even presage an economic rebirth, a new era of Western industrial advancement, after the dispiriting declinism of recent decades.
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