Wanted: A Nuanced Strategy to Engage With China

In 2016, as Donald Trump was campaigning for the US election, one priority was to “start reversing” the US trade deficit with China. Two years later as president, he imposed a series of tariffs on imported Chinese goods.

“Trade wars are good, and easy to win,” he announced, in characteristic style, and by 2018, the trade offensive had escalated across other dimensions: restrictions on Chinese investments into the US, and most importantly, into a “high technology war” symbolised most dramatically by the legal cases and sanctions against the Chinese telecom company Huawei.

Finally, in the closing weeks of the Trump administration, the US announced new rules for Chinese companies to follow, failing which they would be de-listed in the stock exchanges of the US.

Taken together, these actions on trade, investment, technology and finance constitute the narrative of a growing “decoupling” between the US and Chinese economies, with its attendant effects – intended or unintended – across the globe. As the Trump era fades into history and the Biden administration settles in to tackle its aftermath, how does “decoupling” look when we examine each of its elements?

An analysis in Bloomberg describes how the trade numbers have panned out for China and the US since Trump made his promise. Briefly, the US trade deficit has increased since 2016 – both with China and with the world – whilst Chinese exports have risen. Furthermore, it is the US consumer who has suffered the brunt of the enhanced tariffs, since Chinese exporters have not lowered prices commensurately.

On the other hand, US exports have suffered through the enhanced cost of imported Chinese intermediate goods, demonstrating the wide-ranging impact and ironies of globalisation. There has been no reshoring of manufacturing to the US in any significant manner. The recent conclusion of the Regional Comprehensive Economic Partnership (RCEP) treaty, a possible China-Japan-S.Korea FTA now under negotiation, along with China’s declared interest in joining the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP), all taken together, could enhance Asia’s position (already 40% of world trade and 60% of world growth) as the global engine of the economy in this decade.

Also read: Trade War With China Can Set India’s Economy Back by Years: Former Niti Aayog Vice-Chairman

Describing the position on the investment front, James Kynge says that according to research by the Rhodium Group, US$ 1 trillion worth of Chinese equity is held by US investors at present, the highest ever so far. Chinese companies have raised US$ 19 billion in 2020 in the US market – the highest since 2014 (the Alibaba IPO happened then). Companies like Tesla, Starbucks, Apple, CISCO, Texas Instruments and many other investors see China as a good investment bet, even on a risk-adjusted basis.

The recent China-EU Comprehensive Agreement on Investment (CAI) should give further fillip to this momentum. Evidence from other sources such as foreign Chambers of Commerce in China shows that there is no significant movement of their factories or plant and machinery out of China, save the continuation of an already existing trend to relocate in less expensive locations such as Vietnam etc. for low-margin products. 75% of US companies in China intend to continue investing in that country.

Meanwhile, China continues to make itself more accessible to global finance – both as a recipient and as a provider – by a graded integration of its financial system to international norms. Former chief economic adviser Arvind Subramanian’s book Eclipse written in 2011 has some forecasts about China which seem pretty much on line even today, though he missed the force of new technology as a disruptor and standard-setter. But he does recognise that China’s rise could cause considerable unease. His suggestion in such a case is to “tether” China by reviving and strengthening the multilateral economic system, so that the collective power of the latter can restrain China within a system of rules whilst still offering it opportunities for growth.

If the decoupling narrative is losing steam on the trade, investment and finance fronts, it is in some frontier technologies (which will set or influence future standards) that its bite still remains. But here too there are a lot of complicated interconnections which make building rigid walls difficult and expensive. China has been stepping up its game on improving IP protection and is already a significant source of technological talent and innovation in several areas like green energy, mobility, AI, digital commerce etc.

In a piece for the Financial Times, Martin Wolf points out that China has huge leeway for productivity growth, and for this reason will continue to attract investment into many areas including R&D. Particularly if the carrots dangled in the China-EU CAI turn out to be true inducements, capitalism chases profits after all, so it depends on how China intertwines profit and growth for foreign companies alongside ‘socialism with Chinese characteristics’.

Biden’s recent emphasis on ‘fierce competition’ with China indicates a more traditional trajectory of rivalry, with a mix of competition and cooperation. He will tread warily, for there is a bipartisan consensus on the “China threat”; still, a graduated movement is possible. Using Trumpian language, it would be ‘easy to de-escalate the trade war’. Both parties have suffered, and the symmetrical nature of tariffs offers each side a step-by-step route to normalcy that will save face all around.

Simultaneously, the focus on technology will intensify, but here too – over time – the decoupling areas could narrow to those essential to each side for its security and dominance in key technologies. Some period of dual standards may operate with cheaper, ‘looser’ standards (whoever being the producer) being more attractive to many countries in Asia, Africa and Latin America. But the China-Europe CAI shows that European companies nevertheless see continued opportunities within China, despite Europe itself being the originator of very high-level standards such as its General Data Protection Regulation.

Also read: What Would Boycotting Chinese Goods Mean for India?

So, what does all this portend for India? There are five inferences that we might draw. First, China is too big and too globally integrated an economy to ignore, avoid or wholly substitute. Doing so will mean paying a significant price in terms of our economic growth and prosperity. Even advanced economies such as the US, European Union and Japan have realised that China is a reality to be engaged with, but in a carefully planned and strategized manner in order to secure their interests.

Second, this truism matters even more for India. The nature of the India-China economic relationship, as I have written about in detail, is such that in both trade and investment, the Chinese factor has a significant impact on key sectors of the Indian economy such as telecom, pharmaceuticals, digital and e-commerce and segments of infrastructure. It will be expensive and time-consuming to unravel or substitute these connections. Moreover, China is highly integrated into Asia, in particular with the recent conclusion of the RCEP treaty.

India has stayed away from RCEP so far and therefore risks not even being in the queue for entry into the futuristic CPTTP. As the above-quoted article shows, participation in global value chains (of which Asia constitutes the most dynamically-growing segment) is vital for India, whether for inward investment, external trade or technological development. In all these, India will encounter a substantial Chinese presence and will have to deal with it in ways that result in mutual benefit. Such a policy cannot be half-hearted, but must address the reality of Chinese power, presence and capabilities. Before outlining that strategy, we must address a preliminary objection.

It can be argued – and with some force – that a return to “business as usual” is not possible, given the aroused public sentiments in India about China and the several existing unresolved issues in the broader India-China engagement. Perceptions, after all, are very real, as Nobel Prize-winning psychologists Daniel Kahneman and Richard Thaler have demonstrated, and they certainly affect human and political behaviour. Both India and China are very conscious of their long civilisational histories. And current nationalisms in both countries have interpreted those histories so that each country today has a self-image of itself, its status and its ‘rightful place’ in the world order.

This is why India seeks a place in the UN Security Council, and both India and China bridle easily at foreign criticism. Hurt Indian feelings (along with some sectional benefits gained through protectionist mechanisms), it may be argued, will not permit a return to the status quo ante in business, since that may smack of pure economism bereft of any national sentiment.

But – and this is the fourth point – the very nature of that nationalism itself provides an answer. In today’s world, neither population size nor democratic credentials nor civilisational achievements suffice to earn one’s place in the global hierarchy. That depends only on one’s own economic and technological power. In 1979, India and China had the same GDP and per capita GDP. Forty years later in 2019, the Chinese number was five times that of India, on both measures.

Also read: Why Trump’s Trade War With China Actually Hurts Beijing Less

By 2022, the gap is likely to widen further to six times. For India to raise its status in the world, as also resolve its issues with China, this power gap must reduce significantly. That requires a long period of rapid economic growth to improve the prosperity of our population. But can that happen without India engaging fully with its principal geopolitical adversary, which will be the world’s largest economy by 2028?

This uncomfortable dilemma facing India’s leadership can be resolved by recreating the imagery of nationalism: away from a victimhood narrative arising out of Chinese (and others’) deceit, towards one of ‘making India great again through proactive economic engagement with all’. What should ensue is a nuanced strategy to engage with China. Fortunately, the current experience of disengagement and de-escalation in one sector in Ladakh, and the prospect of a similar process playing out in other areas, provides a helpful background.

There have already been some announcements regarding the approval of some Chinese investment proposals pending ever since the Galwan Valley incident. This momentum can be leveraged to generate a strategy that (i) clearly demarcates a narrow set of ‘no-go’ areas for foreign investments, (ii) brings out a clear data protection law for India, (iii) applies normal risk-management business principles to develop alternate (and economic) sources of supply for critical inputs, (iv) decides security guidelines for the adoption of new technological standards, whether from China or elsewhere, and (v) commits India towards advocating global multilateral arrangements that strengthen its economic bargaining position. As these measures come into place, economic relations with China should revert to ‘normal’, with benefits to both countries.

A similar dilemma faces China, whose journey out of poverty generated business models engineered to produce and deliver products targeted at ‘the bottom of the (income) pyramid’. This has expanded its trade and investment significantly worldwide, including into the large and growing Indian market, which is some 10-15 years behind China’s own trajectory. Economic logic would thus indicate that creating an enemy out of India is self-harming for China on many counts. But that truism would become more obvious to China as India’s economic weight increases. Remember, the best period for India-China relations in the recent past was around 2005, when India was on the economic ascent and being spoken of as ‘the next China’ with even a narrative of ‘Chindia’ taking root!

The world must beware of what the future holds: certainly, the ill tides of climate change and future pandemics loom large on the horizon. These could be catastrophic for highly populated countries like India and China.

Turning back those tides require many steps, of which self-strengthening is primary. Let us start that process by creating an open and comprehensive environment for business, from China and elsewhere (with safeguards as indicated), and then allowing those outcomes to generate positive momentum. Without exaggeration, one could say that the future prospects for the world depend on how Indian and Chinese leaders take the next steps in their relationship.

Ravi Bhoothalingam is a management consultant and an Honorary Fellow of the Institute of Chinese Studies, Delhi.