China is Destined to Fall Behind

Whatever happens with my proposal that the West launch Cold War II, the next three decades will be far less friendly to the Chinese economy than the past three decades have been. There are three reasons for this.

First, there is what we might call “the law of large economies.” It’s relatively easy for a small economy to grow rapidly—scores of countries have achieved it in the past, including that former emerging market called the USA. I have on many occasions pointed out that the Soviet Union grew from an almost medieval, serf-based economy to the second largest economy in the world in barely three decades.

But growing a very large economy at the same rate is, essentially, impossible. Trees don’t grow to the sky, as the USSR, Japan and many other nations have learned. China will learn this lesson, too. Indeed, most formerly poor countries never escape the “middle income trap” (Brazil, South Africa) once their labor costs become uncompetitive.

A large, mature economy that is well-managed (e.g., the U.S.) might grow at 3 percent per annum. A large, mature economy that is poorly managed might grow at 1-2 percent per annum (Western Europe, Japan). A large, mature economy that is extremely poorly managed (China) might shrink at 1-2 percent per annum almost indefinitely—at least until the populace has had enough.

The second reason why China’s future will be less rosy than its recent past has to do with this very economic mismanagement. As I mentioned earlier in this series, the Chinese Communist Party is so desperate to keep economic growth strong that it has continued, far beyond any sane level, to inject government capital into its economy. That has created an investment- and debt-fueled bubble that will inevitably burst, making Japan’s three decades of economic malaise look tame by comparison.

Finally, China’s future will be far less positive than its past because that past was fueled by a vast increase in global trade, and the age of expanding globalism is now behind us.

I pointed out last week that globalism was established, funded, and secured by the United States. But the U.S. is no longer the “unipolar” power in the world and the U.S. isn’t the main beneficiary of globalism. China has been the main beneficiary and, thanks to the U.S., is now the second half of a two-bloc world. In short, the U.S. has, for 30 years, mindlessly funded its own demise.

But those days are over. Global trade won’t come to a halt, of course, but it won’t grow much, either. What will grow are (a) regional—not global—trading blocs and (b) countries that are more self-reliant and less dependent on exports for economic growth.

Over the next three decades or so the world economy will be dominated by three trading blocs. The largest and, by far, most competitive, will be the North American trade zone. The U.S. recently concluded new trade treaties with Canada and Mexico that establish a trading bloc of nearly a half billion consumers (almost identical to the population of the EU’s 19 members, post Brexit) and with annual GDP of $22 trillion.

And consider that, depending on what happens with Brexit, it isn’t inconceivable that the UK could join the North America trade zone (renamed the Atlantic trade zone), adding 66 million people and almost $3 trillion in GDP.

The EU will represent the second largest trading bloc—460 million consumers and $18 trillion of GDP—but it is an inefficient and rickety alliance. The fundamental mistake the Europeans made was to accept a lousy compromise structure in a futile attempt to compete head-to-head with the U.S.

A “United States of Europe” wasn’t possible—not a single European nation was willing to relinquish its sovereignty—so, instead, a weak pan-European government was superimposed on the 19 underlying nations. To make matters worse, a common currency (the euro) was established, which vastly magnified competitive differences among the member nations.

In an economic world dominated by regional trading blocs, China will be mostly left out in the cold. Seeing the handwriting on the wall, China is pushing Asia-centric trading alliances like the Regional Comprehensive Economic Partnership (RCEP). Viewed with rose-colored glasses, RCEP looks terrific: it covers 50 percent of the world’s population and 32 percent of global GDP.

But the reality is far different. RCEP participants are mostly jealous rivals (India-China) or historic enemies (Vietnam-China) or important U.S. allies (Japan, South Korean, Australia). RCEP will reduce a few tariffs, but it will never be a true trading bloc. No one trusts China enough to join such an alliance.

Thus, China will have a “bloc” consisting of its own 1.2 billion consumers (and that population is in decline) and a GDP of $12 trillion, far behind the EU and barely more than half that of the North American trading bloc.

China is well aware of what is happening to it, and it has responded in two main ways. First, Xi Jinping has tried to present himself as the “new face of globalism,” replacing the U.S. This went over well at Davos, but the rest of the world found it laughable.

Second, and more important, China has staked its future on the Belt and Road Initiative, a scheme that has actually been written into the Chinese Constitution. Belt and Road is a vast effort to replace the U.S.-dominated global trading system with one dominated by China.

This isn’t a project the U.S. should take lightly, but it is an effort that is ultimately doomed. Already, nations that eagerly signed on to Belt and Road have realized that it is a roach motel—accept billions of dollars of infrastructure aid from China and you become just another Chinese province.

But countries that are desperate for capital will find Belt and Road hard to resist—even Italy, God help it, has signed on—and this means that the U.S. will have to confront Belt and Road head-on. That will require putting intense pressure on countries not to join Belt and Road while also offering them alternative sources of aid.

Next week, we’ll look at how the world’s nations will likely fare in an economic environment that rewards self-reliance.

Next up: Cold War II, Part 9