The Risks of China

“We have no choice but to follow the party,” a Chinese seafood entrepreneur told the Wall Street Journal recently. The Chinese government, the Journal asserts, is increasingly forcing private firms to follow Communist Party guidance and using its control over financial markets to punish those that don’t comply. In the process, state-owned enterprises are playing a larger role in the economy, reversing years of effort to downsize the state sector and expand the economic role of private investment. It’s a pretty good bet that China’s economy will become less innovative in the process.

This development is one more nail in the coffin of what I have called the Third Globalization, the period when international trade grew by leaps and bounds due to long, complicated value chains. As I point out in Outside the Box, this model gained favor in the late twentieth century in part because the corporate bean counters who demanded that manufacturing be located where production and transportation costs were lowest failed to account for risk. Yet risks can’t simply be wished away. If goods don’t get delivered on time, investments are confiscated, or proprietary information ends up in the hands of potential competitors, the costs of long value chains can far exceed the advantages of low production costs and cheap shipping.

As foreign businesses see it, China now has risks in spades. Dozens of foreign companies, from Abercrombie & Fitch to Zara, face the threat of of trade sanctions and customer displeasure due to allegations that their value chains include producers who use forced labor in the western province of Xinjiang. Foreign banks lost an estimated $400 of fees in an instant when the Chinese government blocked a $40 billion stock offering by the financial company Ant Group in November. The threat that Communist Party functionaries will play a greater role in guiding the activities of foreign-owned enterprises and joint ventures in China is just one more risk that has to be pencilled in.

In response to the perception of greater risk, firms are carefully shifting their supply chains out of China and are trying to avoid tying up their money there. According to OECD data, the stock of foreign direct investment in China, which was around 25% of the country’s GDP between 2008 and 2016, fell five percentage points between 2016 and 2019. (For comparison, the share in the United States is over 40% and rising.) In 2019, the net inflow of foreign direct investment into China came to 1% of the economy, the lowest level since 1991.

Skip the eulogies: globalization is by no means dead. But as firms and governments assess its true costs, the global economy is looming less important in our lives. We can expect international trade in goods to grow more slowly than the world economy over the next few years, and perhaps to start declining. One consequence, as Paul Krugman wrote recently, is that “America‚Äôs future will be defined by what we do at home, not on some global playing field.” The came could be said of many other countries as well.

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