Have the Economic Constraints on China’s Geostrategic Ambitions Diminished?

The Council on Foreign Relations’ Greenberg Center for Geoeconomic Studies has just put out a new discussion paper by Willian Norris on an important topic: how China’s economic position shapes its foreign policy.

The paper makes one particularly provocative argument: the extremely unbalanced economic relationship that preceded the global crisis helped moderate China’s geostrategic ambitions, as China was so dependent on open markets for its exports that it wasn’t willing to rock the boat so to speak (e.g. act too aggressively in the South China Sea).

Broadly speaking, an unbalanced trading relationship created positive strategic externalities for the U.S., and the more unbalanced, the better—strategically speaking.

One implication is that China’s post-crisis pivot to growth driven by domestic investment has freed China’s foreign policy hand, and allowed it to act more aggressively to promote its regional and global interests.

Another is that a successful pivot from investment to consumption, while economically desirable, may also position China to act more aggressively to promote its interests abroad.

The thesis broadly fits with the stylized facts—China under Xi has asserted its interests more aggressively than China under Hu. And China’s greater assertiveness coincides with a large fall in China’s dependence on exports—at least if export dependence is measured by the ratio of exports to GDP. That is down from something like 40 percent pre-crisis to about 20 percent of GDP now. China is no longer a particularly export-intensive economy (it isn’t widely recognized but China’s trade surplus now stems primarily from its comparatively low level of imports of manufactures).

But the case isn’t a slam dunk.

It isn’t clear that the driver of China’s strategic shift is its reduced export intensiveness. It could simply reflect Xi’s own world view. Or it equally could be a function of China’s growing economic size: A bigger China was always going to have more ability to throw its weight around no matter what.

Nor is it completely clear that China’s export dependence is in fact way down. Exports to GDP may not be the right measure. The right measure could be a measure of net trade. And the right measure there, arguably, is China’s surplus in manufactured goods—which hasn’t come down much (as a share of GDP) since 2007. Manufactured exports are down as a share of GDP, but manufactured imports are down every bit as much (relative to China’s GDP).

That manufacturing surplus keeps China’s manufacturing sector larger than it otherwise would be, and helps China maintain a relatively high level of manufacturing employment. And it generates the foreign exchange China needs to pay for commodity imports, the lending of its state banks and—over the past few years—private capital flight (some disguised as tourism).

Even so, Norris’s argument is worth considering. The strategic implications of a China that succeeds in both pivoting toward domestic consumption and continues to reduce its need for imported goods and technology—one of the goals of China 2025—warrants a bit more thought.

All this said, I don’t agree with the one of the discussion paper’s arguments.

Norris claims that the imbalances that flowed from China’s export-based economy weren’t that adverse to U.S. economic interests. The positive strategic externality consequently didn’t have a significant economic cost, as the U.S. and Chinese economies were complimentary.

I though never have bought into the strong version of the “Chimerica” thesis: China saves, the United States spends, and together they constitute a more balanced, more complete economy than either were individually.

Obviously, I have been influenced by the work of David Autor and his colleagues. Trade generates winners and losers, and a broad swath of workers in manufacturing intensive regions of the country were on the wrong side of the ledger. A shock to manufacturing employment isn’t just a shock to manufacturing workers; it was a shock to all low-wage workers in manufacturing-intensive regions.

The “China” shock was big in part because China is big. But it was also bigger than it otherwise needed to be because the underlying trade relationship was so unbalanced. The U.S. imported more goods, especially manufactures. But in aggregate it didn’t export more. As a share of U.S. GDP, exports to Asia writ large are no higher than in 1997.* Manufacturing exports to Asia are actually lower as a share of U.S. GDP now than in 1997.

This isn’t just a question of looking at potentially misleading bilateral balances either. Asia is big enough that it influences the global data, which shows the same basic trend.

And I tend to think that the pre-crisis trade deficit contributed to the structural weaknesses in the U.S. economy that gave rise to the 2007-08 financial crisis. Not directly, in the sense that China “caused” U.S. and European financial institutions to take excessive risks with too little capital. But indirectly. With a growing trade deficit and fewer jobs in the tradeables sector thanks to the asymmetric China shock, sustaining the demand needed for full employment required either large fiscal deficits or a lot of borrowing in the household sector. As a result, the U.S. trade deficit could persist in its pre-crisis form so long as a set of financial intermediaries were willing to in effect sell their holdings of safe U.S. assets to China, and invest instead in riskier mortgage backed securities—which in turn allowed Americans to borrow against the value of their homes to support a high level of current spending.

I consequently am not persuaded by the argument—commonly made by geopolitical strategists—that the cooperative economic connections generated by China’s integration into global supply chains and the like generated “win-wins” that consistently buffered Sino-American strategic competition.

No doubt some firms raised their profit margins by producing in China, and no doubt some Americans—those who saw strong wage growth and didn’t consume much oil (or other commodities whose price rose on the back of Chinese demand, at least before global supply caught up)** —benefited from lower import prices.

But there were a fairly large set of people and communities who were left worse off as a result of the China shock, and they have votes. Speaking of the overall gains from an unbalanced trading relationship without considering the distribution of gains and losses leaves out too much of the picture.

So if an imbalanced relationship provided strategic gains, I would argue that it did so at a significant economist cost. Yet Norris's argument that large imbalances effectively acted as a source of strategic restraint on China's foreign policy in the years before the global crisis is still worth careful consideration.

* One small point: looking at the rise in U.S. exports to China after China's entry to the WTO is misleading, as the rise in part reflected a shift away from exporting through Hong Kong—and more generally in the initial phase of China’s industrialization, electronic parts that previously had gone elsewhere in Asia were redirected toward China. U.S. exports to other Asian countries were falling as exports to China were rising (relative to U.S. GDP) in the early part of the 2000s.

** Trade should raise the price of exports even as it lowers the price of imports, a point Dani Rodrik always makes. For the U.S. trade has increased the domestic price of corn and soybeans, which are inputs into a wide range of foodstuffs. Soymilk is the obvious one but, well, it isn't nearly as important as the use of corn and soybeans in the production of most meat (poultry, pork, etc). The impact of China on commodity prices has faded somewhat though as global supply increased. China provided a smaller shock to high-end manufactured exports than predicted back at the time of its entry to the WTO, though, as it quickly ramped up its domestic production of a wide range of capital goods. China's manufactured imports started to fall as a share of China's GDP in 2003 or so.