Supply Chains

  • United States
    CFR and U.S. Department of Commerce Supply Chain Summit
    Play
    Please click here to view the full agenda with all speakers. The Supply Chain Summitcohosted by the Council on Foreign Relations and the U.S. Department of Commerce, explores efforts taken by government and industry to shift from reacting to global supply chain disruptions to proactively strengthening supply chain resilience. The event gathers leaders from industry, government, academia, and civil society to collaborate and share best practices for preventing and addressing supply chain vulnerabilities, including launching a new supply chain risk assessment tool. This summit is presented by RealEcon: Reimagining American Economic Leadership, a CFR initiative of the Maurice R. Greenberg Center for Geoeconomic Studies.  
  • China
    China’s Stockpiling and Mobilization Measures for Competition and Conflict
    Hearing co-chairs Commissioner Cliff Sims and Vice Chair Reva Price, Commission members, and staff, thank you for the opportunity to speak with you today. I commend the Commission for calling a hearing on this critical subject. My testimony today will focus on China’s attempts to develop an antidote to the West’s weaponization of the existing U.S.-led international trade and financial system against China. The escalation of U.S.-China trade tension since 2018 and G7’s sanctions against Russian entities and individuals since 2022, notably the freezing of Russian foreign exchange reserves, have prompted China’s policymaking community to strategize immunizing the Chinese economy against Western sanctions and strengthen China’s financial security. Despite Western pressure and sanctions against Russia, China continues trading with Russia. During Russian President Putin’s visit to Beijing in April 2024, Chinese President Xi Jinping and President Putin strengthened their solidarity.  While criticizing Western sanctions against Russia as having no legal basis, Beijing has been pragmatically evaluating the danger of China’s reliance on Western countries for strategic industrial inputs and technology. Unabated U.S.-China geopolitical tensions and Western governments’ industrial policies to incentivize firms to reduce supply chain dependence on China have diminished trade between China and the West and fueled concerns among Chinese policymakers and academics about further intended decoupling. The Chinese government has accelerated its development of an anti-sanction policy framework and an alternative global system to prevent China from falling victim to Western sanctions like Russia did. China’s economic growth slowdown and domestic economic wounds will not stop the Communist Party of China and the Chinese government from fortifying defense against potential Western financial sanctions. Such determination is driven by two primary factors: first, the perception of U.S. containment necessitates China’s self-sufficiency and strengthened defense against forced decoupling; second, Chinese President Xi prioritizes enhancing China’s financial security as integral to national security and aspires to build up China’s financial prowess. I. China’s Perceived Necessity to Sanction-Proof the Chinese Economy In the eyes of Chinese leaders and policymakers, the punitive economic retaliation against Russia by the United States and its allies reveals that global supply chains and the U.S.-led global financial system can be weaponized against China in extreme geopolitical scenarios. However, the economic war against Russia to punish President Putin’s invasion of Ukraine is not the only factor that raises Chinese policymakers’ concerns about the potential threat of trade and financial weaponization against China. Shortly after President Biden took office, Chinese observers already concluded that the Biden administration’s China policy would feature containment, creating demand for China’s pursuit of economic and technological self-sufficiency. One year into the Biden administration – that was before the West’s collective sanctions to punish President Putin’s war against Ukraine – Chinese academics and state media perceived U.S. policy towards China as containment. For example, in June 2021, Zhang Monan, a chief researcher at China Center for International Economic Exchanges, a public policy think tank operating under the National Development and Reform Commission, observed that “Biden’s China containment policy will go further than Trump.” In August, the Bureau of Development and Planning of China Academy of Sciences wrote that “the focus of the U.S. Innovation and Competition Act of 2021 is to contain and compete with China in science and technology, centered on digital technologies such as semiconductors and 5G.” Also in August, Xinhua, China’s leading state media, quoting Chinese academics, described the trips to Southeast Asia by senior officials in the Biden administration, such as Secretary of Defense Austin and Vice President Kamala Harris, as “the United States seeking to woo Southeast Asia to contain China” with quotes from Chinese academics. In January 2022, the Chongyang Institute for Financial Studies at Renmin University published an article arguing that containing China has become a “new normal” in U.S. policymaking calculations. In this context, Chinese policymakers have become convinced that the United States is determined to implement a full-fledged strategy of containment against China before the West’s punitive sanctions against Russian individuals and entities following President Putin’s war against Ukraine. Naturally, Chinese officials, academics, and media rhetoric increasingly talk of self-reliance and are preparing for a forced decoupling from the United States. Fang Xinghai, a vice chairman of the China Securities Regulatory Commission, proposed accelerating the yuan’s internationalization to prepare for the risk of forced financial decoupling. Even the more moderate voices have acknowledged the profound changes in U.S.-China relations behind the “decoupling theory” and called for China to “prepare for the worst but strive for the best.” Under the leadership of President Xi, the Communist Party of China made “independence and self-reliance” a centerpiece in the landmark Historic Resolution enacted in 2021. On February 25, 2022, one day after President Putin’s invasion of Ukraine, the People’s Daily published an editorial that wrote “independence and self-reliance ensure that the cause of the Party and the people will continue to move from victory to victory.”  Beijing views the Biden administration’s regional arrangements in the Indo-Pacific region as destabilizing and undermining China’s interests. For Beijing, the Indo-Pacific Economic Framework for Prosperity is the economic mirror of the Quadrilateral Security Dialogue and AUKUS, two U.S.-led security pacts that Beijing regards as anti-China coalitions. In May 2022, as President Biden embarked on his first trip to Asia since taking office to visit Korea and Japan, Xinhua characterized U.S. policies towards the Indo-Pacific region as “exhibiting new features of an integrated China containment policy across multiple dimensions” (美遏华战略呈现多领域一体布局的新特征). In June, the Ministry of Foreign Affairs characterized America’s China policy as an attempt of “comprehensive containment and suppression of China” in a statement entitled “Fallacies and Truth in America’s Perception of China” (美国对华认知中的谬误和事实真相). Beijing also views the America’s industrial policies such as the CHIPS Act and the Inflation Reduction Act, and U.S. trade and investment restrictions from export controls to inbound and outbound investment screenings as tools of economic and technological containment against China. Global Times criticized U.S. chip export restrictions as aiming to “suppress and contain the rise of Chinese technology to preserve U.S. hegemony” and quoted expert opinions saying “domestic production in related industries has already become an industry consensus in China.” Researchers at Bank of China Research Institute and China Institutes of Contemporary International Relations commented that America’s “yard and fence harm global supply chains” and that “U.S. industrial policies have China as the primary target of containment and suppression.” With ongoing hot war in Europe and cold war in economic and technology competition, a Shanghai-based academic argued that “the peace dividend is over”—hence, “it is time that China prepare for a full decoupling.” Chinese scholars and policymakers are ideologically prepared for a forced decoupling from the West despite knowing that decoupling undermines China’s interests. They have debated the necessity of reforming the dollar-based global financial system and diversifying away from dollar assets overseas. The Chinese government has taken concrete steps to develop the renminbi’s pricing power in major global commodities. The People’s Bank of China and its affiliates have been working on developing an alternative financial system with the digital renminbi at the center. China’s legislatures have designed an anti-sanctions regulatory framework to deter and penalize cooperation with foreign sanctions against Chinese entities and individuals. Besides these defensive measures, the Chinese state has also identified offensive retaliatory measures by weaponizing China’s critical position in global supply chains. II. Chinese President Xi Jinping’s Emphasis on Financial Security and Financial Power Since President Xi Jinping came to power in 2013, he has repeatedly emphasized worst-case scenario thinking to “prevent macro-risks that may delay or interrupt the process of the great rejuvenation of the Chinese nation.” From Xi’s vantage point, China’s state-owned financial institutions and enterprises must inoculate themselves in advance against more disastrous international sanctions that might be levied against them in the event of a military conflict with the West over Taiwan. That concern has only grown more urgent after China witnessed the collective sanctions imposed by the West on Russian entities and individuals to punish President Vladimir Putin for his war against Ukraine.    Financial security is a core aspect of President Xi’s “Comprehensive National Security.” When addressing a Politburo study group in April 2017, Xi Jinping, as the General Secretary of the Party, emphasized that “financial security is an important part of national security. Protecting financial security is strategic and fundamental to China’s overall economic and social development.” However, it is important to note that President Xi did not invent financial security as national security. In fact, financial security has become an indispensable part of China’s national security discourse since the 1997 Asian financial crisis. Addressing the National Finance Work Conference in November 1997, President Jiang Zemin stressed that “ensuring financial security, efficiency, and stability is a basic prerequisite for the sustained rapid development of the national economy.” Jiang warned, “if the financial system is unstable, it would inevitably affect economic and social stability.” Jiang’s speech reflected the normative impact of the Asian financial crisis on the conceptualization of national security, financial governance, and financial risk management among the third generation of the Communist Party of China’s (CPC) leadership. Awakened by the severity of the crisis, CPC leaders realized for the first time that national security could not be narrowly defined only by military competencies and defense capabilities but must also include financial security.   Under President Xi’s leadership, defending China’s financial security means not only managing market risks but also geopolitical risks. Developing alternative systems to hedge sanction risk and reduce China’s strategic vulnerabilities due to its dependence on the U.S. dollar in international trade and investment has become a priority of the CPC. At the October 2023 Central Finance Work Conference, Xi reiterated that “preventing and managing risk is a perpetual theme of financial work” and elaborated on the geopolitical challenges to China’s financial security. He observed that “a small number of countries treat finance as tools for geopolitical games. They repeatedly played with currency hegemony and frequently wielded the big stick of financial sanctions. … All these have presented new challenges to maintaining financial security under the new situation.”   President Xi’s recent speech suggests that he views improving the renminbi’s international status as an indispensable component of strengthening China’s financial security. In January 2024, President Xi urged leading cadres at provincial and ministerial levels to strengthen China’s financial power and listed “powerful currency” as the top priority among several core financial factors. He called on Chinese officials to promote China-governed financial infrastructures that are safe and efficient to improve China’s financial autonomy. III. China’s Strategies to Reduce its Strategic Vulnerability to the Dollar Hegemony In response to Chinese policymakers’ anxieties over the country’s financial security, China in recent years has accelerated its development of an alternative global financial system independent of the dollar to fortify its economy against potential sanctions. The Chinese government has pursued three primary strategies to push for reforming the existing U.S.-led system while developing an alternative. One strategy has been to support and expand regional and multilateral currency and financial cooperation through various non-Western partnerships. The second strategy has been to increase the broader use of the renminbi in international trade and investment while promoting renminbi-based international financial infrastructure. The third strategy is to improve the role of the renminbi in global commodities pricing, especially in the context of the clean energy transition.  1. Promote Regional and Multilateral Currency and Financial Cooperation The 1997 Asian financial crisis drove demand for a regional currency arrangement to address short-term liquidity difficulty for regional members and reduce reliance on the International Monetary Fund (IMF). Japanese finance authorities proposed to establish an Asian Monetary Fund (AMF) but failed due to the U.S. government’s opposition. In May 2000, ASEAN+3 (China, Japan, and South Korea) managed to launch the Chiang Mai Initiative (CMI), the first regional currency swap arrangement, as an incremental step and laid the foundation for continued regional currency cooperation. The CMI is composed of the ASEAN Swap Arrangement among ASEAN countries and a network of bilateral swap arrangements among ASEAN+3 countries.   A decade later, in May 2008 amid the 2007-2008 global financial crisis, ASEAN+3 (China, Japan, and South Korea) finance ministers agreed to establish a regional foreign exchange reserves pool with a minimum amount of $80 billion, which later increased to $120 billion with China and Japan each contributing $38.4 billion (each 32%) and South Korea $19.2 billion (16%). In December 2009, an Asian regional foreign exchange reserves pool was launched, a step closer to an AMF. In March 2010, ASEAN+3 finance ministers and central bank governors meeting clarified that countries could implement local currencies – U.S. dollar swaps in the $120 billion collective regional foreign exchange reserves pool. In May 2012, the size of the regional foreign exchange reserves pool increased to $240 billion.  In dealing with the economic shocks of the COVID-19 pandemic, at the G20 meeting in February 2022, PBoC Governor Yi Gang said that China would work with Asian countries to promote the use of local currencies in trade and investment to strengthen regional financial security and resilience against external shocks. In June, the PBOC and the Bank for International Settlement launched an RMB Regional Liquidity Arrangement, with the participation of Bank Indonesia, the Central Bank of Malaysia, the Hong Kong Monetary Authority, the Monetary Authority of Singapore, and the Central Bank of Chile. This arrangement has since become an additional liquidity support for participating central banks in times of market volatility.   The Chinese government has actively cooperated with non-Western multilateral partnerships, such as the Shanghai Cooperation Organization (SCO) and BRICS, to develop a non-dollar-based financial system and promote the use of local currencies in trade and investment. Following the West’s punitive sanctions against Russian entities and individuals to punish Putin’s war against Ukraine, the Chinese government has sought to capitalize on concerns among members of the Global South over the West’s sanctions, especially the freezing of Russian reserves. An important agenda behind China’s support of the expansion of non-Western regional and multilateral partnerships, such as the SCO and BRICS, has been to accelerate the expansion of a non-dollar-based system. For example, at the September 2022 SCO Summit, Chinese President Xi Jinping proposed to expand the shares of local currency settlements to promote regional integration, strengthen the development of local-currency cross-border payment and settlement systems, and promote the establishment of an SCO development bank. SCO members agreed on a “roadmap” to expand trade in local currencies. Iran – whose regime has been coping with severe western sanctions and firmly in favor of de-dollarization– has joined the SCO as its ninth full member. Iranian President Ebrahim Raisi made it clear that Tehran sees SCO membership as a way to help thwart American unilateralism and bypass sanctions.  China’s expressed interest in using the SCO framework to promote the use of local currency for bilateral trade and settlement already emerged before the launch of the Belt and Road Initiative in 2013. Following the 2007-2008 global financial crisis, promoting the use of local currencies in bilateral trade has become an important issue in China’s partnership with SCO members, which has received support from SCO members. For example, at the 2012 SCO Business Forum, Vice Premier Wang Qishan stressed that SCO members should promote using local currencies in trade settlement, advance bilateral currency swaps, strengthen regional financial cooperation, and develop new financing models.   2. Promote the cross-border use of renminbi and renminbi-based financial infrastructure Besides collaborating with regional and multilateral groups to pursue the development of a non-dollar-based system, the Chinese government also attempted to improve the cross-border use of renminbi since the 2007-2008 global financial crisis. In July 2009, Chinese financial regulators and central government agencies promulgated “Administrative Rules on Pilot Program of Renminbi Settlement of Cross-border Trade Transactions,” allowing qualified Chinese enterprises designated by the state to settle cross-border trade in renminbi. The Rules marked China officially taking the first step to promote greater international use of the renminbi, with the goal of ultimately establishing the Chinese currency as an international reserve currency alongside the U.S. dollar and the euro.   The Chinese government has put resources into developing renminbi-based financial infrastructure to facilitate the cross-border use of the renminbi. Launched in 2015, CIPS has become a proprietary financial infrastructure that could allow sanctioned entities to plumb into global markets, although dodging sanctions was not the original motivation for its introduction. Initially developed as a critical piece of financial infrastructure to promote yuan internationalization, the Shanghai-based CIPS is increasingly seen as China’s alternative to SWIFT even before Russian banks were recently kicked off SWIFT. CIPS allows global banks to clear cross-border renminbi transactions onshore instead of through offshore renminbi clearing banks, providing a one-stop alternative to the combination of the SWIFT messaging system and the New York-based Clearing House Interbank Payments System. However, CIPS is not a complete departure from SWIFT and still uses SWIFT’s standards to connect with the global system. It has adopted the ISO 2022 international payments messaging standard in order to make it interoperable with other payment systems as well as with correspondent banks around the world. The adoption of the existing cross-border messaging standards serves China’s interest in making CIPS a critical piece of financial infrastructure to promote the international use of the renminbi. According to the CIPS website, CIPS currently has 139 direct participants, 100 of which are in Asia, 23 in Europe, 6 in Africa, 5 in Oceania, 3 in North America, and 2 in South America. In 2023, CIPS’s annual business volume reached RMB123 trillion. By January 2024, CIPS’s average daily transaction volume reached RMB666.8 billion ($93.6 billion).   The Chinese state has accelerated the development of alternative financial infrastructure as a hedging strategy due to mounting concerns over being isolated from the U.S.-led global financial system as tensions between the United States and China have escalated since 2018. The PBoC has cooperated with SWIFT to get localized services, which in theory could mitigate the impact of sanctions. In August 2019, SWIFT set up a wholly foreign-owned unit in Beijing that uses renminbi for its services and products in China and provides the Chinese financial community with localized and customized services. In January 2021, the PBoC and SWIFT launched a €10 million ($12 million) joint venture named Finance Gateway Information Services (FGIS), shortly after the United States, the European Union, U.K., and Canada sanctioned several Chinese officials for human rights abuses against the Uyghurs. FGIS will build a local network for financial messaging services and establish a localized data warehouse to store, monitor, and analyze cross-border payment messaging information. Notably, the CIPS and Digital Currency Research Institute are FGIS shareholders. Their presence suggests that FGIS is empowered to promote the use of digital yuan in cross-border transactions. Once materialized, this could be another damage control mechanism if major Chinese banks were de-SWIFTed.   It is currently unclear whether a localized messaging network combined with a localized data warehouse would be sufficient to achieve netting settlement services for cross-border payments and thereby help China circumvent U.S. sanctions. However, the participating Chinese shareholders can reveal the technical potential of this joint venture. Apart from SWIFT’s €5.5 million investment for a 55% stake, the joint venture’s primary Chinese shareholder is China National Clearing Center, which invested €3.4 million euros for a 34% stake. Other Chinese shareholders include CIPS (Cross-border Interbank Payment System), DCRI (Digital Currency Research Institute), and PCAC (Payment & Clearing Association of China, an industry self-regulatory agency under the PBoC). The participation of CIPS and DCRI accentuates the potential of the joint venture to promote a renminbi-based financial system and boost the cross-border use of the digital renminbi. In January 2023, the Ministry of Commerce and the PBoC jointly issued a policy notice to encourage Chinese firms engaging in international trade and investment to use renminbi in their cross-border settlement and investment. The policy notice also encouraged Chinese banks to extend overseas renminbi loans. Over thirty countries have started to use the renminbi for cross-border trade and settlement. Major Chinese oil suppliers, such as Russia, Angola, Venezuela, Iran, and Nigeria, now accept renminbi in their oil trade with China.   3. Improve the renminbi’s commodities pricing power.   Although China has laid down the renminbi-based financial infrastructure for the international use of the renminbi and has achieved settling commodities trade using the renminbi with over thirty countries, the renminbi’s commodities pricing power remains limited. The major commodity pricing centers are in New York, Chicago, and London, with the U.S. dollar dominating about 90 percent of the pricing of major commodities in global markets. Chinese policymakers have publicly expressed their concerns about the renminbi’s limited pricing power over commodities.  Chinese policymakers are right to consider improving renminbi’s pricing power in global commodities markets as an essential component to boost China’s financial power. China is the world’s largest consumer of fossil fuels and dominates the supply chains of several highly sought-after critical minerals deemed critical for the clean energy transition, such as cobalt and rare earth minerals, which cannot be easily substituted by other materials using existing technology in the clean energy transition. Making the renminbi the pricing currency of major commodities powering the global economy is a crucial step to constructing a renminbi-based global commodities trading system, which could reduce China’s economic and geopolitical vulnerabilities in the global resources trade, elevate China’s influence in the global financial system, and strengthen China’s financial security. In this context, improving the role of the renminbi in global commodities pricing is not just a critical step towards renminbi internationalization but also an essential condition to reduce China’s strategic vulnerabilities.   In this context, China has developed several commodities trading platforms, such as the renminbi-denominated futures market and commodity exchanges. For example, China launched renminbi-denominated oil futures in 2018 and copper futures in 2020 on the Shanghai International Energy Exchange. It also launched the Ganzhou Rare Metal Exchange in 2019, where China’s renminbi currency is used to quote prices for spot trading of tungsten, rare earth products, and critical minerals (like cobalt) that are essential to the clean energy transition. The Shanghai crude oil futures market has already risen to the third-biggest oil futures market by trading volume, behind West Texas Intermediate and Brent but surpassing comparable offerings traded in Singapore and Dubai by a significant margin.  The commodities trading platforms and financial instruments provide marketplaces for the emergence of a renminbi-based commodities trading and settlement system. When addressing the China-Gulf Cooperation Council (GCC) Summit in December 2022, Chinese President Xi Jinping emphasized that China and members of the GCC should deepen cooperation in using the renminbi in oil and natural gas trading and settlement through the Shanghai Petroleum and Natural Gas Exchange (SHPGX). The recent expansion of BRICS supported by China, especially the inclusion of commodities majors such as UAE and Iran, opens up new avenues for members to pursue the use of local currency in commodities pricing and trading. This expansion allows China opportunities to boost the renminbi’s commodities pricing power and erode the U.S. dollar’s dominance in global commodities markets.  Since Xi’s speech, Chinese national oil and gas companies have accelerated initiatives to use the renminbi, instead of the U.S. dollar, in their international fossil fuels transactions through SHPGX. In March 2023, China National Offshore Oil Corporation — known as CNOOC, China’s largest offshore oil and gas field operator — used the renminbi to complete the transaction of importing 65,000 metric tons of liquefied natural gas (LNG) from TotalEnergies SE, a French multinational oil and gas company, through SHPGX. The LNG was produced in the United Arab Emirates, a member of the GCC, carried by a Liberian-flagged LNG tanker Mraweh, and finished unloading in May at the CNOOC Guangdong Dapeng LNG receiving station. This transaction was the world’s first cross-border LNG trade settled using the renminbi. Since then, CNOOC has executed more renminbi-settled transactions using the renminbi through SHPGX. In October, PetroChina, the largest oil and gas producer and distributor in China, settled a purchase of one million barrels of crude oil using the digital renminbi through SHPGX, marking the first cross-border oil transaction using the country’s central bank’s digital currency.    In the near-to medium-term, China could capitalize on the current energy transition to cultivate a “gas-yuan,” emulating the petrodollar. Just as oil-producing countries depend on dollar revenues that aren’t freely spendable elsewhere, gas-producing ones such as Russia and Iran could be dependent on the renminbi. In China’s “World Energy Development Report (2017),” Chinese scholars proposed the concept of gas-yuan. Given the fragmented nature of global natural gas markets and China’s leverage as a leading buyer, the emergence of the gas-yuan is not a pipe dream. Russia, Iran, and China collectively produce more natural gas than the United States and they all have non-dollar financial infrastructure in place. China has become the world’s largest LNG importer. Iran, which shares the world’s biggest gas field with Qatar, is reviving its previously sanction-stalled LNG export plan as the E.U. attempts to cut its dependence on Russian gas as a punishment for President Putin’s invasion of Ukraine. Although China has not provided material support to Russia or bluntly helped Russia dodge Western sanctions, China’s natural gas imports from Russia more than doubled in 2022 from 2021. The collective revisionist geoeconomic power of China, Russia, and Iran arguably is much stronger than that of the OPEC. Higher global demand for natural gas as a transition fuel towards Net Zero and the decoupling of gas prices from oil prices also provide a benign macro condition for the emergence of a gas-yuan.   In the medium-to-long run, China could also leverage its dominance in critical mineral supply chains and its partnership with mineral-rich countries as the global economy transitions from hydrocarbon-dependent to mineral-dependent. SCO members include major hydrocarbon and minerals exporters in Central Asia like Kazakhstan and Uzbekistan, Russia and its newest member, Iran. SCO also includes major commodities importers like China and India. Two of the world’s five largest lithium producers —China and Brazil — are members of BRICS. Iran, a member of both SCO and BRICS, announced last February the discovery of its first lithium deposits, estimated to be the world’s second-largest after Chile. Iran already possesses the world’s largest proven zinc reserves that are extractable using existing technology, the fifty-largest copper deposits, the 10th-largest uranium reserves, and the 10th-largest iron ore reserves. The Iranian regime has been coping with severe Western sanctions for decades and is firmly in favor of de-dollarization.  As a non-Western group of countries, SCO potentially represents a potent coalition of exporters and importers of commodities centered around using the renminbi to finance the entire commodities lifecycle from production to trade to consumption. Similarly, the expansion of BRICS to oil-rich nations bolsters the group’s collective economic power and influence on the clean energy transition despite introducing greater internal complexity among its members, such as regional rivalries in the Middle East, China’s rivalry with India as well as rising populism and its subsequent political unpredictability in Latin America. SCO and BRICS now share overlapping members with similar incentives for using local currencies in international trade settlement and investment. This configuration facilitates formal and informal policy efforts to implement incremental de-dollarization initiatives in energy and commodities markets, with the potential to scale up, making the two major non-Western groups attractive platforms for China to create an alternative financial system as the world moves beyond hydrocarbon.  IV. China’s Anti-Sanctions Regulatory Framework Besides developing a renminbi-based financial system to reduce its vulnerabilities to Western financial sanctions, the Chinese government has also developed anti-foreign sanctions regulatory framework to provide domestic legal basis to weaponize access to Chinese market. From Norwegian salmon, Philippine bananas, to Australian lamb, the Chinese government has often resorted to importing restrictions to punish foreign governments for their violation of what China deems as its core national interests. Escalating tensions with the United States since 2018 have led China to establish domestic legal foundations to restrict market access should foreign entities choose to comply with foreign sanctions and hurt China’s interests. In October 2018, China enacted its International Criminal Judicial Assistance Law (ICJAL) as a blocking statute to prohibit entities located in China from unilaterally cooperating with foreign civil and criminal investigations without the consent of the Chinese government. Specifically, Article 4 of the ICJAL states that “the international criminal judicial assistance shall not damage the sovereignty, security and social public interests of the People’s Republic of China, and shall not violate the basic principles of the laws of the People’s Republic of China.” This provides a broad spectrum of legal basis for Chinese entities not complying with foreign investigations. The Chinese government further weaponized access to the Chinese market by establishing the Provisions of the Unreliable Entity List, or UEL Provisions, an export controls framework issued by the Ministry of Commerce of China (MOFCOM) on September 19, 2020. MOFCOM published the UEL Provisions the next day after the U.S. Department of Commerce implemented an Executive Order to restrict the use of WeChat and TikTok, two Chinese-owned apps, in the United States. MOFCOM first announced the establishment of such an entity list on May 31, 2019, ten days following the U.S. Department of Commerce added Huawei to its entity list. The timing of these events suggests that China’s entity list is designed in response to foreign actions.  In January 2021, MOFCOM issued another sanction blocking statute, Rules on Counteracting Unjustified Extra-Territorial Application of Foreign Legislation and Other Measures, or the Extra-territorial Rules, as a countermeasure to the U.S. long-arm jurisdictions. The Rules empower aggrieved parties to report damages to MOFCOM and sue for compensation in Chinese courts. The Rules also grant Chinese authorities certain powers to block the extraterritorial application of foreign laws if deemed as unjustifiably prohibiting or restricting Chinese individuals or entities from engaging in “normal economic, trade, and related activities” with foreign entities, especially secondary sanctions and export controls. According to the Rules, the Working Mechanism comprised of MOFCOM, the National Development and Reform Commission, and other relevant Chinese authorities is in charge of determining whether the extraterritorial application of a reported foreign law or measure is unjustified. Within five months of the issuance of the Rules, the Standing Committee of the National People’s Congress enacted China’s Anti-Foreign Sanctions Law. This Law leans heavily towards countermeasures rather than blocking, as evidenced by the fact that eleven out of the twelve articles in the Law are dedicated to specifying the content, standard, and legal responsibilities of countermeasures. The Law introduces a new sanctions list known as the Countermeasure List. The Ministry of Foreign Affairs and other relevant ministries have the discretion to identify foreign entities to put on this list. This legislation came in response to the United States, E.U., and U.K. sanctioning more Chinese individuals and entities over concerns of human rights violations in Xinjian or ties to China’s military and surveillance activities. Altogether, China’s anti-sanctions regulatory framework is designed to deter and penalize cooperation with foreign actions perceived to be detrimental to Chinese business and national interests. As the enforcement of these statutes continues to flesh out, the Chinese state can force foreign companies to choose either the Chinese market or the western market. V. China’s Retaliatory Capacity Through Export Controls and Controls of Overseas Ports Strengthening the international role of the renminbi, developing an alternative financial system, and building an anti-sanctions regulatory framework are defensive in nature. If China were forced to decouple from the dollar-based global system, such defensive measures could provide some relief for China but cannot fully immunize China from collective Western sanctions. However, in the worst-case scenario of a financial war, Beijing would not confine itself to financial defense. It would likely retaliate against Western sanctions with offensive measures. Beijing could respond with two detrimental retaliatory measures: China could impose export controls on some controlled items, including but not limited to rare earth minerals; it could also deny foreign access to critical infrastructure, especially ports, around the world controlled by China. In October 2020, China promulgated its Export Control Law. The ECL is the first Chinese law that establishes a comprehensive and integrated export control regulatory regime to protect China’s national security and interests. It has a provision on “reciprocal measures,” which states that China may take reciprocal measures against any country or region whose abuse of export control measures endangers China’s national security and interests as assessed by Chinese government agencies. In December 2021, the State Council published a white paper on China’s Export Control that states the government strives to build an export control system commensurate with China’s international status and in line with the state’s national security and interests. The ECL and the follow-up white paper suggest that Chinese policymakers have formed a more mature view of how to strategically leverage China’s critical status in global supply chains to protect China’s national interests and retaliate against foreign restraints when necessary. China’s export control framework may give the Chinese government a new opening to restrict rare earth exports under a national security exception to WTO rules against restraints on free trade. Deng Xiaoping said in 1992 that “the Middle East has oil; China has rare earths.” China produces 60 percent of all rare earth elements used as components in high-tech devices and controls about 80 percent of the global supply. China has also maintained a near-monopoly over the complex refining process, controlling about four-fifths of global rare earth refining capacity. Beginning in 2007, China has set rare earths production limits, export quotas, and cut down the number of export enterprises to meet diverse policy objectives ranging from reducing pollution and increasing fiscal revenue to the development of processing sectors. Beijing believed these restrictions were justified under the WTO’s General Agreement on Tariffs and Trade Article XX on General Exceptions for the conservation of exhaustible natural resources and the protection of human health. However, the WTO ruled in July 2011 that China violated international trade rules by restricting the exportation of raw materials, refuting Beijing’s claim that these restrictions were based on environmental grounds. China rejected the WTO ruling, arguing that it was unfair and subjective, exposing the insufficient representation of developing countries in the WTO and its inability to understand developing nations’ problems. The ECL could provide a legal foundation to empower the Chinese government to ban exports of rare earths and refining technology to countries or corporations it views as a threat to China’s national security. If isolated from the US-led global financial system, China could possibly retaliate by restricting exports of rare earths that are crucial for the manufacture of high-tech consumer electronics and sophisticated American weaponries, including F-35 fighter jets, to the United States and U.S. allies. China supplied 80 percent of U.S. rare earth imports between 2014 and 2017. Beijing reportedly has been exploring such an option in 2019, following deteriorating Sino-US relations and an emerging technology war between the two countries. Imposing export control over certain rare earths has been a frequently used tool in China’s economic statecraft repository. The reported threat of retaliation against the United States mirrors China’s ban of rare earths exports to Japan in 2010 following the detention of a Chinese fishing boat capital who rammed Japanese patrol boats in disputed waters near the Senkaku/Diaoyu Island. Besides its dominance over rare earths, China’s critical position in global supply chains also rests on its emergence as a leading commercial maritime power. Domestically, China has more shipping ports than any other country in the world. Globally, China invested in 101 port projects by 2019, including 37 in Asia, 33 in Africa, 11 in Europe, 9 in South America, 6 in North America, and 5 in Oceania. Three Chinese port operators, COSCO Shipping Ports, China Merchants Port Holdings, and Qingdao Port International Development, had already held stakes in 16 European ports as of 2018. Chinese port operators controlled 10 percent of European shipping throughput in 2021. COSCO, a leading ports operator in the world that carries one-tenth of global seaborne trade with its one-eighteenth of the entirety of global shipping capacity, has stakes in some of the world’s largest ports, including a 67 percent stake in the Piraeus Port Authority. It owns 100 percent of Peiraeus Terminal, 85.5 percent of Zeebrugge Terminal, 51 percent of Valencia Terminal, and minority shares in several other European ports. To date, central-government-owned port operators, such as COSCO Shipping Port and CMPort, and central-government-owned constructors and builders, such as China Communications Construction Group and its subsidiaries, remain the primary participants in overseas port projects investment and construction, sometimes with financial participation from Chinese sovereign funds such as China Investment Corporation and policy banks such as Export-Import Bank of China and China Development Bank. Besides investing in commercial ports, China has also pursued a strategic strongpoint approach to developing dual-use port facilities, which has been a cause for concern in the West. Chinese naval deployments have followed Chinese investments in the ports of Djibouti, Sri Lanka, and Pakistan. While there is no public record of China’s plan to turn European ports into Beijing’s military bases, a Chinese navy fleet’s visit to Greece’s Piraeus port in 2017 did raise the eyebrows of some European policymakers. Chinese port acquisitions grant the Chinese government greater control over global shipping and commercial flows, which may pose risks to the ability of foreign governments to secure supply chains.  VI. Assess China’s Existing Ability to Defend Against Financial Sanctions and Issues for Congress to Consider Despite China’s intention to hedge against sanction risk, plenty of evidence suggests that China does not have the capability to fully neutralize Western sanctions. The renminbi is far from being a global currency, let alone posing a credible threat to the dollar’s hegemonic power. China’s proprietary financial infrastructure has limited international coverage compared with SWIFT. Additionally, China’s CIPS still relies on interoperability and integration with SWIFT if it wants broader participation of leading global financial institutions. China’s anti-sanctions regulatory regime could force Western companies to choose either China or the West. However, it lacks concrete enforcement mechanisms. Finally, the PLA does not have combat experience commensurate with China’s prominent commercial maritime power.  While China has been attempting to mobilize a de-dollarization coalition to defend against the dollar-based system weaponized against China through non-Western partnerships such as SCO and BRICS, such a coalition at present remains a vision and cannot provide China with substantive material support to mitigate Western financial sanctions, especially secondary sanctions. The reason is that commodity-exporting countries from which China imports resources to fuel its economy depend on the dollar-based system to price and trade their commodity exports. Their banks remain reliant on the SWIFT-CHIPS system for international payment settlements. However, the basic infrastructure for mitigating sanctions has come into existence. If China could expand the renminbi-based financial infrastructure to cover its major trading partners and convince them to use the renminbi for cross-border settlements, its ability to shelter the Chinese economy from Western financial sanctions would be much higher.  Chinese policymakers have witnessed that Europe’s dependence on Russian energy has not prevented the European Union from sanctioning Russia for Putin’s invasion of Ukraine. Therefore, from Beijing’s vantage point, the West’s dependence on China may not stop the United States and its allies from slapping stringent sanctions on the Communist Party of China and Chinese entities in reaction to dramatic events, such as a militarized conflict over Taiwan or in the South China Sea. Beijing views that the risk of Western sanctions against China may increase if the West reduces its economic dependence on China. Members of the U.S. Congress need to consider that if China and the West were to engage in economic warfare within the next decade, the cost to the entire global markets would be enormous. The United States would not be exempted from the losses. According to a U.S. Chamber of Commerce-Rhodium Group report, if half of the U.S. investment in China were abandoned, it would cost American companies $25 billion annually in lost profits, on top of a $500 billion hit to the U.S. gross domestic product. Members of the U.S. Congress also need to consider that supply chain diversification cannot be achieved overnight, and hastened policies to bring manufacturing back to America cannot achieve its desired goals but raise inflationary pressure at home while increasing protectionist concerns among U.S. allies and partners. It takes time and effort for people to move houses; supply chain diversification is much more complicated than moving houses. If the United States and China were pulled into a financial war before Western companies could be sufficiently independent of Chinese suppliers and markets, the costs to U.S. companies and American consumers would be enormous, disrupt American people’s ordinary lives, and end globalization. While it is hard to determine whose loss would be greater, a forced decoupling of China from the existing global system would put a definitive end to globalization. I encourage the U.S.-China Commission and members of the U.S. Congress to consider the following policy recommendations aiming at strengthening U.S. financial leadership and keeping China embedded in the U.S.-led system so that the U.S. government can maintain the credibility of its financial deterrence in the long term. First, Congress should develop mechanisms to offset the potential negative impact of the Rebuilding Economic Prosperity and Opportunity for Ukrainians Act (REPO Act), passed by Congress and signed into law by President Biden, on the role of the U.S. dollar. The REPO Act specified conditions in which the President may confiscate Russian official assets subject to the jurisdiction of the United States to provide aid for Ukraine. While seizing Russian assets for Ukraine aid may be seen as an optimal solution given the current geopolitical circumstances, the cost of unilateral or coordinated confiscation of Russian official assets by the U.S. government with its allies to support Ukraine is likely to lead to diminished trust in the U.S. dollar-based system as well as decreased U.S. leverage over foreign rivals in the long run. To mitigate the negative consequences, Congress should consider legislative measures to strengthen the use of the U.S. dollar in international trade and investment. To this end, Congress can consider empowering the U.S. International Development Finance Cooperation (DFC) in its ability to work with a broader range of partners and countries rather than limiting it to a restricted set of low- and lower-middle-income countries. By expanding the countries and regions where DFC can work, the United States can offer a credible alternative to China’s state-led development finance that aims to advance a renminbi-based financial system. Second, while currently there is no evidence to suggest that China can credibly augment the rudimentary renminbi-based financial infrastructure to be a full-fledged alternative to the dollar-based system, China and its partners that are concerned about Western sanctions will continue deepening their de-dollarization cooperation via new technological means and platforms, such as block-chain based central bank digital currencies. Additionally, the availability of digital assets such as cryptocurrencies and their exchangeability with other assets offer new mechanisms to bypass financial sanctions. Congress should consider legislation to enhance scrutiny of crypto asset transactions, especially stablecoins, to prevent them from being used by foreign entities and individuals to circumvent sanctions. The Financial Innovation and Technology for the 21st Century Act passed by the U.S. House of Representatives made good progress in establishing regulatory oversight of the digital asset markets in the United States. However, as it stands now, the regulation does not include clear rules on monitoring and restricting the illegal use of digital assets and cryptocurrencies for sanction evasion. Updating U.S. law to combat the illicit use of digital assets is critical for U.S. national security and for maintaining the credibility of U.S. government financial statecraft in the long term. Third, Congress needs to consider strengthening U.S. critical minerals supply chain security and resilience to support the continued U.S. leadership in a decarbonized global economic system. China currently dominates the refining and processing of key mineral resources critical for the clean energy transition. China has in the past weaponized its dominant position in rare earths minerals and rare earth processing technology to retaliate against territorial disputes and export controls, which makes U.S. dependence on China for mineral resources a national security concern. The United States depends on China for over half of its supply of 25 mineral commodities, making the U.S. economy and industries vulnerable to supply disruptions stemming from China, especially in times of geopolitical tension. As the global economy continues to move beyond hydrocarbon, China’s dominance in critical minerals supply chains combined with the Chinese government’s attempts to increase the renminbi’s pricing power in mineral resources markets could dilute the dollar’s centrality in a decarbonized global economy. So far, the United States has taken substantive measures to secure critical mineral supply chains by forging minilateral partnerships in the Indo-Pacific region through the Quadrilateral Security Dialogue, commonly known as the Quad, comprising the United States, Australia, India, and Japan. The Indo-Pacific Economic Framework for Prosperity, as outlined by the White House, also put on its agenda the assurance of critical minerals access as a means to counter China’s dominance. In addition, the Biden administration has launched a broader multilateral Minerals Security Partnership (MSP) with critical partners to “friend-shore” critical mineral supply chains. These initiatives are necessary but insufficient to boost domestic supply and secure diversified access to overseas supply in a timely manner. Congress needs to consider streamlining the permitting and licensing process and setting timelines to ensure the timely development of critical mineral projects at home. Congress also needs to consider expanding funding for research and development on alternatives and mineral resource recycling technologies. Last, Congress may wish to consider China-related legislative measures across the whole spectrum of geoeconomic competition with China to allow fair competition, avoid costly conflict, and prevent unintended escalation. A motivating factor for China to develop an alternative system to hedge against Western sanctions originates from Chinese leaders’ perceived insecurity and vulnerability in the U.S.-led global system. It is in the interest of U.S. national security and the American people that Congress takes punitive measures against the Chinese government’s unfair practices. However, an overreliance on “sticks” to punish China without offering any “carrots” to incentivize China to behave as a responsible stakeholder in the U.S.-led global system would likely only encourage China to pursue an alternative international trade and finance system further. Congress may wish to supplement its existing laws on China with issue-specific legislative measures that encourage U.S.-China cooperation in areas that do not pose national security risks to the United States while also creating jobs and bringing tangible socioeconomic benefits to communities across the United States. Three areas worth Congress’s consideration include environment and climate change cooperation, food security cooperation, and disaster relief cooperation. Neither the United States nor China can effectively deal with the worldwide challenges of climate change, food security, and disaster relief. The U.S. government cannot stop the Chinese government from developing an alternative trade and financial system to defend against Western sanction risk. The U.S. government also cannot make macroeconomic policy decisions for China. However, the U.S. government and members of Congress can take measures to encourage China to stay embedded in the U.S.-led global financial system rather than incentivizing China and its partners to divert trade settlements and financial flows outside of the dollar-based syst
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Headshot of Shannon Oneil
Shannon K. O'Neil

Senior Vice President, Director of Studies, and Maurice R. Greenberg Chair

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    Play
    Shannon K. O’Neil, vice president, deputy director of studies, and the Nelson and David Rockefeller senior fellow for Latin America studies at CFR, and author of The Globalization Myth: Why Regions Matter, leads the conversation on why regionalization, not globalization, has been the biggest economic trend of the last forty years. FASKIANOS: Welcome to the first session of the Winter/Spring 2024 CFR Academic Webinar Series. I’m Irina Faskianos, vice president of the National Program and Outreach here at CFR. Thank you all for joining us. Today’s discussion is on the record and the video and transcript will be available on our website CFR.org/academic if you would like to share the call with your colleagues and classmates. As always, CFR takes no institutional positions on matters of policy. We’re delighted to have Shannon O’Neil with us to discuss the globalization myth. Dr. O’Neil is vice president, deputy director of studies, and the Nelson and David Rockefeller senior fellow for Latin America studies at CFR. She’s an expert on global trade, supply chains, and Mexico and Latin American democracy. Dr. O’Neil is a columnist for Bloomberg Opinion and has often testified before Congress. And she is the author of The Globalization Myth: Why Regions Matter, which was published by Yale University Press in October 2022, and just came out in paperback in October 2023. So it’s just out in paperback. She’s also the author of Two Nations Indivisible: Mexico, the United States and the Road Ahead, which was published by Oxford University Press. So, Shannon, thanks very much for being with us today. I thought that we could start with you talking about why regionalization, not globalization, has been the biggest economic trend of the last forty years. O’NEIL: Great, Irina. Thanks so much for having me. And, hello, everybody. Nice to—can’t see you, but nice to be here with all of you. And, you know, let get at that, sort of why I argue that regionalization is really the biggest thing that’s happened over this last forty-plus years. Let me get at it, starting with a tale of two cities. And the first city is the city of Akron, Ohio, which is where I happen to be from originally. And Akron, Ohio was once dubbed the rubber capital of the world. In the 1950s and 1960s it was a boom town. People were moving there to work in the factories. And, in fact, one out of every two tires that were made around the world were made in Akron, Ohio, out of all of the factories and production that was there. Now it is a town that, when I was growing up—so in the 1970s—hit hard times. They started to face more competition from Japanese tiremakers, from French and German tiremakers. And the competition got so stiff that by the early 1980s the last tire came off of a factory line in Akron, Ohio that’s ever been made. And most of the companies were sold off to their competitors—to Michelin in France, to Continental in Germany, to Bridgestone in Japan. And since then, you know, Akron has hit pretty tough times. You saw lots of people leave the city. It’s been, you know, a place with lots of the challenges of the quote/unquote, “rust belt” that people talk about. And many people would say, you know, this is a classic example of the vagaries of globalization. This is what happens, right? They get competition from abroad, and these are the real challenges. But let me put a little nuance on that. And let me compare it to another town, Columbus, Indiana, which is about a four-hour drive from Akron, Ohio. And this also was an industrial town. It is the home of Cummins Engines. So, a particular engine type was invented there between the world wars. And during the postwar period, just like Akron, Ohio, you saw a huge boom as Cummins Engines went to be part of the Marshall Plan, rebuilding Europe, building up Asia, building up the United States and the like. And you saw a huge boom in prosperity come to this town, that’s about the same size as Akron. Now, Columbus, Indiana and Cummins Engines also hit tough times in the 1970s. All of a sudden, Japanese engine makers were beating them out for contracts with Ford and GM and others because they could make more efficient, you know, more sophisticated and reliable engines than Cummins was able to make. But Cummins was able to limp through the 1980s and not go bankrupt. And then in the 1990s, it saw a rebirth. And one of the key factors in its rebirth was NAFTA. All of a sudden where they had struggled vis-à-vis, you know, German engine makers, Japanese engine makers, they could now distribute their costs across North America, making some things in Mexico, some things in Canada, and some things still in Columbus, Indiana and parts the United States. And all of a sudden, they had new markets as well. And in fact, today if you go down to Mexico and you’re on one of the highways in Mexico and there’s trucks that are going up and down, in part because of the trade with the United States, chances are that is a Cummins engine in that truck, made in actually upstate New York for all of the trucks that are in Mexico, or a big portion of the trucks that are in Mexico. So, Cummins was able to get its mojo back and actually grew and is one of the big engine makers again. Was able to kind of come back. And also the town of Columbus, Indiana, was able to do so as well. And it’s actually one of the most trade-dependent towns in the United States. And is also one that is thriving. Now, what’s the difference between these two? I would argue it’s not globalization, because both face globalization, but it was regionalization. And in fact, in the case of Akron, it was limited regionalization. They got hit by competitors from other parts of the world before NAFTA, before they were able to bring in partners through free trade agreements, and the like. And they were facing regional supply chains in Europe through what was the European Community at the time, which is now the European Union, and Asia, where Japan had reached out and it had factories all over Asia. And it was able to use its economies of scale and scope and different kinds of labor and natural resources to make better products at lower prices. So they were competing against regional supply chains, and Akron wasn’t able to keep up. While Cummins Engines and Columbus, Indiana, because they could hang on there until the 1990s, were able to form regional supply chains that allowed them to compete. Now, this is sort of an example, I would say, or anecdotes that get to a larger theme. And, you know, there’s a lot of talk out there about globalization, and people feel passionately about it. They love it or they hate it. They have strong opinions about it. But as Irina said, you know, I think the biggest phenomenon is that we actually misunderstand it over the last forty to fifty years. And what we’ve seen, more than globalization, is regionalization. And let me just put out what I would say are two myths about globalization. The first over the last forty, fifty years is that the world, in fact, globalized. And when you start looking at trade and economic data, what you find is that very few countries actually participated in quote/unquote, “globalization.” And so, what I did is I measured trade as a percentage of GDP. And so if you globalized—the way I measured it is, did your trade double or more as a part of your economy, right? That’s a big shift or transformation of your economy. And when you look at it that way, there are only about two dozen countries in the world that saw their economies transformed. And in contrast, you have eighty-nine countries that saw trade as a percentage of GDP stay the same—so stagnate not change—or even decline. So there’s a good number of countries that deglobalized over these last forty, fifty years, in terms of their access and their openness to markets around the world, rather than globalized. So that’s one myth, is that everybody—it was an all-penetrating phenomenon that swept the world. It’s actually only twenty-five countries that really participated. So that’s one side. The other myth is that when companies, and money, and people, and ideas, and patents, and goods, and inputs went abroad—which they did, we’ve seen trade go from two trillion to twenty-two trillion around the world since 1980. But when they went abroad, they didn’t necessarily go to the other side of the world. They didn’t necessarily globalize. And, yes, there are companies out there that you and I all know—you know, Boeing sources from fifty-plus different countries, and Coca-Cola can be found in every small town everywhere in the world. But the vast majority of companies that went abroad, the other tens of thousands, hundreds of thousands that you or I might not know their names, yes they did go abroad, but they didn’t go all that far away. They went closer by. And in fact, when you look at trade statistics, something that brings us home is the average good that is traded internationally travels about four thousand miles. And that is roughly the distance between New York and Los Angeles. That doesn’t get you to Shanghai. It doesn’t get you to Berlin, if you’re leaving from the United States. It’s much closer. It’s much more regional. And when you combine those two together, that not that many countries participated and when they did their companies did not go all that far away, and what you’ve gotten over these last forty-fifty years are three big regional hubs. The European one, an East Asian one—or, focused on East Asia—and a North America one. And between those three hubs, 90 percent of all global trade happens. So you add up all those other dozens of nations, all the nations of South America, of Africa, of the Middle East, of South Asia including India, all together they’re just 10 percent of global trade. The real dynamism is within these three big hubs, within these three big regions. What we’ve also seen is that all regions, or these three regions, didn’t do it equally. And so, we see more integration in some versus others. So we see within Europe and the European Community, and now the European Union, we see almost two-thirds of trade, and the movement of money, and the like within these nations. So, these are nations that make things together and they sell things to each other, mostly. When we look at Asia, we see in 1980 about 30 percent of trade stayed within Asia. That has grown over these last forty, fifty years to almost 60 percent. So there too, they make things together and, increasingly, sell them to each other. They still sell them, obviously, to the United States and other parts, but increasingly to each other. When we turn to North America we see, pre-NAFTA, about 40 percent of trade was within the three countries of Mexico, Canada, and the United States. It grew in the decade after NAFTA almost 48-49 percent. So almost, you know, half—one out of every two dollars—was within the region. And then after 2001, it fell back down to about 40 percent. So, it’s much less integrated than the other two blocs or regions. Now, it’s more integrated than the rest of the world. You look at South America, Africa, the Middle East, South Asia, only about 15 percent of trade stays within those regions. When they trade, they trade with places further away. But it’s not all that much trade, right? It’s only 10 percent of global trade. But the three regions, we see North America much less integrated than Asia or Europe. And I would argue that is to North America and the United States’ detriment, and to Asia and Europe’s competitive strength. And why is that? Well, why that is—and this gets back to the story of two cities. Why did Akron fail and Columbus, Indiana succeed? And in part because regionalization, the ability to draw on different labor markets and different labor costs, draw on different access to capital, draw on different skill sets, draw on different natural resources, draw on different access to markets all over the world, allows you to be more competitive with your goods. Not just in your home market, but in markets more broadly. And that allows you to, as a company and then as your workers within the company, to grow and thrive. So, you have scale that you can’t have as just one country, even a country like the United States. That’s one side. The other side is that when you’re working, or trading, or integrated through supply chains with others in your region, they’re much more likely to buy from you. So today when you look at goods that are coming in from Mexico to the United States, imports from Mexico to the United States, on average 40 percent of that good was actually made in the United States. That’s U.S. suppliers. That’s U.S. intellectual property. That’s U.S. inputs that are going into that good that’s there. The same good average, you know, amount of American-made value added in something coming in from China is less than 4 percent. So there’s really nothing there, because most of it is Asia. That’s where the other parts and pieces and components come from. So, when a factory opens up in Mexico, it’s much more likely to create jobs in the United States than if a factory opens in China. And that too is an aspect of regionalization. And so what we’ve seen over the last forty-fifty years is that, whether we like it or not, manufacturing has gone from being a one country thing, often, to being a team sport across groups of nations. That is what international supply chains are. And what we’ve also seen is that when those are regionalized, it’s much more likely to create economic prosperity in jobs and growth in the countries that participate than those that do not. And I think that it’s a lesson for the United States as we go forward. As we’re trying to create jobs, we’re trying to create growth, we’re trying to create inclusiveness, is that we need to be thinking more regionally than just domestically in terms of our economic prospects. So let me stop there. FASKIANOS: Shannon, thanks so much for that. Really terrific. Let’s go now to all of you for your questions. (Gives queuing instructions.) So we’re going to go first to a raised hand from—let’s see. The first one comes from Babak Salimitari, who’s a graduate student at the University of California, Irvine. Q: Hello? Can you guys hear me? FASKIANOS: We can. O’NEIL: We can. Q: Good morning. So, my question—I don’t know, when I was reading the articles and listening to what you were saying, it seems more so that this regionalization versus globalization is a debate over the semantics. Because at the end of the day, a lot of the jobs that were in the United States, they just got up and left. Now whether they went to a specific region or whether they went to globally—you mentioned the fact that the Middle East, and Asia and, I think, Africa, that was, like, only 10 percent of where globalization went to, or like—yeah, 10 percent. And I was also looking yesterday that in Macomb County of Michigan, from, like, 2010 up until, like, President Trump was elected, a hundred thousand jobs disappeared. And there was also a town hall where I remember President Obama said: Those jobs are never coming back. You’re going to need a magic wand to bring them back. And it’s just—I wonder, what is it about those regions that did globalization or, as you say, regionalization happen—so, like, the EU and then Asia—there was one more if I’m not mistaken. But why were those places more appealing for our jobs to go to in comparison to the places that you mentioned that weren’t as appealing? O’NEIL: Great. Thanks, Babak. That’s a great question, and actually gets right to the heart of what’s really different between regionalization and globalization. And we have seen jobs leave the United States, for sure, right? And I would say, where we have is often when it has gone to places further away, right? As you—as you highlight there, right, lots has gone to Asia, right, because that is a place that’s more competitive because they have regionalized much more than we have here in the United States. So, you know, there’s a lot of great academic studies out there that look at the hit that China sort of coming into the world. So in 2001, China joined the WTO. And for lots of reasons, that allowed or encouraged capital to go into China because it was—they knew they would have access to global markets, and the like. At the same time, China was joining already established Asian regional supply chains. These are supply chains that, you know, I talk a bit about in the book, of the history, they were first created by Japan. Japan in the 1960s started going out and started putting factories and what, at the time, was very poor South Korea, and Taiwan, and other countries. And then South Korea and Taiwan got much wealthier and began doing more value-added things. And then they started sending factories out to Thailand, to the Philippines, to other countries around there, and to China, as China started opening up in the 1980s and 1990s. And what’s interesting here is we see the China shock. And, you know, a lot of this academic literature, it estimates somewhere between one and two million jobs left the United States because of China coming in. Now, we don’t usually talk about this but I—you know, if you look at some of the statistics and the like, yes, the United States was hit very hard by China coming into global markets. Hit harder, at least in a per capita way, was Mexico. They lost hundreds of thousands of jobs which, given their size, was sort of more important to their economy, because they were a direct competitor with China, right? They made shoes. They made clothing. They made toys, and things—industries that were just destroyed and taken away and moved to Asia. Now, the difference here, which I was trying to get out—and I’ll explain it again, perhaps, make it a little bit clearer, Babak, is when a factory opens up in Mexico it’s much more likely, one, that what’s made in that factory, or assembled at that factory, will be price competitive. So be able to compete in U.S. markets, but compete in global markets. And two, it’s much more likely to keep or create jobs in the United States. So when a factory moves to Asia, or moves to China, there will be no U.S. jobs associated with that, right? Like, you’ll come back, and you’ll buy it, you know, at Walmart or at a store, and it’ll be a good price, and it’ll be good quality, likely. And so it’ll be attractive to a U.S. consumer. But there’s no jobs there, right? If a factory opens up in Mexico, they are likely going to be U.S. jobs. And because it’s spread across three different nations, and the benefits of economies of scale that we can get, you’re much more likely to be price competitive. And so you’ll be able to sell to U.S. consumers, right? When you go to the Walmart store and you’re deciding to buy, you know, this blender, that blender, the prices can be the same. So you could buy the one that was actually made in Mexico, the United States, and Canada, not just the one that was made in Asia. And so that actually, both keeps but also creates U.S. jobs. And so what’s interesting here, and, you know, there’s a lot of talk about NAFTA. Now NAFTA’s become the USMCA. But at the time of NAFTA, that, you know, this stole U.S. jobs. You know, factories were moving to Mexico and the like. But careful studies of actually what the costs have been is that, basically, NAFTA was a wash, right? It didn’t create jobs in United States—or it didn’t—we see a net zero in terms of the jobs that went back and forth. What we do see is countries like China, with whom the United States does not have a free trade agreement, there is where you see really the job losses. So I think as we—the point I want to make, and I think is really important to understand, is that all globalization is not created equal for U.S. workers, for U.S.-based factories, for the U.S. economy. And that regionalization provides real benefits. If you want to create jobs, and good jobs, here in the United States, regionalization provides a benefit. It’s sort of a Goldilocks. It’s not too close that things are too expensive, then you can’t compete on the store shelves because things cost more. But it’s not too far that the whole supply chain goes somewhere else and there’s no U.S. jobs created. It’s sort of this happy medium, where you can actually get benefits to the U.S. economy, and to U.S. workers, and to communities. And that’s how you bring back—or, you create and see a blossoming of jobs. And the last thing I’ll say is just tied to that, is when we think about, you know, quote/unquote, “good jobs,” right, jobs that are tied to trade, that are tied to other parts of the economy, on average, pay 18 percent more than jobs that are part of the local economy. So you could say, oh, we should just close the borders and we’ll all just do everything here. And the problem with that is then when you do that, things cost more money. So people buy things less often. So there are jobs that disappear with that, right? If your car cost $3(,000) to $5,000 more because it was only made in the United States, you might not buy a car as often. You might wait six months, you might wait an extra year with your current car. Which means then, you know, people who sell cars, not going to—you don’t need as many of them right? And then, you know, all the things that go on to that. You lose lots of jobs in the economy. So the benefit of internationalization is, one, those jobs pay more than jobs that are just domestic. And, two, it creates jobs in the sense that the economy moves more quickly, people buy and sell and move and trade and do things more often, and there’s more jobs overall in that process. FASKIANOS: Thank you. There are two questions about China, so I’m going to pair them. One from the University of Missouri at Columbia and one from Stony Brook University. Does high integration in Asian supply chains mean that it’s difficult or impossible for the West to decouple from China? And then, the other question is, why is so much made in China? How are we to understand this? O’NEIL: Yeah. Those are both great questions. So the made—I’ll start with the made in China, and then we’ll go to how can we get out of—can we get away from China. (Laughs.) So made in China for so many years was in large part because China was the last stop on the assembly line. And especially when you look back at the 1990s, early 2000s, China was not as technologically sophisticated as South Korea, or Taiwan, or Japan, or even places like Thailand and the like. So those are the places that would make the semiconductor, or make the engine, or make, you know, the technology that went into the phone or the Sony Walkman at one time, now, you know, the AirPods, and the like. And China was a place where they were put together. And the value that China added was much smaller. But because it was the last stop on the chain, it was dubbed “made in China,” right? And there’s a great study that someone did about the iPhone. And, you know, one of the early iPhones came out of China. So it was made in China. But the value added was, you know, I don’t remember the exact numbers, but it was something like, you know, $10 of the $400 price. And then today, when you fast forward, and iPhones are coming out of China it’s a third of the value is actually made in China. And that sort of shows them becoming more sophisticated, right? They aren’t just putting things together, they’re actually now making the microphones, or the screens, or the other parts to it. So part of the made in China and the ubiquity of that for so long was it was the last stop on the assembly line. And much of its growth was fueled by trade. So it was very export oriented. China has changed its model. And just to give you kind of an example or a statistic is, if you look back at the late 1990s, early 2000s, trade, as part of China’s GDP, was maybe, you know, 33 to 35 percent. So a third of its GDP came from trade. Today, it’s 20 percent. It has declined. It’s a much more inwardly focused economy than it was, say, at the beginning of this century. And partly there you see a little bit less made in China because it’s focused on its own markets, or it’s focused on other markets rather than the United States. Which gets us to the, are we able to decouple? Can we get away from China. (Laughs.) And, first, I would say, actually, China’s doing a very—you know, a pretty successful job of getting away from us. So it has cut its imports from the United States and buys, you know, less soybeans and grains, and other things. It’s diversified and buys many more from Brazil, and Argentina. and other places around the world, because they don’t want to be so dependent on the United States. It has invested significantly, to the tune of hundreds of billions of dollars, to try to create its own technology—its own semiconductors, its own green technology, its own electric vehicle batteries, and the like—because it doesn’t want to be dependent on U.S. technology. It doesn’t want to have to import from the United States or its allies. And I think the real question is, how can the United States and Europe, in a part, can it decouple, or de-risk, or whatever the term is that people like to use? And particularly in industries that we’re worried about the connection to China, because they might cut it off, right? If they decided to stop shipping us toys, you know, kids might be a little bit upset because you couldn’t get the latest whatever it is, but it wouldn’t be a national security concern, maybe. But if they stopped shipping out semiconductors, or they stopped shipping out some other technologies maybe, you know, Air Force jets wouldn’t be flying. Maybe the basic communications and telecom, the fact that we can all talk here over the internet and have this, you know, Zoom, we couldn’t do that because we wouldn’t have the technology. And that would be a bit more of a challenge. What we’ve seen over the last five years is trade between the U.S. and China, as a percentage, decline significantly. So, China’s trade with the United States used to be about 21 to 22 percent of U.S. trade and imports. It’s now down to 16 or 17 percent. So huge decline. Lots of that is replaced by Mexico, is replaced by Southeast Asia, is replaced by Poland, by some other countries sort of around the world. So we’re seeing some movement. The real challenge here is there are particular things that China really dominates. And you can’t really get it anywhere else. Either you can’t get it all anywhere else, or you can’t get it at an affordable price anywhere else. So, there are all sorts of minerals that it processes. There’s rare earths, they’re things like graphite, and germanium, and gallium, which—you know, a bunch of names, but these are really important things if you want to actually have a phone or do you want to have sort of modern technologies, and the like, or if you want your car to drive. They’re part of all of that. And they, in many of these areas, controls 60, 70, 80, 90 percent of processing and production. They also make the vast, vast majority of solar panels. So, if you want to go green and you want to have clean energy, this is the place where they make most of them. And so I think there’s a lot of challenges here, is how do you build up capacity in other parts of the world for these various products? And the last thing I’ll say is, one is just can you make the investment in other places, right? There are environmental regulations with mining and refining that are kind of hard to deal with in some places. But two is, because China has such a lock on some of these industries—80 to 90 percent of production—they can flood the market. And if you’re a private company who has to make a profit, China and state-owned enterprises in China don’t actually have those limitations sometimes. So they can lower the price, drive your business, and then put it back up. So this is where a lot of governments are starting to think about industrial policy, think about subsidies, thinking about supporting industries to make sure, you know, we have things, like masks, made in the United States, or basic medicines made in the United States. Thinking about things that we see as part of national security, and paying for them so that we don’t rely on countries that maybe we don’t quite trust to give it to us in an emergency. FASKIANOS: Thank you. I’m going to take the next question from Ibtissam Klait, who’s with the University of the People, and is also a CFR Higher Education Ambassador. Q: Hello, Dr. Shannon. Hello, Irina. Thank you for this invitation. Dr. Irina, I believe that the belt of—the One Belt, One Road that connects China to the world, this is a stark example of globalization which would have manifested into a military power. I want your perspective, please. Thank you. O’NEIL: Sure. No, happy to talk about that. And let me say two things about that. One is, I’m not saying there hasn’t been any globalization. Of course, there has. I’m just saying that there’s been more regionalization than globalization. So on the company side, right, we see companies that are truly global. We just see more companies that, when they went international, they went regional. And I would say the Belt and Road is actually a really good example of this. Because when you look at the investments that that China has made abroad, a strong majority have been within the region. They focused a lot of that money in Asia. Yes, they have projects that span Europe, they buy up, you know, percentages of ports. Yes, they have projects that go to Latin America, where they build grids and roads and deepen ports, or in Africa the same. Sure, they do. They have those. But the strong majority has been regional. That’s really where they focus the Belt and Road money to create the infrastructure, to lower logistics costs that make it even more regional, right? Make it even more competitive for companies to operate across border lines, for ships, and roads, and rails, and airports, and the like to fly and to move within the region. So, I think this is a question—it is a situation of both. But even there, Belt and Road has actually been a regionalizing force. The hundreds of billions of dollars they have put in there throughout Asia have made it even more regional in Asia than global, often. FASKIANOS: Thank you. I’m going to take the next question from Charlotte Hulme, who is an assistant professor of the U.S. Military Academy at West Point: I’d be curious to know your thoughts on what would have been the differential political fallout had the United States focused on regional integration as opposed to globalization? O’NEIL: I mean, this is a hard challenge for the United States, right? Because part—the United States was and has been really the anchor of global order since—at least in the post-World War II period, right? The United States is one of the bigger pushers of the Bretton Woods institutions, you know, the IMF, the World Bank, the World Trade Organization, and others. So, they really have been sort of holding up this system. The other interesting thing with the United States is, yes, while we participate in the World Trade Organization and the like, we actually are not all that open in terms of trade. Trade, as a part of our economy, is not a particularly big part. And, in part, because we have such a big economy and in a fairly prosperous one, when you think about relative to other global actors and countries around the world. But we also have not signed very many free trade agreements. In fact, we have access—preferential access through free trade agreements, you know, no tariffs or lower regulations, the like, to less than 10 percent of the globe’s economy. And just to put that into perspective, Mexico and Canada have signed free trade agreements that gives them access to 60 percent of the globe’s economy. So when we are trying to send exports out into the world, Mexico and Canada have an advantage over us in about 50 percent of the globe’s economy, because they have free trade agreements. So they don’t pay tariffs. They have fewer barriers, you know, sanitary checks or other kinds of certifications than the United States, because we, frankly, just don’t have market access. We don’t have preferential market assets, because we haven’t signed free trade agreements. So, one of the benefits of this regionalization is we can actually export through—if we—you know, our inputs, the things that—you know, parts and components that we make in the United States are assembled in Mexico or assembled in Canada, they can go out and go tariff-free into markets like Japan, like Australia, like much of Asia. They can go tariff free into Europe if they go out from Mexico, in ways that we can’t. Where we would pay money. I’ll give you an example. If a car is exported from Mexico into Europe, you know, a Ford Fiesta, let’s say, or a car from Mexico, they pay zero tariffs because Mexico has a trade agreement with the EU. If a car is exported from the United States, it’ll pay depending on the car a 10 to 20 percent tariff. So it’d be unaffordable. So we don’t export cars. But if the engine comes from the United States, and it goes into a car in Mexico, then that car is exported, then all the workers, they get to participate in that trade and they don’t pay tariffs. And you can see a competitiveness. So, the importance of this regionalization, we in some ways the United States are held back in our exports because we don’t have preferred access. Other people have—don’t pay tariffs, and we do pay tariffs. So our goods are more expensive. And one way around that, particularly right now when the United States government in Washington doesn’t seem particularly keen on signing any new agreements. One way to get in the back door there is to focus and double down on regionalization. Because Canada and Mexico are partners in a free trade agreement, the USMCA, they do have access. They have signed agreements. And it’s a way that we can actually benefit, sort of piggyback on that work that they’ve done in their market access, in ways that we don’t have. FASKIANOS: Great. I’m going to go next to Sophia Samara. Q: Can you hear me? FASKIANOS: Yes, we can. And you’re— Q: OK, great. FASKIANOS: You’re with what university? Q: I study international and European studies at the University of Macedonia in Greece. And I want to ask something more theoretical. You focused on economy and trade. However, theoretically, globalization has, like, an analogy with global threats. And I wanted to—I want your opinion on, do you think that those threats that are global are a region-to-region phenomenon, that rise on the region and then move to another region? Or do you think that they’re actually global? So does the distinction you make only apply to the realm of economy and trade? Or could we apply it to other realms? Thank you. O’NEIL: Sure, Sophia. So this regionalization argument, I think, is most convincing on the economic side, and sort of commerce and the like. We do see regional aspects to other things as well, you know, to culture, to information. You know, when people read websites that are not in their home country, they tend to read those nearby. They don’t tend to read those far away. So you see, even in areas where there’s no cost, right? You and I can go online and we could look at a newspaper from anywhere in the world. We tend to just look at the ones that are nearby to us, and countries nearby, right? Not the ones further away. And you could—there are reasons there, right? There’s language reasons and the like. But that tends to be true. When you look at the movement of students, when you look at the movement of vacationers, they too tend to stay regional. So this sort of movement of people and ideas, that too has a much more regional sense than one would imagine. And so there is a centripetal force, if you will, there. Now, in terms of global threats here, right—and so, you know, I think there’s sort of different levels to this, right? When you go to war with someone, you tend to go to war with the people next to you, right? Sometimes you go to war with people far away, but usually it tends to be people next to you, right? We can just look at the most regional recent conflicts we have, right? We have Russia and Ukraine, and we have, you know, Israel and Gaza, right? Because you share borders, you tend to—some of those threats. Bigger, existential threats, like nuclear weapons and the like, sure, there are things that are—that are going to be regional that can reach any part of the world. Things like cyber threats, too, presumably could reach anything in the world as well. So, you know, there are aspects. I mean, in all of this I’m not—I would never say that things aren’t global, because they are, right? And as communications, as the movement of ideas and people, and information, and even goods and physical things, has—the costs have come down because of technology, because of shipping, because of airplanes, all this stuff, right? We do see movement around. But what’s surprising, given how low transportation costs have become, especially for ideas and the like—we’re at zero, frankly, right, with Zoom or voice over IP, or all of that. What’s surprising is how close things stay to particular countries or within particular regions, given that there’s no other frictions there, right? And even threats, I would argue, lots of threats come between—or conflicts come between those who are near each other. So does cooperation, right? You look at free trade agreements and things like that, they tend to be with your neighbors, they tend to be with those closer by. But so do conflicts. You know, overall—of course, there’s conflicts with places far away, but they tend to be, especially the kinetic ones, with those who are next door to you. FASKIANOS: Thank you. I’m going to take the next written question from Blake Dann, a junior at Arizona State University, majoring in global politics: I’m curious if this trend toward regional economic integration may affect multinational defense agreements as these countries become less tied together economically. For example, European dependence on American defense. O’NEIL: Hmm, yeah. No, that’s a good question. I guess I would say that—I’d say, you know, I’ve been talking a bit about sort of the trends of the last forty to fifty years, which was, you know, I would argue more regional than global. I would also say right now, over the last decade but particularly accelerated the last couple of years, we’re seeing sort of a once-in-a-generation fluidity to these supply chains. And there’s all sorts of reasons. There’s automation and technology, there’s demographic changes. There’s climate changes. But particularly, there are geopolitical changes and there are industrial policy changes. So governments intervening in markets. So where many of these decisions were market based, where people were looking for price competitiveness and the ability to compete, now increasingly I think many companies are making decisions based on things that governments are doing, right? They’re either—you know, geopolitics, they’re favoring certain countries over other countries, or they’re offering subsidies or tax breaks, or sanctions to force sourcing or production or sales in different countries. So I’d say all of that, you’re seeing some movement around there. Part of that, especially the geopolitics of it, is you’re seeing what our Treasury Secretary Janet Yellen calls friend-shoring but, you know, looking to put particular industries that you find important to your national security in places that you trust will give you access to those things if bad things happen, right? So in this, the United States trusts Europe, pretty much. They don’t trust China so much. And vice versa. And so I think here, just getting back to your defense question, what the United—what I think all countries will find, including the United States, is that it’s going to be very hard to indefinitely subsidize many industries. Perhaps semiconductors is something that we’ll permanently subsidize, but other than that there are very few industries that you’re willing to permanently subsidize, for lots of reasons. So industries, companies are going to have to be profitable. And to be profitable, it’s very hard to make things in just one country, just in the United States. So for defense, when you’re sourcing different parts for planes, for what—surveillance equipment, for whatever it is that you need, you’re going to have to have manufacturing and industrial partners. And you’re going to add on this national security layer, which is it needs to be countries that you trust. So there, actually, I don’t think Europe will be cut out, because that’s a whole host of countries that we trust. I think many of the arrangements that we see the government trying to make—the Biden administration trying to make with countries in Asia that we trust—Japan, South Korea, Australia, India, perhaps—that’s partly trying to find different places where you can source. Lots of things there. There’s geopolitics there too. But on the commercial side, that you can source from. And I think you’re going to see the United States turning more and more to those in the Western Hemisphere, particularly Canada and Mexico, given the already deep trading ties, the industrial bases there, and the trust that we have in those countries. So it doesn’t mean Europe will be excluded, but I do think there still will be the sort of regional aspect to that, because it is profitable, because there’s already a proven path to profitability for private companies who participate in all this who, if they don’t turn a profit, will go out of business tomorrow. Which is different than places where you have state-owned enterprises that have a cushion of a federal budget. FASKIANOS: Great. I’m going to go next to Zachary Billot. Q: Hi, there. I’m a senior at the University of Nevada, Las Vegas, majoring in political science. But my main interest area is in international organizations and the design of them. So I’m interested to see your opinions on the Chinese integration, either as an observer state or sort of as a funding partner, to several different international organizations—the Arctic Council, building of the African Union new headquarters. I’d be interested to see how you think that might play into this idea of regionalization first, but still globalized focus or command of control abroad? O’NEIL: No, that’s a great question. And, you know, one thing you’ve seen China successfully do, and concertedly do, is really become big players in all kinds of international organizations, in all kinds of UN bodies, and the ones that you’ve just discussed. They become really big players in lots of the standard-setting bodies around the world, the International Telecoms Union and others, that set the standards for all kinds of technologies, and the like. So they submit dozens and dozens of papers and the like. In part, because if they can set the standards then their companies can get ahead, but also in part, they have, you know, an interest in those aspects. We’ve also seen them create organizations when they have felt—or, be part of founding organizations if they felt that the international ones out there don’t suit their purposes. The BRICS is one of them. You know, sort of a group of emerging markets that came together. China being one of them, Brazil, Russia, India. China, the first founder, South Africa and the new members who just joined in the last few months as well. You see them forming an Asian Infrastructure Bank. I mean, there’s a lot of things that they’re doing on the global stage as they’ve sort of kind of emerged and want to assert their influence and authority, and the like. Some of this is good, right? One of the previous questions was about the Belt and Road Initiative, and China’s invested hundreds of billions of dollars to build infrastructure in countries that didn’t have it and needed it. And it’s helped those countries grow. And so some of that is important. Other parts, you know, there is at times a coercive side to this. So much of the funding that China has put out there, often some of the terms are onerous or very opaque, and, you know, at times collateral is natural resources or even the ports or airports or things themselves, as we saw in the last couple of years in Sri Lanka and places, where it’s a very difficult balance. So as China is the second-biggest economy in the world, it’s an incredibly important player and it needs to be a voice in these global institutions if they’re going to matter. That’s for sure. But you also need to find some sort of balance. And it’s hard when some countries come to these organizations to try to solve problems together and others come just to get kind of advantage, right? And I think there’s moments when you see that, and where they don’t really work. And I think, you know, one of the challenges, for instance, with the World Trade Organization today is many countries, including the United States, feel that it isn’t working to actually set ground rules that are fair and transparent, right? Because it deals with tariffs, but it has nothing for subsidies. And that’s really been the China growth model, is to put in subsidies to sort of give its companies and its products a leg up in various places. So, you know, I think this is one of the things that international organizations struggle most with, is we need to include China because it’s one of the most vital players in the world and countries in the world. And if we’re going to solve climate change and all kinds of other things, they’re going to have to be part of it. But there’s often a disappointment, and a frustration, and even anger that they are not playing—they’re not contributing to the public good within these organizations. And how do you balance all of that? So, I don’t think there’s any easy answers, Zachary—(laughs)—on how we do this. But I think it is—it is why we’re seeing struggling. And, frankly, why I think we’re seeing more issues coming down to bilateral, multilateral things. So rather than the World Trade Organization, we’re seeing the G7, or the G20 take on these issues, because these bigger global organizations aren’t able to grapple with the global problems we have today. FASKIANOS: Great. I’m going to take the next question from Fernando Reimers, who wrote his question but has also raised his hand. So, Fernando, you can just ask it yourself. Q: Thank you, Irina. Shannon, thank you so much for writing the book and for the—for the webinar. So what is your explanation for how U.S. domestic politics explain the fact that we didn’t pursue regionalization more aggressively? I’ll just share an observation which may not have anything to do with it. But I remember when we began to talk about NAFTA, I was convinced it was going to be like the European Common Market, if not the EU. And I remember writing to Larry Summers, saying we should be prepared because there are going to be all kinds of education exchanges between universities and so on, between countries in NAFTA. And none of that came to pass. In contrast, in my own field, in education, I’ve seen an extremely effective creation of exchanges between China and the U.S. You know, the Confucius Asia Society played an incredible role getting K-12 schools to teach Chinese to kids, teach them about China, and so on. So, anyway, that may not be part of the answer, but why? How are own domestic politics a part of the explanation for why we missed this opportunity? O’NEIL: Mm hmm. And, Fernando, nice to hear your voice. It’s been a long time. (Laughs.) Q: Yeah. O’NEIL: But, you know, I think there’s a lot of answers. But one of the reasons is that I think it caught us by surprise. And, you know, you look back at the postwar period after World War II, and the rest of the world was decimated because those wars have been fought in their places, right? So Europe was decimated, right? The roads were destroyed. The rails were destroyed. You know, it had been the center of war. And Japan had also been destroyed, right? The bombs—so, you had—for twenty years there was no industrial competition around the world, right? The United States was the only game in town in terms of this. And we got—we didn’t have to be efficient. We were the only ones who were able to produce. And we did produce for the world, right? We did send these things out to the world. The other thing is that when Europe, and Japan, and Asia rebuilt, they rebuilt more technologically sophisticated for the time, right? They rebuilt with a more modern infrastructure. And when you see that today, if you go to China, their infrastructure is much better than our infrastructure. I will say that as living in New York and going—I mean, our airports are getting better, but it’s been a while. But you go there. And so as you get to the 1970s, and 1980s, the United States and had no competition for twenty years, and had gotten used to, like, there’s nobody else who makes anything out there that’s any good. In fact, part of the Marshall Plan was bringing people from Europe here to train them how to make stuff again, and all of this right? And then all of sudden you hit the 1970s and 1980s and, you know, what? Europe and Japan figured out how to make stuff. And they had set it up in a different way that was much more competitive than the prewar period, and much more competitive than the United States was by itself. And so, I think there’s a little bit of just a mindset here, is the United States—I mean, we’re a huge country. We’re a prosperous country. We have some of the best technology, the best universities—of which you’re a part of. I mean, there’s all these things and advantages that we still have. But I think we got a little bit used to resting on our laurels, that nobody else could compete with us. And, you know, lo and behold, 1980s, 1990s, lots of people compete with us. And, in fact, they had a leg up a bit, because when they rebuilt their manufacturing industrial base, they did it in a more efficient, later twentieth century into the twenty-first century kind of way. And they never kind of came at it as, like, we’re going to be alone. We don’t have to do it with anyone else. And I would say just the comparison with China. I mean, China is shifting right now, but it came up knowing—I mean, its rise—its incredible rise with double-digit growth for twenty-five, thirty years, was really based on the global economy. And it’s just the last ten years where they’ve been pulling back, right? They’ve been reducing trade as part of their economy. They’ve been trying to become self-sufficient, right? Indigenous innovation, all these, you know, five-year, ten-year plans are all about becoming more self-sufficient. But they too harnessed the global economy, and the United States, frankly, for that rise. In ways that, you know, we didn’t. Our path was different in our industrialization and our growth. And so, I think we have to adjust our mindset that for us to succeed it’s got to be kind of a team effort, right? We can’t just be—we’re not playing singles here anymore, right? This is a team. Q: Thank you. FASKIANOS: Thank you. I’m going to go next to Mojúbàolú Olufúnké Okome. Q: Thank you very much. Mojúbàolú Olufúnké Okome. And I teach political science at Brooklyn College. So thank you very much for your thought-provoking presentation. I have to confess, I haven’t read the book. But I was just—a lot of questions came up for me. And one is, if regionalization is so beneficial and NAFTA was supposed to be a regional economic agreement, why hasn’t NAFTA been beneficial to North America in general? Also, China doesn’t seem to be putting all its eggs in the regional basket. And wouldn’t it be more logical to combine regional and global strategies? So and what is intriguing about your presentation is that this regionalization thing has been pushed in the Global South more than, you know, in the Global North. So why is it that there was no embrace of the usefulness of regionalism in the Global North? You know, because in the Global South it was, like, if we’re going to develop, we have to do more south-south trade. And for Africa, where I’m from—actually, I’m speaking from Nigeria today—this has been the thing. But, you know, we haven’t managed to grasp it. But there’s that African Continental Free Trade Agreement that’s supposed to maybe push it some. So really love to hear what you have to say. O’NEIL: Great. I’ll give you a short answer, since there’s three questions. And I guess, good afternoon, or good evening, since you’re in Nigeria. (Laughs.) So on the first one, NAFTA, you know, I think the limitations to NAFTA are that it’s just not that deep an agreement. It’s basically an investment agreement. So it makes sure there’s a level playing field for investment. It does reduce tariffs. But it isn’t as deep in agreement as we saw, say, in Europe, where, you know, it’s about regulations, it was about monetary policy, as the euro came along. It was about the movement of people, it’s about the way—you know, sanitary checks and all sorts of things. You saw the EU really develop a central bank, develop a judicial system, develop a parliament. It’s a really deep integration that has been, frankly, beneficial on a commercial side in ways that NAFTA never was, right? NAFTA has no staff, right? NAFTA is a trade agreement, but it’s much more limited. What I would say is that it’s always hard to prove the counterfactual, but I think there’s a good case to be made that without NAFTA the United States and North America wouldn’t have an auto industry anymore. It just wouldn’t be competitive. We’d be importing cars from other places. You know, there are a lot of industries actually that have integrated. What NAFTA has done is certain industries have integrated, but not all that many. And the industries that have integrated have actually become locally, but also globally, competitive. So automotive industry, aerospace industry, some processed foods. There’s some machinery and the like. You see sort of competitiveness, and growth, and prosperity in those industries that really have integrated and used NAFTA as the base. But you haven’t seen as many as you see in Asia. So, I would say NAFTA actually has been a good thing. It just hasn’t been as widespread. And in part, because it’s a somewhat weak agreement, right? It’s not all that significant and forcing of integration. On China, I would say what you see in China and part of its rise is it chose a regional strategy in making things and then a global strategy in selling things. And so you see a bit of both. And now more recently, China has been turning to a regional or even more domestic in making things. Sort of its China for China policies, where they want the value-added to be made in China not made in other places. And more regional in selling things. So there’s movements over time. Part of that is U.S.-China tensions. They don’t want to be dependent on the United States, so they’re looking for other markets. Often within the region, Southeast Asia, and the like. But they did combine that. Regional in making things, hooking into regional supply chains for sort of the growth, and learning, and in learning managerial skills, and knowledge, and intellectual property, and the like. And then looking at global markets as a place to sell these goods. And then finally on sort of the Global South and regionalization, you hear a lot of talk about regionalization in the Global South. You hear it in Africa. I do a lot of work on Latin America. You hear it over—you’ve heard it in Latin America since the 1960s. There’s been almost twenty organizations set up to bring regionalization to Latin America. The reality is, Africa, Latin America, the Middle East, South Asia, they haven’t been able to do it. The rhetoric is there, but the reality is not. And the trade between the countries in Africa, or the trade between the countries in South America, is very low. It’s 10 to 15 percent. And really, the vast, vast majority, 85 to 90 percent, goes to places far away. And what that has meant is largely that Africa and Latin America and other places have been kept on the ends of supply chains. So they send out raw materials and they buy back the finished goods. And all of the value-added, the manufacturing and the technology and the sophistication, happens in other places. So they don’t learn. You know, you don’t have sort of climbing the value added. You don’t have educational gains. You don’t have better jobs with better wages paid, because you just are sending out the raw commodities—the oil and the minerals and the cobalt and the like, and then you’re bringing back the iPhone or the Samsung phone, or whatever it is. And that’s where I think regionalization has a real promise for Africa, for other places. And hopefully the Africa Continental Free Trade Agreement will help begin to do that. But I think this is the real challenge. There’s a lot of talk about it, but we haven’t seen the actual numbers change. And I think that’s why in some places you haven’t seen inclusive growth. It’s one of the factors. FASKIANOS: We have very little time left. So I’m just going to do a quick hit—it may not be a quick hit—for a written question from JP Maddaloni, who’s a military professor at the U.S. Naval War College: Are there certain commodities, he’s thinking energy, that are more global than regional? Do you see a regionalization dominance in certain commodities? O’NEIL: That’s a—that is a great question. And, yes, there is commodities, because some are just found in certain places, right? Like cobalt is only found in the Democratic Republic of Congo, pretty much—(laughs)—you know, places. Others, you know, nickel and things, are in three or four countries. So, yes, oil as well. So those are global commodities. In terms of value, in terms of global trade and the global economy, which is $100 trillion, they’re not a huge value. So that’s partly why they don’t look quite as important. They’re sort of the beginning of a process, not the middle or the end of the process. And even some of those are regional, right? So oil markets are global, though you see different prices in parts of the world. But natural gas markets are very regional. And I will say sort of last, as we finish this out, as we move to a greener economy and greener energy supplies, they will tend to get more regional or even more local, right? You’re not going to send solar power across an ocean. You’re not going to send wind power across an ocean. Geothermal too is going to be used more locally. And natural gas, which is a bridging kind of fuel or energy source, is already very regional in its—in its pricing and in its use. So, yes, there are commodities that are out there that are global, but I think even there some of the phenomenon—especially in the energy and energy transition—is going to be more regional and more local as we go forward. FASKIANOS: Fantastic. Thank you to all of you for your questions and comments. I’m sorry that we couldn’t get to all of you. Shannon, we’re just going to have to have you back. But you should also—I commend her book to you. Again, the title is The Globalization Myth: Why Regions Matter. And you’ll find some answers there. So please check that out. And you can also follow Dr. O’Neil on X, formerly known as Twitter, at @shannonkoneil. So, Shannon, thank you for this hour. We really do appreciate it. The next Academic Webinar will be on Wednesday, January 31, at 1:00 p.m. Eastern Time with Thomas Graham, who is a distinguished fellow at CFR; and Bonny Lin, who’s at the Center for Strategic and International Studies. And they’ll talk about the China-Russia relations. And in the meantime, I encourage you to learn about CFR paid internships for students and fellowships for professors at CFR.org/Careers. Follow us at @CFR_academic on X, and visit CFR.org, ForeignAffairs.com, and ThinkGlobalHealth.org for research and analysis from our fellows. So please do go there for more information on global issues. And again, thank you all for joining us. And Shannon, thank you to you. O’NEIL: Thank you all, and thanks for the questions. (END)
  • Supply Chains
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    It’s Not Deglobalization, It’s Regionalization
    Decoupling and derisking, deglobalization, slowbalization, and localization. Journalists, columnists, and more than a few authors are touting the end of an era of hyperglobalization characterized by open markets and capital flows, of seamless transport and ever-rising trade across the world. Policymakers and CEOs caution that this fragmentation of the global economy is slowing innovation, boosting inflation, and leaving workers, shoppers, and citizens worse off. Yet these takes largely miss the biggest international economic story of the last five decades. More than globalizing, the world economy was regionalizing. That means the starting point for today’s shifts in international supply chains is distinct from most conventional takes. And these views tend to overstate the ability of government policies to disentangle international commerce. Even in the face of hostile geopolitics and industrial policy and protections, the factors that drove regionalization in recent decades will remain powerful and profitable. True globalization may not be in our future, but regionalization still is. Much is being made of the recent downturn in trade, with international exchanges falling over 3 percent over the last twelve months. Yes, trade is slowing down, and no longer outpacing global growth. But this is off of record highs. And looking over the last forty years, trade has steadily grown in volume and importance to the global economy, now comprising a significant majority of all economic activity. To be sure, production and trade are shifting as international supply chains reconfigure themselves. The biggest shift has been from China, which has pulled back as the main engine of global commerce. Trade as part of the Chinese economy has fallen from a high of 64 percent of the GDP in 2006 to just 37 percent today. China’s pullback explains in part why global trade growth has slowed. Yet it has also opened opportunities for other nations to step in. And many have. Vietnam, Thailand, Korea, India, Mexico, Poland, and the Czech Republic are among those that have boosted exports in real terms. None of these rising trading nations will make the singular splash that China’s entry into the world’s economy did at the turn of the 21st century. For most, their populations and markets are smaller, so they won’t individually impact global flows as significantly. India, the most obvious contender to replace China given its size and global ambitions, has yet to be able to get beyond its bureaucracy, limited infrastructure, and inherent protectionism. And for any nation aspiring to fill the trading gap being left by China, the market-led opening of the 1990s and 2000s, often dubbed the Washington Consensus, has given way to one increasingly guided by governments and public policies. The path China took to manufacturing dominance is no longer as clear or open in the 2020s. Still, collectively this host of countries can be as significant for global flows, ensuring that deglobalization, just like globalization, remains a myth. These new trading paths will lean regional. Many of the winners in Southeast Asia are rejiggering supply chains around the region, bolstered by the Regional Comprehensive Economic Partnership, or RCEP, which lowered tariffs and cut out paperwork for inputs and finished goods moving between its fifteen members. The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) helps its five Asian members as well by making it more efficient and profitable to trade with each other compared to those outside the club. Mexico’s trade growth also reflects deepening regional ties particularly with the United States through the USMCA, which replaced NAFTA in 2020. What companies are finding is that internationalization still makes sense for costs, talent, and profits. Governments will find that national security strengthening, supply chain resilience, and economic competitiveness also benefit from a geographic spread. But as we are seeing, it is shifting directions from that of the last forty years. Geopolitics and industrial policy matter. And regionalization looks to be that Goldilocks middle that will enable governments to protect growing national security concerns, boosting supply chain resilience and allowing companies to thrive.
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      Chair Cleveland, Chair Glas, and members of the Commission, thank you for inviting me to testify before the Commission. I appreciate the opportunity to appear before you today to testify about the distinctive features of China’s sovereign funds and their evolution in financing the global ambitions of the Communist Party of China (CPC) since President Xi came to power. Sovereign funds globally today collectively manage over $11.5 trillion in assets under management. These funds are predominantly based in commodity-exporting economies and capitalized by revenues from the monetization of natural resources, notably oil and gas. The world’s first sovereign fund was the Kuwait Investment Authority, established in 1953 from oil revenues. However, the largest of them in terms of assets under management is China Investment Corporation (CIC), based in China, the world’s leading commodity-importing country. In 2022, CIC surpassed the Government Pension Fund of Norway and became the largest sovereign fund in the world, having more than $1.35 trillion assets under management – exceeding the GDP of Mexico, the world’s 15th largest economy. The evolution of China’s sovereign funds has unfolded against the backdrop of China’s domestic financial reform and the globalization of Chinese capital. Once a backward country, China has caught up with Western powers on gross economic terms by relying upon its ability to mobilize capital. No other country in history has so rapidly transformed its economy from being among the world’s poorest and most isolated to one of the world’s largest economies, at the heart of the global supply chain, and a leading source of international investment capital. For the last two decades, China’s sovereign funds have played a significant role in China’s economy, mitigating financial crises and tempering exogenous shocks. They have supported China’s industrial policies by financing the state’s procurement of strategic overseas assets, bankrolling Chinese enterprises’ mergers and acquisitions abroad, and sponsoring the development of indigenous Chinese technology startups. As China’s state-owned capital has gone global, the scope of China’s geoeconomic influence has duly expanded. Let me explain how China’s sovereign funds fit into the state’s political economic system, why these funds are “leveraged” funds rather than “wealth” funds, and how they relate to China’s approach to managing its massive foreign exchange reserves. Unlike traditional commodity-based SWFs, China’s way of leveraging foreign exchange reserves to create sovereign funds does not rely upon natural resource revenues. China’s experience with sovereign funds demonstrates that a state without significant natural resource revenues can take on explicit or implicit leverage to source the seed capital for the founding of what I call sovereign leveraged funds (SLFs). China’s sovereign funds differ from commodity-based SWFs and constitute a distinct class. An inherent trait of SLFs is their funding scheme, which relies upon a series of complicated transactions, including debt issuances and other forms of implicit financial leverage. SLFs are a political-economic innovation because they are the product of the state leveraging its financial and political resources to make it possible to capitalize a fund without relying upon a high-profit revenue stream like the export of commodities. The way through which China created its sovereign funds is by using both explicit leverage and implicit leverage foreign exchange reserves. Explicit leverage means the issuance of debt and using the debt proceeds to capitalize SLFs. How the debts are structured and raised, who provide the debt proceeds, and who would control the newly established funds are not only financial issues but political issues. In other words, the decisions about how the newly issued debt will be underwritten and who will ultimately control the resultant SLF are the product of intensive political negotiation and aggressive bureaucratic competition. The establishment of CIC is an example of using explicit leverage. An alternative approach for the state to obtain investment capital is the use of implicit leverage to convert existing pools of low-risk capital, or state-owned assets like foreign exchange reserves, into high-risk-bearing capital that is subsequently transferred to the management of the SLF. How this process constitutes an increase in the state’s financial leverage can be understood by considering the typical investment made by a SLF. In general, the fund uses its capital to make an equity investment in a target company that is itself internally leveraged—that is, carrying debt on its own balance sheet. The sovereign fund’s equity interest is subordinate to the debt of the target company. The state is implicitly leveraged because the debt of the company stays off the balance sheet of the state, but the state still bears the risk of losing its entire equity stake if the company’s debt cannot be repaid. In other words, the leverage is external to the state’s balance sheet. In this way, the state itself does not issue any new debt or expand its balance sheet, but it still increases its financial leverage. China’s experiment with implicitly leveraging its reserves started with the transfer to Central Huijin of $66.4 billion in foreign exchange reserves in 2003 to recapitalize China’s failing banks and reform China’s nonbanking financial institutions. At that time Central Huijin was not created with the intention to be a sovereign fund but instead a special purpose vehicle for the sole purpose of restructuring China’s failing state-owned commercial banks. The success of Central Huijin’s restructuring of the banks ultimately led Central Huijin to outlive its original mission and take on new tasks of reforming China’s nonbanking financial institutions, such as the brokerage firms and capitalizing major Chinese policy-oriented financial institutions. While Central Huijin was China’s first attempt at leveraging foreign exchange reserves to solve an urgent domestic crisis, its proven track record has made it an indispensable part of the government’s crisis response toolbox. In May this year, the Ministry of Finance (MOF) reportedly proposed to restructure the state’s biggest bad-debt managers, or the so-called asset management companies, by moving MOF’s stakes in three asset management companies to Central Huijin. This proposal is in line with the government’s commitment to separate the government’s role as a regulator and shareholder, strengthening the role of Central Huijin as the “shareholder in chief” on behalf of the party-state while having the state’s regulators, including the newly-established National Administration of Financial Regulation, focus on financial risk prevention and mitigation. The creation of CIC can illustrate the explicit use of leverage over China’s foreign exchange reserves. The Ministry of Finance issued RMB1.55 trillion special purpose bonds and used the bond proceeds to purchase $200 billion foreign exchange reserves from the People’s Bank of China (PBoC), the central bank, and then capitalize CIC. The effect of these transactions was the transfer of $200 billion to CIC from the PBoC, but MOF remained as the sole shareholder of CIC. On September 29, 2007, CIC was officially incorporated as a wholly state-owned company under China’s Company Law. The key takeaway is that this process does not take any sophisticated financial engineering, but it does require a tremendous amount of political engineering and multi-agency political levering in order to move the foreign exchange reserves out of the PBoC for investment purposes without having to revise the PBoC Law, which prohibits the central bank from directly purchasing government bonds and financing fiscal expenditure. Economically, the use of either explicit (internal) or implicit (external) leverage over foreign exchange reserves decreases the stock of foreign exchange assets that can be counted towards foreign exchange reserves as defined by the International Monetary Fund (IMF). A most important distinction between the two approaches is the accounting treatment and awareness among the general public of its existence. Regardless of which type of leverage the state chooses when raising capital, the political outcome is the same: it will inevitably precipitate a political conflict among those that aspire to control the resultant capital. Implicit leverage is usually the more politically expedient choice because the associated liabilities are usually not recorded in official accounts. Both Central Huijin and investment companies affiliated with the State Administration of Foreign Exchange (SAFE) serve as examples of how the state takes on implicit leverage and then political conflict ensues. Since 2007, CIC and SAFE-owned investment funds have become more sophisticated in overseas investment activities. They have become significant market participants in terms of assets under management and prestige. Each has developed its own distinct culture and approach to investing. CIC has taken pains to present itself to the global financial community as a traditional institutional investor by being relatively transparent and pledging to be impartial to politics. Soon after its founding, CIC signed on to the Santiago Principles, a set of guidelines on transparency and governance designed by the IMF and meant explicitly for government-owned investment funds. In CIC’s early days, Chairman Lou Jiwei made great efforts to present CIC as a market-oriented, stabilizing force in global markets. Not everyone shared this view of CIC, and Chairman Lou publicly expressed frustration that some Western countries used “national security” as an excuse to block CIC’s investments. After Lou left CIC and was succeeded as chairman by Ding Xuedong in 2013, CIC began to align its investment strategy much closer to China’s national economic strategy while still maintaining its previous transparency. Compared to CIC, SAFE remains an opaque institution that has largely been able to avoid public scrutiny. Neither SAFE nor its affiliated investment funds disclose their portfolio holdings or gains and losses. At times, this penchant for secrecy has protected SAFE from criticism. For example, CIC received heavy public criticism when its first investments made during the 2008 financial crisis turned out to be loss-making. By contrast, SAFE’s public reputation was unaffected even though its investment losses in 2008 were likely much greater than CIC’s. The Financial Times reported that while CIC was savaged domestically for losing more than $4 billion in its misjudged investment in Blackstone and Morgan Stanley, the secretive SAFE hardly faced any criticism even though its losses were greater than those of CIC by an estimated twenty-fold. CIC may have learned a political lesson from SAFE that transparency is not always worthwhile. One long-time observer of CIC said the fund “has turned to stealth mode; it is doing transactions and is looking at lots of resource-related deals all over the world, but it is trying to hide its involvement.” Undoubtedly, there is some truth to these comments. CIC may be motivated by a desire to avoid potential domestic criticism of its actions and to head off reactionary protectionism in the countries in which it invests. Let me now turn to explain the Chinese government’s strategic use of foreign exchange reserves under President Xi. The bottom line is that the ascendance of Xi Jinping to China’s top leadership position in 2012 and the rollout of the Belt and Road Initiative (BRI) has motivated the party to leverage China’s foreign exchange reserves as strategic financial power to advance China’s overseas interests. According to Li Hongyan, director of SAFE’s Central Foreign Exchange Business Center, since 2013, the party has used foreign exchange reserves to replenish China’s policy banks and establish several new sovereign funds. These new funds include the Silk Road Fund, China-Latin America Production Capacity Cooperation Investment Fund (CLAC Fund), China-Africa Industrial Capacity Cooperation Fund, and Guoxin International Investment Corporation Limited (commonly known as CNIC Corporation). Li Hongyan identified three areas where the diversified use of foreign exchange reserves serves China’s national strategies. First, she argued that creating policy banks and sovereign funds provides a sustainable mechanism to put China’s foreign exchange reserves to work in service of China’s national strategies. Such diversified reserve usage has informed the formation of a Chinese investment system featuring equity and debt in adherence to commercial principles that can provide stable financial support for the Belt and Road Initiative and other national strategies. Second, she stated that using China’s foreign exchange reserves for international investment and cooperation can advance China’s participation in global governance and create a favorable international environment for the Belt and Road Initiative. Third, she asserted that strengthening the party’s leadership and corporate governance can discipline equity investment institutions and drive convergence towards professional management standards that will ultimately serve China’s national strategies. Under President Xi, the party-state has gradually expanded the SLFs model, applying it to reform state-owned enterprises (SOEs) to update the state’s industrial policy. China’s SOEs are supervised by the State-Owned Assets Supervision and Administration Commission (SASAC), formed in 2003 to consolidate many industry-specific bureaucracies. SASAC’s purview does not include the financial sector overseen by Central Huijin, itself sometimes called the “Financial SASAC.” Unlike in the financial sector, SOEs in the other sectors haven’t benefited from a SLF like Central Huijin, which sits atop the whole industry and directs capital flow down to individual SOEs. However, this began to change in November 2013 after President Xi laid out his vision for China’s economy for the first time at the Third Plenary Session of the Eighteenth CPC Central Committee. Xi led the working group that called for creating “state-owned capital investment companies” to invest in “key industries and fields that are vital to national security and are the lifeline of the national economy.” In effect, Xi’s proposed state-owned capital investment companies are SLFs mandated to focus on financing development in state-prioritized strategic industries like civil aviation, energy and mineral resources, nuclear power, and global shipping and logistics. Since July 2014, SASAC has begun reforming nineteen centrally administered SOEs in these strategic sectors and critical for the party’s military-civil fusion strategy to state-owned capital investment companies. Finance Minister Lou Jiwei, the founding chairman of CIC and its former CEO, was the person in charge of fleshing out the details of Xi’s vision. As the primary author of the State Council’s policy document “Opinions on Reforming and Improving the State-Owned Assets Management System,” Lou clearly drew upon his familiarity with the organizational models of CIC and Central Huijin while describing how a group of state-owned capital investment companies could exercise their shareholder’s rights in portfolio companies to “form a ‘separation zone’ between the government and the market.” Such a change in the mode of interactions between the state and the market does not represent the complete retreat of the state from the market but a retrenchment. The ongoing transformation of SASAC speaks to the continued centrality of the state in the market. In May 2017, the State Council approved SASAC’s plan to change its mandate from the administration of SOEs to the management of capital with the stated goals of pursuing long-term interests by channeling state capital into essential industries, critical infrastructure, and forward-looking strategic sectors of national security interest. Xi’s prioritization of capital management in China’s economic reform—and his use of SLFs as a tool to accomplish this—is not a complete departure from the path of his predecessors. Instead, it reflects the enduring influence on China’s economic policymaking of the dual successes of Central Huijin in stabilizing China’s financial system and CIC’s expansion into global financial markets. Like SLFs, the state-owned investment companies of SASAC allow the party-state to exercise control by leveraging capital instead of resorting to administrative directives. For Xi’s generation of CPC leadership, the SLFs model provides a ready playbook for expanding the influence of the party-state both at home and abroad. In recent years, Chinese sovereign leveraged funds have rarely been reported as involved in crass geoeconomic powerplays after SAFE was exposed for using its foreign exchange reserves to buy Costa Rica switching diplomatic relations to Beijing instead of Taipei in 2008. This is indicative of the considered steps taken to structure and obfuscate the funds’ activities in such a way that provides plausible deniability of their role in advancing the party-state’s strategic interests. Cultivating a sense of being detached from China’s geopolitical interests helps Chinese sovereign funds reduce market access barriers and transaction costs when they invest in Western markets, where China’s state-led investment bids have frequently been red-flagged as having geopolitical motives. As foreign animosity toward Chinese state-backed investments has risen, CIC has increasingly turned to joint ventures with influential institutional investors in host countries to shelter its assets from undue scrutiny by foreign governments or to sidestep administrative blocks on investing. CIC has seen some success with this method, as evidenced by the China-U.S. Industrial Cooperation Partnership, a private equity fund jointly launched by CIC and Goldman Sachs. The Partnership has bought several U.S. firms despite escalating U.S.-China trade tensions and intense scrutiny from Washington. The effectiveness of the joint venture strategy is most vividly illustrated by Goldman Sachs’s successful advocacy in front of the Committee on Foreign Investment in the United States (CFIUS) that the joint venture’s plan to buy Boyd Corp., a manufacturer of rubber gaskets and seals, be allowed to proceed. With the evolution of China’s sovereign funds in mind, I would like to discuss the specific case of the Silk Road Fund (SRF) to illustrate how the party-state under President Xi has strategically used China’s foreign exchange reserves and sovereign funds. SRF is unique among China’s sovereign funds that leverage foreign exchange reserves for overseas investment and strategic asset acquisitions. President Xi Jinping created the SRF to finance his BRI global campaign. The fund has closely followed the priorities of the BRI, focusing on infrastructure, connectivity, resource development, and industrial capacity cooperation. SAFE is the majority shareholder of this signature BRI financing vehicle, owning a 65 percent interest in the fund. Former PBoC Governor Zhou Xiaochuan described the SRF as a “private equity investor with a longer investment return.” He compared SRF to the World Bank’s International Finance Corp, the African Development Bank’s Mutual Development Fund, and the China-Africa Development Fund. Apart from the initial $10 billion invested into SRF discussed earlier, President Xi committed an additional RMB100 billion in capital to SRF at the opening ceremony of the Belt and Road Forum for International Cooperation in May 2017. Notably, this capital injection was in China’s currency, the renminbi, not in foreign exchange. Deputy Governor of the PBoC Yi Gang endorsed the plan the day after President Xi’s announcement, calling it “quite necessary and timely to expand SRF’s capital.” Yi explained that abundant capital would help SRF mobilize additional resources in BRI countries and crowd-in investment from other financial institutions. With ample capital, SRF proceeded to finance projects under the BRI umbrella. Bloomberg data show that during SRF’s first three years of operating, it invested $10.5 billion in Europe, more than one-quarter of the $40 billion that President Xi promised when he announced the fund’s establishment. SRF Chairman Xie Duo disclosed that SRF had signed forty-seven projects and committed more than $17.8 billion in investment as of October 2020. SRF’s investment track record suggests that it indeed has an investment horizon similar to that of a medium-to-long-term private equity fund, just as Governor Zhou said it would at the fund’s inception. The fund’s average investment period is seven to ten years, with some investments projected to be fifteen years or longer. Chairwoman Jin Qi disclosed that more than 70 percent of SRF’s committed investments are in the form of equity, with the rest being debt investment and project financing. The infusion of an additional RMB100 billion in cash into SRF was motivated by more than just ensuring the fund had adequate capital; it also served to advance cross-border payment and settlement using renminbi within the framework of the BRI. In a People’s Daily article commemorating the fifth anniversary of the BRI and reviewing the achievements of SRF, Chairwoman Jin Qi said that the renminbi capital injection meant that SRF could “provide financial support to Belt and Road projects in multiple currencies.” She added this would allow SRF to “satisfy different needs of Belt and Road countries for cross-border payment and settlement.” According to her, SRF was “exploring and promoting effective ways of investment in renminbi” and was aiming to take advantage of more “renminbi-denominated investment.” Using SRF as a vehicle to promote the use of the renminbi in international finance has clear benefits for China. First, it decreases currency risks for Chinese investors. Second, the renminbi’s internationalization is essential if China ever develops a financial network independent of the U.S. dollar. Using the BRI to promote renminbi internationalization gives the CPC more control over the process. This allows the party to decide how and at what pace renminbi internationalization will proceed, providing confidence that financial instability can be avoided. SRF has supported leading Chinese SOEs in their overseas project financing. SRF’s debut was its commitment to cooperate with China Three Gorges Corporation (CTG) and to finance the Karot Hydropower Project. The Karot Hydropower Project is a high-profile piece of the China-Pakistan Economic Corridor proposed by Premier Li Keqiang in May 2013. During President Xi’s visit to Islamabad in April 2015, SRF, CTG, and Pakistan Private Power and Infrastructure Board signed a memorandum of understanding to develop Pakistan’s hydropower project. According to SRF’s official statement, the total planned investment for the project is $1.65 billion. SRF’s financial support for this project took the form of both equity investment and debt participation. SRF bought an equity stake in CTG’s investment and operation platform for clean energy projects in South Asia, CTG South Asia Investment. SRF also agreed to participate in a consortium led by the Export-Import Bank of China to provide loans to the project. Besides the project in Pakistan, SRF also agreed to buy a 9.9 percent stake in Russia’s Yamal LNG project – of which China National Petroleum Corporation owns a 20 percent equity stake – and provide a fifteen-year loan of around €730 million (about $790 million). It also joined a consortium of four Chinese and international banks to invest $2.43 billion in the Hassyan Clean Coal Power Plant in Dubai, a project that China Harbin Electric International serves as the general contractor. Besides providing project financing using equity investment and loan provisions, SRF has financed major asset acquisitions by Chinese SOEs. In 2015, SRF provided financing to China National Chemical Corporation (ChemChina), China’s largest chemical company, to buy the Italian company Pirelli, the world’s fifth-largest tire maker, for $7.7 billion. The deal was structured in multiple steps, including a voluntary tender offer, mandatory tender offer, sell-out procedure, and squeeze-out procedure. To finance the purchase, SRF signed an equity investment agreement with ChemChina in June 2015, agreeing to purchase a 25 percent stake in CNRC International Holding (HK) Limited, a special purpose vehicle used to acquire the Pirelli ordinary shares owned by Camfin, an Italian holding company. ChemChina took out a syndicated loan from CDB, China Construction Bank, and the Export-Import Bank of China, all of which previously received cash injections from CIC at different times. The deal was completed in 2017, resulting in a combined entity with a 10 percent global market share in tire manufacturing. The Pirelli acquisition gave ChemChina access to technology to make premium tires that sold at higher margins and gave the Italian manufacturer preferential access to China, the world’s largest automotive market. At the time of ChemChina’s Pirelli acquisition, Italian Prime Minister Matteo Renzi was uncharacteristically silent about the deal. The Italian government made no protectionist noise against ChemChina’s acquisition. The deal led some Italian business leaders, including Pirelli’s CEO Marco Tronchetti Provera, to lobby the Italian government and steer Italian foreign policy towards a pro-China direction. The lobbying may have influenced Italian Prime Minister Giuseppe Conte to sign a preliminary accord for Italy to join the BRI during a visit by President Xi in March 2019. Italy was the first, and so far only, G7 country to sign on to support the BRI. Alongside this signing, Italy and China made about thirty deals that were cumulatively worth an initial €2.5 billion ($2.8 billion) but a potential total value of €20 billion. One of these deals was a memorandum of understanding to cooperate on international investments in China and BRI countries signed by SRF, Italian investment bank Cassa Depositi e Prestiti SpA (83 percent owned by the Italian Ministry of Economy and Finance), and Snam, Italy’s leading natural gas company. Recently, as the Italian government has become more wary about undesired Chinese influence, Prime Minister Giorgia Meloni’s administration has taken actions to block ChemChina from taking control over Pirelli and has been reviewing its options to exit BRI. In recent years, SRF has acquired strategic infrastructure assets like pipelines and ports in the countries along the BRI. SRF participated in a consortium that bought a 49 percent equity stake in Aramco Oil Pipelines for $12.4 billion in June 2021, one of the highest-value energy infrastructure transactions globally. Aramco Oil Pipelines is a new subsidiary of Saudi Aramco, Saudi Arabia’s national oil company and the world’s single largest oil producer. Aramco Oil Pipelines has the right to collect tariff payments for oil transported through Aramco’s crude oil pipeline network for twenty-five years. The consortium included Mubadala Investment Corporation (Abu Dhabi’s sovereign wealth fund), Samsung Asset Management, and Hassana Investment Company, a financial institution controlled by the Saudi government. SRF’s participation in such a large infrastructure deal shows that less than five years after its inception, it has already ascended to the ranks of the world’s largest and most respected sovereign funds and private institutional investors. SRF partnered with COSCO Shipping Ports (CSP), one of the world’s largest port terminal operators, to acquire port assets and advance China’s maritime strategies as part of the 21st Century Maritime Silk Road. In July 2019, SRF and CSP launched Navigator Investco in Hong Kong as an investment platform for equity investment in port assets and related businesses upstream and downstream. SRF owns 49 percent of Navigator Investco through its wholly-owned subsidiary TRD Investco, and CSP holds the remaining 51 percent shares. In October 2021, Navigator Investco agreed to acquire 100 percent of the shares of COSCO Shipping Ports (Rotterdam) Limited (Rotterdam Company), a wholly-owned subsidiary of CSP that owns a 35 percent stake in the Netherlands’ Euromax Terminal. Navigator’s acquisition of CSP’s subsidiary Rotterdam Company has two direct effects. First, upon completing this transaction, Navigator—and SRF, by extension—will become an indirect shareholder of Euromax Terminal through its full ownership of Rotterdam Company. Holding a minority share in Euromax Terminal firmly fits SRF’s mission to support the BRI and contributes to SRF’s portfolio diversification. Second, CSP will replenish its capital base by selling its subsidiary to Navigator and receiving cash. In effect, SRF is providing a capital injection to CSP via Navigator. The essence of SRF’s partnership with CSP and their joint investment platform Navigator is to leverage SRF’s access to China’s foreign exchange reserves and support CSP’s endeavor to establish a global terminal network and advance China’s maritime strategic interests. Besides working alongside Chinese corporations and directly supporting their overseas investment, SRF has entered into many cooperation agreements and memoranda of understanding to establish partnerships with foreign sovereign funds, state-owned asset management firms, and leading private institutional investors. A few of these agreements have already materialized into joint investment funds or cooperation funds. For example, SRF is the sole sponsor of the $2 billion China-Kazakhstan Production Capacity Cooperation Fund, with the Kazakhstan government agreeing to provide tax exemptions to the fund’s investments. This is the first such cooperation fund where SRF has participated as the sole sponsor structure. For its first investment, the fund bought common shares of stocks on the Astana International Exchange. Another example is the China-EU Co-Investment Fund, first proposed in June 2017 and launched in July 2018. The fund made its first investment in Cathay Midcap II, and it is committed to fostering synergies and advancing collaboration among businesses and enterprises in China and Europe. CIC has also adopted joint investment funds as a strategy to more expeditiously invest abroad amid heightened scrutiny of Chinese foreign direct investment (FDI) in foreign countries. For CIC, the primary purpose of investing through joint funds is to mitigate the risk that a foreign government will block an overseas investment. While this is certainly applicable for SRF, SRF’s cooperation funds also have China’s broader strategic agenda in mind concerning acquiring assets overseas and developing China’s long-term geoeconomic capacity in the long run. The economic difficulties triggered by the COVID-19 pandemic have driven policymakers in many countries to strengthen FDI reviews in order to head off opportunistic acquisitions by geopolitically-motivated investors. The supply chain disruptions stemming from the pandemic have brought home to many in government the dependence of the domestic economy on international suppliers. As multinationals reconfigure their global industrial supply chains, it is imperative that the United States and its allies strengthen and coordinate their FDI screening measures to ensure that hostile foreign governments are not allowed to gain control over companies that are critical to the global supply chain. In this context, I would like to conclude with three recommendations for legislative action. First, the U.S. government should take the initiative to consider working with the EU and lead a concerted effort to protect companies in critical sectors from undesired foreign takeovers that may hurt the national interests of FDI recipient countries. The launch of the EU-U.S. Trade and Technology Council in June 2021 is a step towards an integrated transatlantic approach to foreign investment. While high-level consultations are necessary, well-designed procedures for implementation are critical. An important first step is to identify hidden sources of state-owned or state-sponsored investors by enforcing the rule of “follow the money” in a multi-jurisdictional FDI reviewing process. China’s SLFs often operate through an offshore subsidy or joint investment fund, partnering with reputable Western investment brands to mask the source of capital for their investments and ultimately obscuring their connections to the Chinese state. This hidden state-owned capital requires that regulators conduct a forensic audit during the FDI review process. U.S. authorities have enforced the rule of “follow the money in the financial services sector and should consider integrating the practice into its FDI review process. There ought to be more formal cooperation between CFIUS and authorities from other countries going forward. Since the passage of the Foreign Investment Risk Review Modernization Act (FIRRMA) in 2018, the U.S. Treasury has engaged with dozens of countries on FDI screening. FIRRMA provisions make sharing information with national counterparts easier. Secondly, besides “follow the money,” an integrated transatlantic approach to FDI calls for creating a shared Entity List that identifies which foreign investors are unwelcome and a list of exempted foreign entities that are pre-approved, a so-called “white list.” This effort should include commonly adopted and enforced ground rules for determining which industries and segments of companies’ supply chains are off-limits to FDI. Implementing the shared Entity List will require not just support from government officials but also input from legal professionals specializing in cross-border mergers and acquisitions. The governments of the West are bound by the rule of law, and foreign state-led investors have increasingly spared no expense in hiring top-flight legal representation to help navigate FDI screenings and bring to close their cross-border mergers and acquisitions. Thus, western governments must work with legal service professionals to develop and enforce industry-wide best practices to successfully fend off foreign investment from undesired foreign entities. The goal of an internationally coordinated FDI screening regime should not be to implement protectionist policies but to strengthen U.S. leadership in shaping the global FDI investment environment. Ultimately, the United States and its allies should aim to create a level playfield that can protect the national interests of FDI recipient countries while maintaining a fair and open global investment system. When appropriate, domestic capital markets or government support should meet the capital needs of strategically important companies. Finally, the experience of China’s SLFs shows that there is an effective role to be played by the state as a direct participant in the market so as to maximize the embeddedness of national interests in market operations. The advent of China’s SLFs speaks to the broader issue of the rise of state-led investment and finance globally. Western policymakers tend to discredit the idea of state-led investment institutions. This thinking requires some change. With proper design and supervision, Western liberal market economies can establish their own SLFs to work as white knights to fend off undesired foreign takeovers in defense of their strategic industries and national interests. In fact, France and Germany have been making progress along this line. Like China, Western countries can establish and use their SLFs to strengthen the international competitiveness of specific critical companies, defend those companies from foreign takeover, and support the development of strategic industries.
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