Beyond the trade war – what does the new superpower rivalry mean for businesses in Asia?

  • Politics
  • 12 minute read
  • 16 October 2018

Two superpowers face each other warily across a vast ocean. One has been accustomed to dominating global trade and controlling the seas; the other is now powerful enough to challenge a status quo that has existed for decades. The two powers have clashed before and the challenger seeks to push its rival out of its regional sphere of influence. Meanwhile business leaders in the established power complain of unfair trade practices, protectionism and theft of technology.

Sounds familiar? This was the situation in the Caribbean at the end of the nineteenth century as the United States sought to push Great Britain out of the region and its businesses began competing with their formerly dominant rivals. History never repeats itself exactly but historical parallels and challenges can be illuminating. As Henry Kissinger has written: “Inevitably, the rising power impinges on some spheres heretofore treated as the exclusive preserve of the established power…Significant groups [in the U.S.] view China, by analogy to the Soviet Union in the Cold War, as determined to achieve military as well as economic dominance in all surrounding regions and hence, ultimately, hegemony.”

The United States and Britain managed their rivalry and avoided open conflict, but since then – to quote Kissinger again – the U.S. does not “have experience interacting on a sustained basis with a country of comparable size, reach, and economic performance embracing a distinctly different model of domestic order.” Instead of such sustained engagement with a comparable power, America’s political establishment –who mostly rose to prominence when the U.S.S.R. was a threat – easily default to Cold War policies.

What lessons does this offer us as we enter a new era in which China is branded a strategic competitor by the U.S. and the rivalry has moved beyond the military to the economic sphere? We consider a few possibilities for how the rivalry will play out and the implications for Chinese, American and other companies and investors.

It will all be over by Christmas … Much as the First World War was going to be a short skirmish, some commentators believe that after the U.S. midterm elections, the Trump administration will come to a deal with China that will bring the ongoing trade war to an end. The administration may indeed come to a limited deal that could reduce tensions in the short-term; however, the U.S. objectives are long-term and are shared by the left of the Democrats as well as by the protectionist Trumpian wing of the Republican party. This is not really about trade – it is about global dominance and who gets to write the economic rules for the 21st century. It is an attempt to circumscribe how models of state-controlled capitalism such as China’s can fit into the current global economy. It is also about disentangling the American supply chain from China and preventing China from accessing U.S. technology.

The recent U.S. National Defence Strategy paper states that China is trying to “shape a world antithetical to US values and interests”. According to this thinking the U.S. previously promoted the rise of China, believing that the country would gradually become more liberal, both politically and economically; the current administration believes that this hope was (and is) misplaced. For them the U.S. is engaged in a long-term conflict with China in which only one country can come out on top.

Are iPhones going to be made in Ohio? One of the hopes of the China hawks in the U.S. is that American companies will repatriate their supply chains, but – at least in the short-term – this is highly unlikely. It is not just a question of cost – the infrastructure of tech supply chains is highly complex, requiring the assembly of parts from many countries (with a high percentage of those parts being made by specialist manufacturers around Asia). It would take years to create this infrastructure in the U.S. and would be uneconomical to do so. In addition, China is also a huge domestic market (although in Apple’s case – with only 7 million iPhones sold in Q2 2018 in China – its market share is declining). However, there is another option for manufacturers in China – relocate elsewhere in Asia …

Who is going to benefit from this new Cold War? The prime candidate within Asia is Vietnam. It has a booming economy, a workforce that is skilled but still relatively cheap (compared to China), and a stable political system; on the downside, infrastructure needs to be upgraded and corruption remains an issue. In addition, Vietnam has a close political relationship to the U.S., as one of the countries that feels most threatened by China’s growing power.

Vietnam has already seen a boom in FDI (from Samsung in particular, which was responsible for a quarter of Vietnam’s total exports in 2017) and the economy grew at over 7% in 2018 Q2. The country is already the top ASEAN exporter to the U.S. But even for Vietnam there are risks: a trade war could lead to an overall drop in global demand that could hit Vietnam’s export economy. Equally, tariffs on Chinese goods could also affect those Vietnamese exports to China that are used as inputs in Chinese exports.

In the medium to long-term Vietnam could benefit from antagonism between China and the U.S. but in the short term it might lose out. Even if a significant amount of investment moves from China to Vietnam (including by Chinese companies themselves) it will take years for this process to play out.

What’s going to happen to US-China investment? Cross-border investment between the U.S. and China is (unsurprisingly) in steep decline. According to the research firm Rhodium Group Chinese investment in the U.S. fell by over 90% in the first five months of 2018 to just USD 1.8 billion. A number of Chinese investors who have previously focused on the U.S. market now say that it is almost impossible to do significant deals. Even non-Chinese companies are having difficulties. Take the Singaporean company Broadcom’s attempts to buy the chipmaker Qualcomm in the United States: the deal was hurriedly investigated by the US Committee on Foreign Investment in the United States (CFIUS), which claimed in March that there were national-security concerns that “relate to the risks associated with Broadcom’s relationships with third party foreign entities”. The suggestion was that the deal could have benefitted Chinese companies such as Huawei in the race for 5G dominance.

The implication is that companies in Asian countries other than China must choose between China and the U.S. in terms of commercial partners and investors. This is replicating at a commercial level what already happens at a geo-political level where Asian countries are being pushed towards alignment with either China or the U.S. Most have China as their largest trading partner but want the U.S. in the region to act as a balance to China. This policy requires a certain diplomatic ambiguity which may be difficult to retain in the future.

What about regional investment? The effect of a decrease of US-China investment will be an increase in intraregional investment, as more investors in Asia focus on their own region. Even within global companies and funds there will be more defined regional silos. Already large global PE funds are segregating their Chinese operations from their U.S operations and are no longer buying companies in China with the aim of helping them to expand into the U.S. market. Chinese investors who are blocked from the U.S. market may concentrate increasingly on Southeast Asia, where there will be stiff competition from Japanese and Korean companies. As U.S. investors find it increasingly difficult to invest into tech in China, more investment may come from Korea and Japan (it was recently announced that Softbank’s South Korean venture unit had launched a $300m venture fund targeting China). If the U.S.’s strategic rivalry with China pushes Asia to become increasingly economically integrated ironically it may help to diminish U.S. influence in the region.

It will all be over by Christmas …

Much as the First World War was going to be a short skirmish, some commentators believe that after the U.S. midterm elections, the Trump administration will come to a deal with China that will bring the ongoing trade war to an end. The administration may indeed come to a limited deal that could reduce tensions in the short-term; however, the U.S. objectives are long-term and are shared by the left of the Democrats as well as by the protectionist Trumpian wing of the Republican party. This is not really about trade – it is about global dominance and who gets to write the economic rules for the 21st century. It is an attempt to circumscribe how models of state-controlled capitalism such as China’s can fit into the current global economy. It is also about disentangling the American supply chain from China and preventing China from accessing U.S. technology.

The recent U.S. National Defence Strategy paper states that China is trying to “shape a world antithetical to US values and interests”. According to this thinking the U.S. previously promoted the rise of China, believing that the country would gradually become more liberal, both politically and economically; the current administration believes that this hope was (and is) misplaced. For them the U.S. is engaged in a long-term conflict with China in which only one country can come out on top.

Are iPhones going to be made in Ohio?

One of the hopes of the China hawks in the U.S. is that American companies will repatriate their supply chains, but – at least in the short-term – this is highly unlikely. It is not just a question of cost – the infrastructure of tech supply chains is highly complex, requiring the assembly of parts from many countries (with a high percentage of those parts being made by specialist manufacturers around Asia). It would take years to create this infrastructure in the U.S. and would be uneconomical to do so. In addition, China is also a huge domestic market (although in Apple’s case – with only 7 million iPhones sold in Q2 2018 in China – its market share is declining). However, there is another option for manufacturers in China – relocate elsewhere in Asia …

Who is going to benefit from this new Cold War?

The prime candidate within Asia is Vietnam. It has a booming economy, a workforce that is skilled but still relatively cheap (compared to China), and a stable political system; on the downside, infrastructure needs to be upgraded and corruption remains an issue. In addition, Vietnam has a close political relationship to the U.S., as one of the countries that feels most threatened by China’s growing power.

Vietnam has already seen a boom in FDI (from Samsung in particular, which was responsible for a quarter of Vietnam’s total exports in 2017) and the economy grew at over 7% in 2018 Q2. The country is already the top ASEAN exporter to the U.S. But even for Vietnam there are risks: a trade war could lead to an overall drop in global demand that could hit Vietnam’s export economy. Equally, tariffs on Chinese goods could also affect those Vietnamese exports to China that are used as inputs in Chinese exports.

In the medium to long-term Vietnam could benefit from antagonism between China and the U.S. but in the short term it might lose out. Even if a significant amount of investment moves from China to Vietnam (including by Chinese companies themselves) it will take years for this process to play out.

What’s going to happen to US-China investment?

Cross-border investment between the U.S. and China is (unsurprisingly) in steep decline. According to the research firm Rhodium Group Chinese investment in the U.S. fell by over 90% in the first five months of 2018 to just USD 1.8 billion. A number of Chinese investors who have previously focused on the U.S. market now say that it is almost impossible to do significant deals. Even non-Chinese companies are having difficulties. Take the Singaporean company Broadcom’s attempts to buy the chipmaker Qualcomm in the United States: the deal was hurriedly investigated by the US Committee on Foreign Investment in the United States (CFIUS), which claimed in March that there were national-security concerns that “relate to the risks associated with Broadcom’s relationships with third party foreign entities”. The suggestion was that the deal could have benefitted Chinese companies such as Huawei in the race for 5G dominance.

The implication is that companies in Asian countries other than China must choose between China and the U.S. in terms of commercial partners and investors. This is replicating at a commercial level what already happens at a geo-political level where Asian countries are being pushed towards alignment with either China or the U.S. Most have China as their largest trading partner but want the U.S. in the region to act as a balance to China. This policy requires a certain diplomatic ambiguity which may be difficult to retain in the future.

What about regional investment?

The effect of a decrease of US-China investment will be an increase in intraregional investment, as more investors in Asia focus on their own region. Even within global companies and funds there will be more defined regional silos. Already large global PE funds are segregating their Chinese operations from their U.S operations and are no longer buying companies in China with the aim of helping them to expand into the U.S. market. Chinese investors who are blocked from the U.S. market may concentrate increasingly on Southeast Asia, where there will be stiff competition from Japanese and Korean companies. As U.S. investors find it increasingly difficult to invest into tech in China, more investment may come from Korea and Japan (it was recently announced that Softbank’s South Korean venture unit had launched a $300m venture fund targeting China). If the U.S.’s strategic rivalry with China pushes Asia to become increasingly economically integrated ironically it may help to diminish U.S. influence in the region.