Montrose Journal Winter 15


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SOFTWARE VERSUS HARDWARE: THE NEW TRADE WAR BETWEEN THE US AND CHINA -

Philip Delves Broughton

American policy towards China involves a constant effort to calibrate the gap between its ambitions and its ability to execute, between Beijing's propaganda, and its achievable intent. The New Silk Road is a significant new piece of this puzzle, to go alongside China's ghost cities, its war on corruption, the cyber attacks on American companies and government networks and its naval jousting around the Spratly Islands in the South China Sea.

No one in Washington can say for sure whether these are genuine challenges to the current economic and military order or as phony as film sets, vulnerable to being toppled at the slightest push. But equally, no one is willing to take their eyes off this fast-evolving situation.

For every move either side makes, the other has a counter. China announces the New Silk Road, America finalizes the Trans Pacific Partnership (TPP). China sends its Pacific fleet on manoeuvres, America encourages Japan's re-armament.

Depending on the time of day, and who you talk to in New York, Washington and Silicon Valley, China's emergence as an economic superpower is viewed either as America's greatest economic opportunity or its greatest threat. There is a cadre of international bankers, like Hank Paulson the former Treasury Secretary, who have long been China bulls, urging deep and constant engagement. Until very recently, they have been the dominant voice of American economic diplomacy towards China, muting concerns about China's governance, human rights or environmental records in favour of supporting its market reforms and economic growth.

But the sceptics and bears have been gaining ground, the New York based short-sellers who say China's economy is a debt-fueled mirage soon to collapse. They are concerned that China's newfound military assertiveness and Xi Jinping's attempt to build new global alliances reflect an internal panic about the slow implosion of China's export-driven economy. Silicon Valley, the other significant US voice in this debate, is torn between soaring iPhone sales in China and a booming Internet market, and the relentless battle to fend off Chinese based hackers and operate under Beijing's censorship rules. We see Mark Zuckerberg learning Mandarin - and starting to speak it excellently, by the way - while behind the scenes the giant tech firms have to spend fortunes protecting their firewalls.

Europe's response to China's surging economic clout reflects a different internal debate. When the Asian Infrastructure Investment Bank (AIIB) was established in 2014, Britain led the rush of Western countries to join, against the wishes of the Americans. Europe is already starved for growth, and the possibilities presented by China's markets and its investable capital are irresistible. Britain's Northern Powerhouse plans, for example, are likely to depend heavily on Chinese investment. There is no economic risk to European countries tweaking America, but plenty in missing out on China. Both the AIIB and the New Silk Road have already served an important purpose for China, smoking out allies long before any serious trade has to be done.

America is not so desperate as Europe. The response of the Obama administration to China has been a kind of wary engagement. The diplomatic back and forth has been as busy as at any time in relations between the two countries. But the US believes that the trick to this relationship in the coming years will be in keeping China always slightly off-balance, forever chasing the dream of global economic supremacy, but never quite getting there. Managing the physical and legal infrastructure of global trade is going be decisive in achieving this goal.

David Dollar of the Brookings Institute in Washington DC describes the different Chinese and American approaches to global trade as hardware vs. software. The Chinese are roaming the world building factories and ports and sending workers all across Africa, Asia and Europe. They are promising to build the infrastructure of the future which will carry Chinese goods to new markets and secure vital commodities. For most of the period since Deng Xiaoping's reforms began opening China's economy, its advantage has been cheap labour. That advantage is now eroding. China's workers, particularly in the most developed areas along its southern and eastern borders, are demanding higher wages in return for their fast-improving educations and skills. There is cheaper labour to be found elsewhere in Asia, in Vietnam and soon in the slowly opening labour market of Myanmar, and Africa. The New Silk Road is part of China's evolution away from an economy driven solely by cheap exports, to one fueled by domestic consumption and the export of higher value goods. One can even add the recent decision to let families have two rather than just one child to the set of policies designed to improve China's domestic market.

America views the attempt to build and control global infrastructure as quaintly old-fashioned. It smacks of grandiose, shambolic projects like the Pan-American Highway, the kind of projects America has long since abandoned. Instead, Washington has chosen the route of sweeping trade deals like the TPP with 11 countries in Asia and the Americas and the Transatlantic Trade and Investment Partnership (TTIP) with Europe, seeking to open markets and bind its allies through the free exchange of goods and services. While the Chinese build railways, the Americans draft legal documents. If you accept Dollar's analogy, then America's approach makes a lot of sense, as software tends to be cheaper and more easily updatable to handle new circumstances. China prefers the hardware approach because its code, its laws and authoritarian government, are not so amenable to change.

If China's plans were easily achievable, they would not have proved nearly so galvanising domestically. The New Silk Road rhetoric has proved popular in part because of its back to the future grandiosity. In one breath, Xi Jinping sweeps China back to the age when its great 15th century Admiral Zheng Ye led China's fleets to trade with Africa and Arabia.

But the practical challenges are immense and America can see that. For now it sees OBOR as more a rhetorical weapon than a real one. At best, it might lead to China being able to sop up some of its under-utilised industrial capacity by forcing projects on allies too weak to refuse. But set aside the engineering feats required to build new single-gauge railways and highways across Central Asia to Europe, or new ports around the Indian Ocean and the Horn of Africa. Building out the trade route along the Kashgar-Gwadar economic corridor linking western China to the Indian Ocean via Pakistan is not as simple as adding a new intersection to the M4. Not every country lying along the path of the New Silk Road is thrilled about China running new trade routes across their territory and spheres of influence. Russia does not want China building its influence in the former Soviet republics of central Asia. India is already unhappy about China's investment in Sir Lanka's port infrastructure. The Japanese are growling about China's naval manoeuvres in the Pacific. Lurking in all this discontent are possibilities for American leverage and influence.

The most cynical interpretation of the TTP and TTIP is that they are America's efforts to isolate China, to reassert Western influence over the global economy. While the TTP could in theory one day include China, the TTIP emphatically does not, while moving the United States and Europe towards a more integrated market. Once the TTIP is complete, China might find it more difficult to enter the US and European markets if various technical and environmental standards are raised.

But another way to think about the different American and Chinese approaches is to see them as complementary rather than hostile. The British government certainly seems to take the view that one can easily serve both masters. David Cameron's government has tested Washington's patience by actively courting China. Washington's response has been to view the British as a little uppity, greedy and perhaps naive, but nothing worse. There may even be a grudging admiration for Britain's efforts to develop greater trust with China, a commodity still short in US-China relations.

If one spins out trade scenarios over decades, it is easy to imagine global trade deepening and spreading courtesy of both US-led deals and Chinese-built infrastructure. The biggest change from today would be that the West will have lost its ability to use trade as a cudgel to improve governance, human rights and environmental protections in China - though that cudgel has already been reduced to a twig by the rise of China's economy relative to the West's.

What we are seeing now, with the Chinese promising decades of infrastructure building and the Americans locking down deals with its major trading partners, are the two great sumo champions of the world economy settling in before a bout. They are settling in, slapping their thighs and throwing salt in the air, the way sumo wrestlers do to purify the ring. They are getting themselves ready for the moment when they must hurl themselves at each other. During the Cold War, the much-feared confrontation between the Soviets and America never occurred. In this new Silk War between the United States and China, one can only hope for the same.

Philip Delves Broughton is the author of Life's A Pitch and What They Teach You at Harvard Business School. He lives in Connecticut and writes regularly on US affairs.

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