Twenty years ago, many reasonable people thought that bringing China into the global trading order would encourage the eventual liberalisation of its politics. Drawing on the experience in Western and Asian countries, it was argued that once China reached a certain stage of development, both the rising middle class and the logic of a developed economy would require political liberalisation. The middle classes, it was argued, would demand political and personal freedoms that accompanied their material wealth – only in this way could they be truly happy. And the logic of economic development held that authoritarian systems could not produce the intellectual discoveries and innovation that allowed countries to move from being an industrial society to a post-industrial one.

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The latter point also directly addressed the contention that a rising China could pose a geo-strategic threat to the West. Only a healthy, innovative post-industrial could produce the military that could eventually challenge the West. If an authoritarian system could not produce that type of economy, it follows that it could never create the military that would pose any real threat.

Alas, experience has shown these views to be at best optimistic. China’s burgeoning middle class seems not be taking to the streets to protest the Communist Party’s monopoly on power. President Xi Jinping’s successful removal of term limits, effectively allowing him to remain “president for life“, has passed with barely a peep from the Chinese people. China is now developing a “social credit score“, assigning each person a number based on how socially desirable they behave – in other words, whether they do what the Party wants. Rather than jail offenders as old-style Maoist regimes did,[3.  As occurred during the Anti-Rightist Campaign and the Cultural Revolution.] the new system simply denies those with low scores access to travel, property ownership, and other advantages. Call it “Nudge” for the totalitarian set.

Nor is China hesitating to spread its influence abroad. Its claims to islands and territory in the South China Sea, threatening countries that border the region, is only one way it is upsetting the West’s dominance. Its “One Road, One Belt” initiative is another. This will link it to over 70 countries.

Ancient Rome used its network of roads to tie conquered lands together and permit its military to move quickly to suppress any dissent. Russia used its control over a crucial natural gas pipeline to influence European and Ukrainian policies earlier this decade, and its proposal to create a new pipeline has raised legitimate fears that Russia could use this to further influence EU policies. At the very least, the One Belt, One Road initiative would give China’s military the capability to move vast distances and influence events far away from Asia should it choose to. Why should this not trouble the West?

Nor is China using its position within the global trading order responsibly. As Juliet Samuel’s audio documentary shows, China habitually tilts the rules of trade within its borders to favour its own firms over Western ones. Moreover, it stands accused of either masterminding or turning a blind eye to technology theft or mandatory transfers that allow it to acquire advanced methods and insights that can be turned to military purposes.

In effect, China has used “free” trade to acquire what it has been incapable of producing on its own, giving it capabilities for innovation that the Soviet Union never possessed.

The evidence is that it is using these developments to quickly catch up with Western standards of military capability. Its newest naval vessels and aircraft display Western-style stealth technology that many allege has been stolen from America. Other aspects of its military also display advanced technological capabilities. China is increasing its official military budget by nearly 9% a year, meaning it has more than doubled in just the past decade, and it is steadily closing the gap with America’s advanced technology. It is only able to do this because of its access to Western money, markets, and methods.

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The Greek historian Thucydides wrote over 2,000 years ago that “the strong do what they can while the weak suffer what they must”. In terms of military power, the West has been “the strong” for over five hundred years; it used this superiority to force the weak, including Imperial China, to suffer what they must for centuries.[1.  See, e.g., the Opium Wars.] It would defy our knowledge of human nature and human history to think that a humbled power which acquires the ability to be strong would not seek to redress past humiliations. Our experiences in the last century with post-Versailles Germany and Imperial Japan should loom large in our thinking.

A Cold War-era quote apocraphyally ascribed to Soviet founder Vladimir Lenin is apropos: “We will hang the last capitalist with the rope that he sold us.” China is on a path that could prove Lenin right, but with a twist: the rope that would hang the capitalist world would have been produced in China using methods and money provided freely by the capitalists.

United Western exclusion of the Soviet Union from Western money, markets, and methods hastened that totalitarian state’s demise. Perhaps the West should learn from its past victory and avoid a future defeat by using its power to nudge China back to a responsible, mutually beneficial course.

But as well as asking ‘why?’ we should also ask ‘how?’. Goods and services have to be paid for, so how do some countries manage to buy more than they sell, year after year, decade after decade? The answer is that enough money to fill the gap flows in from other countries – for instance, in the form of loans or as asset purchases. The inflow of capital ultimately pays for the deficit in trade. The corollary is that a persistent trade surplus is balanced by a net outflow of capital to other countries. It has to be, because if were consumed instead (i.e. used to pay for imports) then, by definition, the surplus would disappear.

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Cross-border capital flows matter a lot – arguably more than the global trade that they enable (and result from). For a start they influence exchange rates and interest rates, and hence prices, jobs and wages. The sudden withdrawal of capital from a country can crash its property market, its banking system – indeed its entire economy. (From a Chinese point of view, the 1997 Asian Financial Crisis, which brought down the decades-old Suharto regime in Indonesia, is a salutary example.) An influx of capital can also be disruptive, fuelling spending booms, debt bubbles and asset inflation.

When capital flows between nations, it’s not just money that budges, but also things such as technological know-how, diplomatic influence and even national sovereignty.

In short, money makes the world go round – especially the kind of money that goes around the world.

When money flows uphill

An economic nationalist like Donald Trump should be at least as interested in the cross-border flow of capital as he is in the cross-border flow of goods and services. Certainly, some of his most influential supporters are very interested. For instance, here’s what the billionaire tech investor Peter Thiel said on the subject:[1. Peter Thiel interviewed by Maria Bartiromo on Fox Business, 16 March 2018; https://m.youtube.com/watch?v=IY14NQEJXu0]

“Capital should be flowing from the US to invest in China, and then China should have trade deficits that offset the flows. We instead live in a world in which the money is strangely flowing uphill. The US, the slower growing economy, has the trade deficits and the investments are flowing from poor people in China into the US economy. It’s completely backwards. That tells us something is very strange in terms of the trade dynamics…”

Thiel raises a perplexing issue. One would indeed expect capital to flow from mature economies with modest levels of growth to emerging economies with high levels of growth. After all, investors like to put their money where it can get the biggest return.

So why does money flow ‘uphill’ – that is against the gradient of growth – from China to the West?

Before accusing China of ‘fixing’ the global economy, western governments need to address the distortions caused by their own policies. For instance, while their overall growth rates are low compared to China’s, returns on some investments are rather more attractive. The impact of perverse housing policies on property markets and QE on stock markets, has created a speculative free-for-all. Having supplied so many get-rich-quick opportunities, we can hardly blame foreigners for filling their boots.

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This suits our politicians very well. The influx of foreign cash not only provides a short term economic stimulus, it also helps keep interest rates low – always handy when there’s a perennial budget deficit to finance. Having foreigners buy up our assets requires them to buy our currency, thus pushing up its value, keeping imports cheap and inflation under control (always a worry when interest rates are low).

Obviously this is a disaster for our own exporting industries – and those parts of the country that are especially dependent on manufacturing. Meanwhile, asset bubbles suck the oxygen out of productive investment, as well as pushing house prices out of the reach of young people. All of this will come at ruinous long-term cost, but if, for the moment, it keeps the economic show on the road, our myopic rulers won’t mind.

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That said, Chinese government policy is also to blame. In particular, China’s refusal to reciprocate the West’s openness to Chinese investment in western assets. As Juliet Samuel explains in her documentary, lack of reciprocity is a general theme in China’s trade relationship with the West.

How the savings of the poor changed the world

Then again, the tendency for capital to flow from developing economies to developed ones is not limited to the Chinese case. It’s pretty much a universal pattern, at least in recent decades. This is known as the Lucas Puzzle, which is named after the economist Robert Lucas, who described the phenomenon back in 1990.[2. Robert Lucas, ‘Why doesn’t Capital Flow from Rich to Poor Countries?’, American Economic Review, 1990] His fellow economists have been trying to figure it out ever since.

There are various theories that apply to various countries to varying extents, but what does appear to be a common factor – and, indeed, the root cause – is that people in emerging economies save a much bigger proportion of their incomes than they do in the West (and thus generate a pool of capital that needs investing somewhere).

Though one might assume that people in richer countries are in a better position to be the bigger savers, people in poorer countries have the greater incentive. If a country becomes rich enough that typical incomes rise above subsistence level, but still too poor to afford a social security system, then its people must save – or starve in old age (which they are now more likely to reach).

Something else that happens to countries when they escape poverty is that birthrates – and, hence, family sizes – come tumbling down, which puts paid to the traditional social security system of having lots of children and grandchildren to support you in your dotage. China’s one-child policy is an especially extreme example of this demographic phenomenon. Introduced in 1979, it coincided with Deng Xiaoping’s economic reforms. The latter freed China’s people to make enough money to save some of it, the former made it essential that they do so.

Finally allowed to profit from their labour (and accumulate savings) the explosion of enterprise from China’s peasantry, took the government by surprise – as Deng himself admitted in 1987:[3. Deng Xiaoping quoted by Jonathan Fenby in Tiger head, snake tails, Simon & Schuster, 2012]

“The result was not anything I or any other comrades had foreseen; it just came out of nowhere.”

Today, it is forgotten that the Chinese economic miracle got its start in the countryside, not the cities – and that it was the spontaneous action of ordinary people, not central government planning that got it all going. However, through its control of the banking system, the state had a monopoly over the use of all those savings – a near-inexhaustible source of artificially cheap capital that was ploughed into the development of China’s industrialised export capacity. Growth thus begat more growth – and the accumulation of ever more capital. So much money, in fact, that not even China’s investment-led economy could absorb it all.

Xi Jinping gets a grip

Whether directed by the state, or by privately owned enterprises, or by China’s burgeoning middle class (only America has more people on salaries of $40,000 and above),[4. Jim O’Neill, ‘Missing the forest for the Xi’, Project Syndicate, 12 March 2018] vast sums of Chinese capital have been invested abroad. For instance, over the last decade, Chinese purchases in Europe include the Greek port of Piraeus, the Swedish car company Volvo, the Swiss pharma giant Syngenta and, of course, numerous helpings of London real estate.[5. Andre Tartar et al, ‘How China is buying its way into Europe’, Bloomberg, 23 April 2018]

Western concerns about China’s shopping spree are, mirrored by Chinese concerns about the outflow of so much wealth. Things got so bad that by 2016 that the central bank was intervening to prop-up China’s currency (how times change).[6. David Dollar, ‘China is struggling to keep its currency high, not low’, Brookings, 26 January 2017]

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Xi Jinping likes nothing more than getting a grip – which he has done with the aid of tighter exchange controls and a shift to a more consumption-orientated economic policy. Fears of wholesale capital flight have subsided. Indeed, the net flow of capital is, for now, in positive territory, i.e. more flowing in than out.

So does that mean that Peter Thiel and Donald Trump can stop worrying? A China that is less export-orientated than it used to be, that won’t let its currency fall too low, and is keeping capital flows in balance, is surely less disruptive than it used to be.

And yet the potential for imbalance is huge. According to Michael Howell, managing director of CrossBorder Capital, China has accumulated $35 trillion in ‘liquidity’ – i.e. savings plus credit. This amounts to 27% of the global sum total – a proportion that has more than doubled over less than a decade, overtaking America’s share.[7. Michael Howell, ‘The loud warning noises from Chinese capital flows’, Financial Times, 19 April 2018]

Tweeting about Donald Trump last month, Kanye West vouchsafed that “we are both dragon energy”.[8. Kanye West, Twitter, 25 April 2018; https://twitter.com/kanyewest/status/989179757651574784?s=21] I would suggest that the real ‘dragon energy’ in the world today is the power that the Chinese Government has over such a vast pool of capital.

In this respect, Xi Jinping is the world’s most powerful capitalist – quite a distinction for the world’s number one communist.

This particular tweet came alongside Trump’s shock decision to impose 25% tariffs on steel imports – a move targeting China. The People’s Republic is the world’s largest steel producer, responsible for over half of annual global output. The International Monetary Fund, traditionally reluctant to criticise US policy-making, said a Trump-inspired trade war could trash the global economic recovery. “Trade wars not only hurt global growth, they are unwinnable,” said IMF Director General Christine Lagarde.

Trump has long used stump-speech rhetoric to tell voters that low trade barriers in wealthy nations like the US, and unfair protectionism elsewhere, have caused the collapse of rust belt jobs – not least in industries like steel production. It’s an over-simplification, but one that Trump is hardly the first to use. In mid-2016, just months before the US election, Barack Obama imposed duties of over 500% on Chinese dumped “cold-rolled steel”.

Over recent months, though, Trump has dialed up Sino-US trade tensions to a whole new level. The US has proposed up to $150 billion of tariffs on Chinese goods – some of which could bite from next month. China retaliated, warning of tariffs on American exports if these US measures are imposed.

Trump then countered, demanding a “written plan” from Beijing to take $100 billion more in US exports. In recent days, these demands have escalated, with the White House now targeting a $200 billion cut to the $375 billion trade deficit by 2020.

The US wants China to open its market for financial services and reduce limits on foreign shareholding, while significantly tightening rules on intellectual property theft. President Xi Jinping’s top economic adviser is now in Washington for the second round of trade negotiations this month. There are signs of movement from China, but very few. As the world looks on nervously, amid fears of an international trade war, the US Ambassador to China says the two sides remain “very far apart”.

Trump’s trade policy is often dismissed as ignorant economic nationalism. In her UnHerd documentary, my colleague Juliet Samuel questions that view. The President’s bombastic rhetoric could be a bargaining ploy, she suggests, with the White House using lurid threats to try to push China towards less protectionist outcomes. I’d say that’s right – and would go further.

Audiocast

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The US trade regime is far from perfect. America itself can be protectionist – and, of course, uses trade sanctions for broader geopolitical purposes. But after years of Chinese currency manipulation, patent law violation and state-sponsored corporate espionage, the usual forms of trade diplomacy have completely failed. Trump is right to come out swinging.

Now the world’s biggest manufacturer, China has proved adept at capturing overseas markets and buying up foreign companies – but with a marked lack of reciprocity. China has developed so fast, becoming so powerful so quickly, that the broader global economy – particularly previously hegemonic Western economies – have struggled to cope.

The truth is that, while Trump is hogging the headlines, Beijing holds most of the cards. The pertinent question now isn’t if Trump will do trade deals with China. It’s whether China will do trade deals with Trump.

As Beijing has turned the screw, Trump has made concessions. Last weekend, ahead of these latest Washington talks, Trump tweeted a pledge to help ZTE, a Chinese telecom giant, “get back into business, fast”. The US Commerce Department recently blocked American firms from selling parts and services to ZTE, which makes smartphones and other telecommunications equipment, after the firm apparently breached US sanctions relating to North Korea and Iran – causing ZTE, which employs 75,000, to halt operations.

Trump’s surprise volte face, for no apparent gain, has been spun as a “grand gesture”, part of the President’s “bait and switch” negotiation tactics. But it results from direct Chinese pressure. Over recent weeks, Beijing has ramped up inspections of US pork exports to China – with the implied threat that such “enhanced checks” could extend across US agricultural produce. Lucrative US scrap metal exports have also been effectively halted after the Chinese customs authorities suddenly stopped their cargo checks.

Reports have also emerged of Ford vehicles being held up at Chinese ports, with the US carmaker being asked for extra checks on emission components. In this tense trade stand-off, Trump may be doing the shouting, but it is the Chinese who are flexing their muscles – harming domestic US industries that Trump needs and winning concessions.

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This reflects an underlying reality often unacknowledged. China has huge influence over America, not least due to its pivotal role in keeping the US financially afloat. Beijing officially owns around $1,200 billion dollars’ worth of US Treasury bills, making it by far the world’s largest creditor to Washington. On top of those holdings, swathes of US government debt is held via murky funds domiciled in Belgium – many of which lead back to Beijing.

The US national debt is now over $20,000 billion dollars, having more than doubled over the last decade. That’s 104% of GDP. As US debt grows, and with China soaking up vast amounts of new Treasuries each year, any signal Beijing might slow its purchases would send US markets into an immediate tailspin. That gives Beijing enormous power – leverage Trump will understand.

China is calling the shots on several fronts. Trump has lapped up plaudits for his role in brokering peace talks on the Korean Peninsula, for instance. Only a fool would fail to welcome the US President’s upcoming bilateral meeting with North Korea’s Kim Jung-Un. The meeting, though, is part of a broader Beijing-driven plan to ease the US out of the Pacific basin.

Dependent on China for food and fuel, Kim does what he is told – which is why this summit is happening. Trump will be allowed to claim some credit for denuclearising the Korean peninsula, as a pretext for downsizing the US naval presence in the region. China wants both outcomes, of course – and Trump, too, can live with this, as part of his “America First” strategy.

The same principle applies on trade. Trump is clumsy, his rhetoric often shocking. But he is, above all, a transactional President. Xi knows that China, now economically strong and financially flush, finally needs to open its doors to the world. And if Trump wants to claim credit for making that happen, in return for ongoing US access for Chinese goods, it’s a “win-win”.

The theory seems simple enough: each nation should focus on the things it does best, and trade for everything else. It’s attributed to 19th century English economist David Ricardo, since when it has been the basic idea behind “free trade”.[1.  Simple on the surface, comparative advantage is a bit more complex than it seems as it’s not about absolute advantage (A just makes things cheaper than B) but opportunity cost. Also, some writers now attribute the theory not to Ricardo but to James Mill. But Ricardo’s memorable example stands: Portugal should focus on making wine, and Britain on cloth.]

China’s big comparative advantage has been cheap labour, and as a result it’s yanked great swathes of manufacturing out of the US economy. Retail behemoth Walmart, for example, works with 5,000 different Chinese suppliers. That’s a lot of stuff American workers aren’t making any more. On the other hand, that’s a lot of stuff American workers can buy very cheaply.

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Yet this worry has a very 20^th century feel. We should, instead, be looking ahead. For the problem isn’t going to be cheap human labour – it’s going to be nearly-free machine labour. We should be far more concerned about what Norbert Wiener, the “father of cybernetics” called the emergence of a new slave economy.

The conventional wisdom, of course, is that automation is always good for us. It won’t eat our jobs. Like the first Industrial Revolution, every tech disruption since has led to more and better jobs. Some of us have been challenging this view for years, and either been ignored or told not to rock the innovation boat. Make what you will of his politics, Jeremy Corbyn is so far the only political leader in the west to have noted this challenge in a major speech.

In any event, the widely-held view of the first Industrial Revolution is simplistic. Andy Haldane, chief economist of the Bank of England, recently made that clear. It did huge damage done to skilled labour markets that lasted a generation and more.

And Ricardo himself, who was living through the dramatic changes, had more than a little sympathy for the Luddites.[2. The original Luddites were worried about their jobs, and took the law into their own hands – with an occasional riot and many incidents of what was called “machine-breaking”. The government sent in the army. Hangings followed. Things calmed down.] But, believer that he was in comparative advantage, he wrote that if Britain didn’t employ these new technologies other nations would anyway.

Back to the future, in a 2013 report by two Oxford economists, they analyse the susceptibility of 702 different jobs being done by machines. The report concluded that the job most likely to disappear to machines was telemarketing. It struck me when I read the report that that calls from robotic, metallic, voices delivering potted sales pitches would be easy to hang up on. How could a computer programme really “sell”?

Well, Google has just proved once and for all that telemarketers are history. Every single one of them, worldwide. And also everyone else who earns a living talking on the phone. Listen to these sample calls, as a robot makes a hair appointment and books a table for dinner and see if you can tell which of the speakers is a machine. The impact is stunning.

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And so here we are again, on the cusp of an automation revolution in which what economists politely call “technological unemployment” is going to be a major challenge.

In one of the most ridiculous public statements ever, US Treasury Secretary Stephen Mnuchin blithely assured the American public that not only are their jobs safe from automation, but the issue is “not even on our radar screen”. Any such effects are “50 to 100 more years” away.

As an American President keeps faith with his voters by starting a global trade war, we can only imagine what’s in store once he (and they) work out where the real threat to fly-over country jobs lies.

According to Krysztof Pelc in the Literary Review of Canada, “there is little academic support for trade agreements having much of an effect on jobs, either up or down”. Indeed, his argument – if I read it correctly – is that trade agreements aren’t really about trade.

To understand what they are about, it’s worth recalling the 1951 classic movie Strangers on a Train (based on the Patricia Highsmith novel of the same name). The plot revolves around a pact between two strangers who each agree to commit a murder on behalf of the other. The theory is that by swapping targets, there will be nothing to connect the killers to their victims, thereby enabling each to literally get away with murder.

The same principle applies to trade agreements – only, in this case, the killers are nation-states and the intended targets are lobby groups within each nation state:

“…trade agreements are about defeating your own worst impulses. And the worst impulse of democratic leaders is to give in to demands from powerful lobbies that help them stay in power, even when it comes at the expense of the rest of the country. “

In his 1965 book, The Logic of Collective Action, the economist Mancur Olson explained how narrow interest groups prevail against the greater good. For a start, it’s easier to organise a small group of individuals than a much larger one. But even more important are the asymetric incentives – in a zero sum conflict between a narrow interest group and the general public, individual members of the former have lot more to gain than individual members of the latter have to lose. Or to put it another way, a small group with a lot at stake is going to fight harder than a large one with less at stake.

Pelc provides a prime example of the nonsense that can result:

“Consider Japan, which has long imposed duties of 778 percent on foreign rice, making the price of rice in Japan multiples higher than in neighbouring countries. That makes growing rice in Japan artificially attractive, so the government also has to pay rice farmers not to do it, so that a third of all fields lie fallow. The system is a significant drag on the economy, but policymakers have been unable to change it, so great is the political power of the rice lobby.”

However, Shinzo Abe, the Japanese PM, is fighting back – with the aid of the Trans-Pacific Partnership (TPP) trade agreement, of which Japan is a member.

In signing up to a general framework of rules that outlaw sweetheart deals for interest groups, a national government not only acquires a perfect way to refuse demands for special favours – it can get other national governments to refuse on its behalf.

Like murderous strangers on a train, trade agreements allow governments to do one another’s dirty work. Still, as long as the lobby groups deserve to be knifed, why should we worry?

The problem is when trade agreements are used not to achieve the common good within each nation, but to allow in-groups to permanently exclude out-groups from influence over policy-making.

For example, mass immigration may be of benefit to the metropolitan elites of a nation, but not to those whose wages are suppressed as a result. If immigration policy is under national control, then conflict may lead to compromise – or at least some form of compensation for those losing out. If, however, free movement is part of an international trade agreement then the winners have a pretext for ignoring the losers.

Except that treating millions of your fellow citizens as if they were a narrow lobby group has a fatal flaw: in a democracy, they have votes.

No Chinese leader, would accept them, and certainly not a muscular nationalist like Xi Jinping, who already hopes that history is going his way.

This is a missed opportunity to tackle significant problems in China’s trade and industrial policy – problems that urgently need a response, not only from the US but also from other advanced economies that have suffered by it and stand to suffer further. But Trump’s  behaviour continues to create winning scenarios for China, allowing it to pose as a staunch defender of global free trade, while continuing its harmful restrictive practices.

To develop an effective defence of their interests, China’s trading partners need first to abandon some illusions. In the 19^th century, an excited British textile manufacturer dreamed of the fortunes that would be made in Lancashire if every “Chinaman” were to add just one foot to the length of his shirt tails. This mix of hope and ignorance lingers on: the persistence of it in the face of reality is testament to China’s skilful deployment of its most powerful weapon – the irresistible attraction of market opportunities in a country home to one fifth of the world’s population.

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So let’s be clear: yes, the market is huge. No, China does not intend to open it in ways that will assist the US, the UK or any other advanced economy.

What is likely, particularly in a weakened post-Brexit Britain, is China’s continuing effort to use the UK as a bridgehead. It has already happened with China’s nuclear industry with Hinkley Point and the promise to China that it will be allowed to build and operate nuclear plants in the UK; with digital infrastructure (the Huawei-BT deal), and now, the MOU that Liam Fox has just signed with Tencent, a Chinese digital services giant that answers directly to state security in China.

China’s policy is not a secret: it is clearly set out in a string of documents that detail the regime’s industrial masterplan. These include the National Medium- and Long-Term Science and Technology Development Plan Outline (2006-2020), the State Council Decision on Accelerating and Cultivating the Development of Strategic Emerging Industries (SEI Decision), and, the shortest and most succinct iteration, the Notice on Issuing “Made in China 2025” published in 2005.  This is not light reading, but anyone with an interest in the shape of the future China envisages would be advised to take a look. In particular, anyone who still imagines that as yet untapped markets beckon in China for Brexit Britain should pay close attention.

In them, the Chinese government helpfully lays out its strategy: to keep barriers to the China market high, to enforce technology transfer and to acquire foreign companies that possess advance technologies, all to help China leap-frog the risky and difficult innovation stage, to upgrade its industrial technologies and to become dominant both domestic and global markets. Extensively recorded elsewhere, is the third route to the acquisition of advanced technologies – industrial and digital espionage.

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The starting point for China’s vision is uncontentious: by pursuing a traditional catch-up strategy, aided by WTO membership and globalisation, foreign investment, and a huge and hardworking population, China has attained middle-income status, become the world’s second largest economy and accumulated a substantial, though not inexhaustible, war chest of foreign currency to spend.

But the next bit is tricky: growing from poverty to middle-income status is relatively straightforward; getting through the middle-income trap to become a rich country is tougher, especially when burdened with an ageing population, incumbent resistance, a shrinking workforce, too much debt and a legacy of industrial damage to the country’s life support systems.

Some countries make it; most have not. According to The World Bank’s China 2030 report, published in 2013, of the 101 economies classified as ‘middle-income’ in 1960, only 13 had become ‘high-income’ by 2008.  The advice of a paper published last year by the Asian Development Bank was that “the starting point… has to be the existence of political will to embark on an innovation-focused strategy with the requisite active policies to implement it”.

That is a lesson China has taken to heart, realising that it needs to upgrade its industrial technologies and raise its productivity as fast as possible and China deploys every means at its disposal to achieve it – begging, borrowing, acquiring and, yes, stealing advanced technologies from those who have them, in a range of practices, some of which are illegal under WTO rules and most of which are characterised as unfair. The end result of this strategy, if successful, will be the loss to advanced economies of hard-earned competitive edge. It is a prospect that has provoked alarm not only in the US but also in Europe.

Every country is entitled to upgrade its technology and to grow. The contentious point for China’s partners and competitors is how it is done. China deploys a wide range of restrictive practices: compulsory joint venture arrangements that only win regulatory approval if they involve technology transfer; digital industrial espionage on a grand scale; and the targeted acquisition of high-tech companies while reciprocal investment into China is prohibited. This is not so much an uneven playing field as a cliff face that foreign competitors are obliged to climb, in the hope of reaching the sunlit uplands of the huge Chinese market.

It’s a Morton’s Fork dilemma, as many western partners have testified: they either hand over their most valuable asset in the hope of accessing one of the world’s largest markets, or they stay out, and wrestle with the downside of exclusion.

The impacts are documented in the US Trade Representative’s Section 301 Report into China’s Acts, Policies, and Practices Related to Technology Transfer, Intellectual Property, and Innovation, and it is clear that the serious issue is less about the current balance of trade than who owns the future and how the game is played.

Made in China 2025 highlights high-tech industries, automotive, aviation, machinery, robotics, high-tech maritime and railway equipment, energy-saving vehicles, medical devices and information technology among others, with the ambition of achieving future market dominance in these areas. The ambition is import substitution and the terms employed – “indigenous innovation” and “self-sufficiency” – are no more concealed than the targets set out to achieve them. These include a deadline for increasing the proportion of domestically produced components to 70 per cent by 2025, enabled by large subsidies and low-cost government backed finance to favoured Chinese enterprises.

The second aspect – making life difficult for foreign operators in China, is also copiously documented. As a recent report from the Berlin-based MERICS think tank put it, while Chinese high-tech companies enjoy massive state backing, the foreign counterparts face:

“The closing of the market for information technology, the exclusion from local subsidy schemes, the low level of data security and the intensive collection of digital data by the Chinese state. As China’s own smart manufacturing capabilities mature, it is likely that the Chinese state will further step up its discriminatory practices and restrictions of market access in the field of smart manufacturing.”

The outbound aspect of Made in China 2025 is the acquisition of international high-tech companies, facilitated by the open nature of advanced economies. But China’s acquisitions are directed by state strategy, funded with capital that hides behind opaque investor networks. As the MERICS report points out:

“In the long term, China wants to obtain control over the most profitable segments of global supply chains and production networks. If successful, Made in China 2025 could accelerate the erosion of industrial countries’ current technological leadership across industrial sectors. As illustrated by the fierce discussions surrounding recent high-profile high-tech acquisitions, governments in Europe and the U.S. increasingly perceive this dimension of China’s quest for technological upgrading as a crucial and pressing challenge.”

There are many possible responses. Unfortunately President Trump is unlikely to choose the most effective: a firm alliance with the EU and other powerful trade partners to enforce and defend the rules.

More from our 'Taking on China' series

Test article

By James Coney

Leaving the European Union is often presented as an opportunity for the United Kingdom to go out into the world. Global Britain, they call it, a concept not devoid of logic.

By the very nature of their integration project, EU member states have to spend more time than they would like coming to terms with each other. Right now, for example, they are busy trying to reach an agreement on the next multi-year budget, when it might be more advisable for their attention to be fully focused on the clouds gathering over the global economy and global politics.

The UK has its hands full with the Brexit negotiations, but these – one hopes – will eventually come to an end. At which point, it might be advisable to have a strategy for the life outside the EU in place – one which takes into account all the dangers and opportunities presented by that painful separation.

So what kind of Britain will emerge after Brexit? Will it prosper? To know that, we need to know who it will be doing business with. What we can say with certainty is that in this new world Europe will count for far less than it does right now; in this world, four out of the five largest economies in the world will likely be located in Asia – none in Europe.

And so the success of global Britain depends far more on the relationships it can build with those Asian giants, than on strictly domestic political variables. A great British future will rely less on London and Brussels than on a third, hidden pole of magnetic attraction: Beijing.

Listen to the audiodoc

Taking on China: how the West can save free trade

By Juliet Samuel

China is introducing such dramatic changes in the global balance of power that even a seemingly regional question like Brexit cannot be properly solved without bringing its economic might to bear. Relations between China and the EU are going to dominate European politics in coming decades. But the real question is: will Britain be in a better or worse position to deal with China once it has left the EU?

I see a number of scenarios in which Brexit could move Britain’s foreign policy in highly desirable directions. Contrary to conventional wisdom, there is no indication that only large economic blocs can thrive in the new world order. Countries such as Switzerland, Singapore or New Zealand have ridden the wave of global change better than anyone else because they feel the urgency of doing so earlier than others and can adapt more quickly. Britain will be under enormous pressure to adapt to life outside the single market, and swiftly. The best way it can do that is by forging a new economic relationship with China.

In a recent presentation on the future of British foreign policy at the Treasury, I argued that the UK needs to first ask itself what it wants. And to know this, it needs to understand how China is changing and how those changes can affect it. Only once that position is known can Britain confidently exert influence and leverage over Beijing. As I see it, there are two key areas where Britain can make an impact.

The most important issue is technology. As China sets its sights on exercising significant control over the industries of the future, large parts of the European economy will be negatively affected. Germany is already facing increased competition in high-value sectors such as sophisticated industrial machinery, and is worrying about diminished returns once China develops its own technological standards. At present, German companies earn billions every year from licensing fees and royalties. Some of those revenue streams will be diverted to China.

Once released from the European Union and its one-size-fits-all trade negotiations, Britain can play a substantive part in the discussion on these new industries. It’s a discussion about specific standards rather than – as tends to happen now – endless ruminations concerning the role of the state in the economy and other abstract notions. Britain could take the lead in defining relative spheres of influence, in helping consolidate control over standards, and determining areas of cooperation where it could work with China to develop new technologies.

The second key area is infrastructure. Control over critical infrastructure is where competition between countries increasingly takes place. The growth of global value chains means that we must increasingly think of different countries as parts of the same factory floor, across which are distributed the various stages of production. These value chains are held together by physical and digital infrastructure. Whoever controls that infrastructure can organize the most efficient and competitive value chains.

More on China

One Belt, One Road: How China's ambitions span the globe

By Michael Burleigh

China is leading a bold economic and political project – the Belt and Road – by which it will strive to reorganise global value chains, with its own companies and its state at the steering wheel. This is surely a project in which every country has or should have a stake. It presents a clear opportunity for the United Kingdom to leverage its financial services industry to participate in the Belt and Road, provided it can also acquires managing rights in the initiative, something China has so far reserved for itself.

These moves call for fresh and original thinking. There is no reason for Britain to spend valuable time discussing the outlines of a free-trade agreement with China. Leave the traditional elements of a free-trade agreement – industrial tariffs, regulatory norms, agriculture – for a more convenient time. The priority right now should be technology and infrastructure, the two pillars of the future global economy, upon which Britain and China can build a new economic partnership.

Bruno Maçães’s latest book, The Dawn of Eurasia: on the trail of the new world order, is published by Penguin.

China is now the world’s biggest exporter and its second biggest economy. Its quasi-communist, state capitalist system is massively distorting global trade. When Donald Trump was elected, he promised to put a stop to these distortions. Unfortunately, his main tactic for doing so seems to involve wading into trade war with everyone. Watching this, as a supporter of free trade, I bristled. “Who is this madman intent on taking us back to the 1930s?” I thought.

In order to make this documentary, I had to look into the issue far more closely. I found that some of my criticisms were valid: Trump has managed to alienate everyone who could be a potential ally and thereby seriously reduced his likelihood of success. On the fundamental issue, however, I had to concede: Trump has a point. China is breaking the rules of global trade and the West has been far too weak about it for far too long.

To explain why this matters and what we should do about it, I spoke to voices on both sides. I heard from supporters of Trump’s approach, such as Florida senator Marco Rubio and Clyde Prestowitz, the former US commerce secretary under Ronald Reagan. I obtained an interview with AMSC, one of the only companies in the world willing to talk openly about how its Chinese business partner’s theft of its technology almost tipped the company into bankruptcy.

But I also spoke to those who shared my instincts for free trade and openness. I interviewed David Willetts, the former UK universities minister now leading a Sino-British investment fund, and a senior manager at Imagination Technologies, an innovative British firm that was saved from being broken up when Chinese investors bought the company.

To hear my conclusions, listen here to “Taking on China: how the West can save free trade”.

These critics, however, fail to understand that the status quo is now politically unsustainable within the United States; it has created too many losers whose lives and communities have been upended.

Millions of Americans have lost their jobs solely because of China. David Autor, David Dorn, and Gordon Hanson found that US labour markets exposed to Chinese manufacturing competition between 1990 and 2007 experienced higher unemployment, lower labor force participation rates, and reduced wages compared with markets not similarly exposed. Those estimated million lost jobs were heavily concentrated in exactly the Rust Belt communities whose votes elected Trump president.

Other economists have calculated  the job loss to be even higher, closer to two and a half million. Efforts intended to ameliorate the effect of job loss, such as increased minimum wages and liberal disability insurance policies, have reduced the labour force by an additional one million people. Three and a half million lost jobs are huge even for an economy as large as America’s – and this research does not account for increased competition from Mexico and other nations.

Trump owes his election to these developments. The regions where he gained most over President Obama are exactly those areas that have experienced the outflow of high-paying manufacturing jobs over the past 20 years. Moreover, Trump’s popularity has risen over the last six months as he has moved his economic policy away from Republican, tax-cutting orthodoxy and towards aggressive protectionist measures.[1.  Trumps’ job approval rating has increased from 37.0% in mid-December 2017 to its current level of 43.4 percent. If one removes the polls that only sample adults rather than registered voters (the former includes many non-citizens not eligible to vote), his current job approval stands at 44.6%] Pro-status-quo opinion within the United States, meanwhile, is increasingly isolated within Democratic and Democratic-leaning voters – those who would never consider voting for Trump or any other Republican.

Listen to our protectionism podcast

Test article

By Ayesha Hazarika, Henry Olsen and Juliet Samuel

So what’s the way forward? In the UK, the sharp division on Brexit has rationally given rise to calls for compromise – Brexit with some continued ties to the European Union. A similar approach ought to prevail in America’s trade and tariffs debate. Neither the status quo nor a trade war is what America needs. And that means supporting alternatives to tariffs.

Quotas are one such alternative. The advantage quotas on imported goods have over tariffs is that they encourage foreign producers to establish factories within the United States to get around them. Ronald Reagan’s quotas on Japanese auto imports in 1981 – sold as a “voluntary export restraint“[2.  This worked so well that President Reagan proposed similar programs to combat steel imports and machine tools] – resulted in Japanese companies establishing “transplant” factories in the United States so their cars did not count as “exports”. That created over 100,000 automobile factory jobs with non-American companies in 2013 and 130,000 currently. In effect, quotas encourage overseas companies to share the gains of trade with American blue-collar workers at the expense of the owners of their American competitors – exactly the “Labor over Capital” trade-off America’s distressed workers support.

South Korean exporters might already be looking at doing this in response to Trump’s proposals. The Wall Street Journal reports that at least one South Korean steel manufacturer, Nexteel, is considering building American factories as a way to continue to sell steel to US customers despite an export quota agreed to in March. The example of the automobile industry is likely to encourage more countries to accept quotas over tariffs, and then encourage their companies to build transplant factories in the US over the coming years.

There are other ways to reduce the pain global trade is inflicting on local communities. US policy makers might consider adopting the practices that already commonplace in some of their competitors to close the skills gap that is causing economic underperformance and social unrest. American public education, for example, has largely abandoned large-scale vocational education in recent decades. Manufacturers already complain they cannot find workers who can do the jobs they do have available because of a lack of skills. Germany and Switzerland, in contrast, have extensive job skills training that prepares teenagers for real jobs in the modern economy. Seriously adopting this type of approach could give many younger workers who will never go to college access to the sort of well-paying jobs their parents and grandparents once had.

America also suffers from a social welfare system that subtly encourages people down on their luck to stay put in declining areas rather than move or better paying jobs. Unemployment insurance, government-subsidised health care, and a host of other commonly accessed income support programs are delivered by states, not the national government. This means that displaced workers who come to rely on these programs would lose their benefits if they tried to leave the state in search of better work. Given the wide regional disparities in economic opportunity within the United States, this approach unnecessarily encourages short-term gain at the expense of long-term pain.

Wage subsidies might also be an attractive alternative. If the only jobs that a region can support are low-wage, service industry work, it might be conducive to social peace to make tax-financed wage top-offs a 21st-century addition to the social welfare system. This approach clearly states that it is a social obligation to ensure that all citizens share in economic growth; it is clearly more conducive to innovation and change than trying to use tariffs to enshrine the past into law.

Recommended listening

Taking on China: how the West can save free trade

By Juliet Samuel

Global trade is lifting hundreds of millions of people throughout the world from poverty, and as such should be endorsed, even if it were not also lifting living standards for many in the developed world. But such gains cannot come at the expense of millions of our fellow citizens. The oft-heard refrain among the Davos set and their devotees “those jobs aren’t coming back” – can’t be code for “we don’t care about you”.

A sensible approach to the modern economy involves exactly the sort of prudent compromises that capitalists and their allies made to industrial workers over a century ago when the modern mixed economy was created. Tariffs are not the answer, but neither is doing nothing. These alternatives are a good place to start.

If not protectionism, then what?

Three pro-poor alternatives to Trump's dangerous tariffs

By Tim Montgomerie

Not on UnHerd, though. From an introduction to the project itself, to the international challenge of raising the trillions of dollars required to finance it, to the significance of the Eurasian landmass, we’ve tried to explore the issue from every angle.

Recommended reading

One Belt, One Road: How China's ambitions span the globe

By Michael Burleigh

One question we haven’t yet asked, however, is: why bother?

Yes, the world’s biggest infrastructure network is primarily intended to transport the output of the world’s biggest exporter – but don’t we have ships and planes for that? Increasing exports may require more ports and airports, but why build land links across 10,000 kilometers of Eurasia? It’s all a bit Genghis Khan, isn’t it?

An excellent article by Richard Pomfret for Vox EU provides a lot of the answers. It explains the value of the ‘Eurasian landbridge’ i.e. the direct rail freight services that have been established in this decade between China and Europe:

“At current transport costs, auto components and laptops/printers fit into an intermediate category of goods for which a rail link between China and Europe offers a useful niche; the goods are too bulky for air transport, but the firms want faster and more reliable delivery than intercontinental maritime transport can provide and are prepared to pay for the time-saving that rail transport offers over maritime transport.”

It’s worth adding that sea routes from China to Europe and the Middle East run through some highly sensitive pinch points. For instance, there’s the Straits of Hormuz (between Iran and the Arabian Peninsula), the Suez Canal, of course, and the Bab el-Mandeb. That last one is the entrance to the Red Sea between Yemen and the Horn of Africa – and translates as the ‘Gate of Grief’. Reassuring!

Unsurprisingly, the Chinese would like some alternatives to those dire straits – hence the new focus on the overland routes.

Recommended reading

How Brexit Britain could help China build a new world

By Peter Franklin

The new era of regular rail-freight services from China to Europe began in 2011, with the inauguration of the Chongqing to Duisburg route:

“Since 2011 the number of trips along the Landbridge has mushroomed to 6,235 by December 2017, and over half of those were in 2017.”

That said, we’re only at the beginning of things :

“In 2016, 42,000 containers passed through Kazakhstan, a big increase over the 2,000 in 2011, but they would fit on four container freighters that can pass through the Suez Canal. “

Pomfret notes that there’s been relatively little investment in the landbridge. Establishing the China-Europe routes has so far been a matter of negotiating transit agreements between the relevant governments so that services can run on existing track. Then there’s a few technical matters to sort out:

“At Khorgos, on the Kazakhstan-China border, the transfer for a 40+ container train can be done in 47 minutes. This investment has contributed to shaving the time (e.g. Chongqing-Duisburg took 16 days in 2011 and 12 days in 2017), but most of the time-saving is associated with better logistics and prioritising the profitable service.”

Twelve days, by the way, is three times faster than the equivalent maritime route.

Now imagine what billions of dollars of investment could achieve. New tracks, proliferating routes, more services, longer trains, faster journey times and the inevitable automation of just about everything currently done by hand.

The full exporting power of the Chinese economy will be soon he arriving at a platform near you. Just don’t expect anyone to apologise for any inconvenience.

Recommended listening

Taking on China: how the West can save free trade

By Juliet Samuel