26 February 2019

Xi feels the heat

  • China is under pressure from Washington to liberalise in ways that are uncomfortable
  • Liberalisation has consequences for the Communist Party to which it is strongly opposed
  • But China’s economic slowdown and domestic pushback are edging it closer to a deal

By George Magnus

In the US-China trade war, politics seem to be driving both sides towards a deal. Both Donald Trump and Xi Jinping have incentives to reach an agreement, but who needs a deal more?

Trump wants a deal to show that his trade strategy has worked, and perhaps bask in a passing surge in business optimism that detracts from problems at home. He is rowing back from his initial deadline of 1 March.

“I can’t tell you exactly about timing,” Trump told his officials, “but the date is not a magical date. A lot of things can happen.”

But there are two things about China that make Xi’s incentive to get a deal more pressing.

 

First, China’s economy is slowing down. There are weaknesses in everything from manufacturing and investment, to the property, auto, consumer and export markets. The official economic growth rate of just under 6.5 per cent and the 3.8 per cent unemployment rate are considered as far too optimistic by seasoned economists. Trump’s tariffs haven’t had a major impact on China’s economy yet, but if the President follows through with his increase to 25 per cent on imports from China then its economy would take a further blow.

Sean Gallup/Getty Images

A container ship from China Shipping Line being loaded at the main port in Hamburg, Germany.

Second, in the last year Xi has run into some political pushback at home, which is remarkable for the authoritarian state. His approach to the US and the trade war has been criticised for stirring up unnecessary confrontation. The Communist Party’s narrative stressing the role of the Party, the state and top-down policy in China’s success is in question.

For both these reasons, Xi Jinping would like the trade war to go away. Referring to the negotiations, Xi Jinping said last month, “I hope that both teams can meet each other halfway and reach an agreement beneficial to both countries and the world.”

ANTHONY WALLACE/AFP/Getty Images

A roadside stall in Hong Kong.

For this to happen, Xi needs to satisfy a hawkish US administration and business lobby – even if Trump, himself, proves to be a soft touch in the current talks. China will have to go a lot further than simply buying more US products.

The US is looking for Xi to change tack in a more fundamental way; to open up China, and embrace a new wave of meaningful liberal reforms in industry and technology.

The US gripe is that China’s global ambition to be a technology leader in a decade hinges around unfair industrial policies. These include the transfer of technology to Chinese companies including state enterprises, weak intellectual property protection, preferential and anti-competitive advantages for its firms, and restricted access to protected markets.

Yet, Xi’s China isn’t the reform-oriented China that many know from globalisation’s heyday. We can see how the rhetoric of reform does not always carry over into implementation in financial services.

China Photos/Getty Images

A steelworker at the Baotou Iron and Steel Group, one of China's largest producers.

In recent years, China has taken action to boost flows of money into its markets by lifting quotas on foreign investment, pushing for shares and bonds to be included in global indices like the FTSE and MSCI, and enhancing the schemes that make it easier to trade mainland equities through the stock exchange in Hong Kong.

China likes the idea of foreigners putting capital to work in China, but it has not liberalised capital that wants to flow out of China. On the contrary, China tightened rules around capital outflows in 2016-17. China still fears, rightly, a resurrection of capital flight.

Last spring, China planned to lift the ownership caps for foreign banks and asset managers, including majority ownership in securities and insurance companies, and allow them to set up branches in China. But foreign banks account for barely 1.5 per cent of total banking assets, so their role is small and they lack the protection afforded to state banks and domestic non-banking financial intermediaries.

AFP/Getty Images

A job fair in Tengzhou, in China's eastern Shandong province.

Liberalisation tends to make headway in areas or sectors where domestic players have already become dominant or have little to fear from foreign competitors. The much delayed permission for MasterCard and Visa to operate in China, for example – even if it were re-offered soon – has allowed time for China UnionPay to become a de facto monopoly in China, and the largest card payment provider in the world with free access to developed country financial systems.

Now, imagine how much harder the negotiations are regarding liberalisation, the role of the state, and opening up in technology and industry, where the Party’s political sensitivities are much greater than in the finance industry.

Xi could extend to Trump some commitments to intellectual property protection, technology transfer, reduced state subsidies, some other reforms, and cooperation on cyber and other issues. The US, though, will need assurances about compliance which are likely to be fudged or impossible without impinging on China’s sense of sovereignty. That same sense will preclude any concessions on most technology, industry and state enterprise policies.

Xi’s gameplan is to play for time, and stretch the talks out, hoping that the longer they continue, the greater the chance the need for a deal switches from Beijing to Washington and Trump’s re-election campaign.

But make no mistake: Xi needs to avoid Trump’s tariffs like the plague, and these talks will by no means end the trade war.

George Magnus is an associate at Oxford University’s China Centre and at SOAS

Further reading

  • George Magnus, who wrote this piece, is the author of Red Flags: Why Xi’s China is in Jeopardy (Yale, 2018). The book looks at the economic problems China faces, including trade conflicts and its relationship with Trump.
  • Michael Pettis at the Carnegie Endowment for International Peace provides frequent in-depth analysis of the Chinese economy in his China Financial Markets blog.
  • “Is China Socialist?” is the question Barry Naughton asks in a recent Journal of Economic Perspectives article. Naughton charts the changes in China’s economy from Deng Xiaoping to today.
  • The Economist has just published an essay on China’s economic evolution through the New Century Global Centre in Chengdu, the world’s largest building.