Reconciling security and growth

“America First” approach taken by the US will strengthen China’s own hardliners, who will push to emphasize national security over reform

HONG KONG – Earlier this month, at a conference to commemorate the 40th anniversary of China’s “reform and opening up,” President Xi Jinping underscored the tension between the continuation of that process and the imperative of protecting national security. Xi recognized that “China cannot develop itself in isolation from the world, and the world needs China for global prosperity.” Yet he also emphasized that “no one is in a position to dictate to the Chinese people what should or should not be done.”

There is no doubt that the world—and especially the United States—has lately been trying hard to pressure China to make changes. US President Donald Trump’s trade war—which he justifies in national-security terms—is the most potent example. But earlier this month—on the same night Xi and Trump struck a 90-day trade truce—Meng Wanzhou, the chief financial officer of the Chinese tech giant Huawei, was arrested in Canada at the behest of the US.

While the reason for Meng’s arrest has not been clarified by the US Justice Department, it appears to relate to US suspicions that Huawei has violated American sanctions against Iran. But it also likely reflects the technological dimension of the escalating economic and geopolitical competition between the US and China.

In any case, the possibility of unexpected restrictions or sanctions on businesses or individuals, imposed in the name of national security, sharply increases the risks faced by Chinese, American, and other businesses. This sends a chilling signal to financial markets, which have been plumbing multiyear lows all month.

There is good reason to hope that China can weather the challenges ahead. After all, the country has endured serious internal and external shocks almost every decade over the last 40 years: the Cultural Revolution in the 1970s; high domestic inflation in the 1980s; the Asian financial crisis of the 1990s; and the 2008 global financial crisis.

In fact, China turned these crises into opportunities. The result has been average annual GDP growth of 9.5 percent (compared to a 2.9 percent global average) since 1978, which raised China’s share of global GDP from 1.8 percent to 18.2 percent and lifted 740 million people out of poverty. China now ranks second in the world in terms of GDP, consumption, and foreign direct investment, and first for manufacturing, trade in goods, and foreign-exchange reserves.

As Xi emphasized in his recent speech, this success reflects the hard work of the Chinese people, the innovative practices of Chinese businesses, and the leadership of the Communist Party of China. Yet it is this centralized, one-party system of governance that the US is trying to change, in what amounts to the first significant external shock with a prominent national-security dimension that China has faced in the last 40 years.

The risk today is that the increasingly hard-line “America First” approach taken by the US will strengthen China’s own hardliners, who will push to emphasize national security over continued reform and opening up. As Pascal Lamy, a former World Trade Organization director-general, put it, “a more aggressive US can create a more aggressive China in a chain reaction that would be bad for all.”

Such a chain reaction would include a negative downward spiral in global trade and investment dynamics. Rising trade tensions are already increasing the chances of a synchronized global recession, with slower growth in the US, China, and Europe in 2019. Meanwhile, resistance to China’s Belt and Road Initiative—which has also been demonized by some Chinese national-security hawks—could choke off one of the world’s few sources of finance for much-needed infrastructure and public goods, particularly in developing countries.

Chinese dilemma

China now faces a dilemma. In order to minimize its vulnerability to external hostility, the authorities may need to rethink some elements of their domestic reform agenda. From a national security (and public goods) perspective, maintaining a strong state sector, emphasizing debt financing, and strengthening CPC leadership make more sense. But, in order to ensure quality growth, the country must continue working to boost private business, expand equity financing, and advance decentralization, thereby spurring competition, innovation, and job creation.

Xi hopes to balance these imperatives by doubling down on China’s growth model with Chinese characteristics, incorporating lessons from Chinese philosophy and history, as well as from his predecessors: Mao Zedong, Deng Xiaoping, Jiang Zemin, and Hu Jintao. This means consolidating Party leadership, contrary to America’s wishes, in order to maintain a pragmatic, flexible, and strategic approach to managing systemic risks and addressing internal concerns and external threats.

Domestically, China’s government will aim to support development that emphasizes boosting productivity and thus delivering innovative, coordinated, green, open, and inclusive growth. Such a strategy will include continued experimentation and adjustment, particularly when it comes to developing effective institutions that can provide public goods in a transparent and accountable way. On the international front, Xi plans to maintain a responsible foreign policy aimed at inclusive global development and resisting hegemony by any single actor.

In short, Xi will uphold China’s tried-and-tested, deeply pragmatic approach to modernization. Like so many of his predecessors, but unlike many in the West, Xi understands that there is no simple, one-time solution to the challenges ahead. As he put it at the 40th anniversary conference, “We must resolutely reform what should and can be changed, we must resolutely not reform what shouldn’t and can’t be changed.”

China seems ready for realistic reforms. Is America ready for a pragmatic deal?

Andrew Sheng is Distinguished Fellow of the Asia Global Institute at the University of Hong Kong and a member of the UNEP Advisory Council on Sustainable Finance. Xiao Geng, President of the Hong Kong Institution for International Finance, is a professor at Peking University HSBC Business School and at the University of Hong Kong’s Faculty of Business and Economics