The U.S.-China Cold War Will Get Worse Before It Gets Better

(Bloomberg Opinion) -- We are in the midst of a new Cold War, with the United States and China carving out separate economic and political orders. Let's consider how it might look in a few years.

There will be two separate internets, with the U.S. and China as the two dominant players. American tech companies still will be kept out of China, and Chinese tech companies will find it hard to get Western contracts or sales, as Huawei is discovering with its plans to build 5G networks. National security and surveillance considerations will make these risks too high, and such restrictions will become increasingly important as “software eats the world.”

There is already talk that the U.S. should not buy solar panels from China. What if those panels are monitoring Americans, or have embedded kill switches? Even if the chances are not high, risk-averse businesses, as well as businesses that have contracts with the Pentagon, will feel more comfortable with other sources of supply. Already, CFIUS — the U.S. regulator charged with scrutinizing foreign investment — is no longer welcoming Chinese investment in American sectors that might be considered sensitive in terms of either national security or advanced technology.

Furthermore, Apple iPhone sales in China are down, and that was long one of the biggest export success stories for an American company. You can blame that on the Chinese economic slowdown. But in the longer run, a mix of cheaper “good enough” Chinese brands, plus security considerations and patriotism, means Apple has probably peaked in China.

The new dynamic affects people as well as products. China is asking state firms to avoid travel to the U.S. and its allies. And if you were an American or Canadian tech company executive, would you travel to China right now, given that Canada has detained a leading Huawei executive (and daughter of the company's CEO) for extradition to the U.S.? Meanwhile, many American universities are kicking their local Confucius Institute off campus, most notably the University of Michigan, amid complaints that those institutes are spying on Chinese nationals who attend those schools. Whether or not that is true, this is another sign of the collapse of trust.

This is the deeper issue with the U.S.-China relationship: the continuing erosion, in an era of rapid deglobalization, of previous ties built at least partly on a common sense of purpose. Looking back at 2018, it now seems obvious that this was the most important story of the year.

It is easy enough to imagine how things might get worse. More and more accounts of Chinese espionage are likely to surface, and the U.S. is hacking Chinese systems, too. As deals are rejected, commercial and political grudges will stick and fester. Hong Kong may fall even further into the Chinese sphere and behind the Great Firewall.

Headlines will focus on tariffs and the short-term trade war with China. But the issues are geopolitical, not commercial. Even if there is a truce in the trade war in the next few months, any agreement on Chinese economic policy will itself be hard to enforce. And of course no settlement can change the fundamental dynamic of declining trust.

I don't necessarily see the endpoint here as a major war between China and the U.S., simply because the costs of such a conflict would be too high for all parties. Still, it is easy enough to imagine China making military moves or threats in its immediate neighborhood, perhaps against Taiwan. China could become more of an international pariah, as was the Soviet Union after its invasion of Afghanistan, and that would cement this basic pattern of delinking.

The U.S. is unlikely to be the major loser from this process, which in part explains why it may happen. Higher prices for Chinese goods will harm American consumers, but they will also accelerate outsourcing to lower-wage nations such as Vietnam and Bangladesh. Furthermore, the U.S. has the preponderance of strong allies, as compared to China, so it will enter a more intense geopolitical struggle in a better position.

The biggest losers are likely to be nations which wish to keep strong commercial ties to both the U.S. and China, for instance Germany and Singapore. And China itself, which is still relatively poor and may be entering an economic slowdown, has a history of political instability. So it is much more vulnerable than the U.S.

My biggest fear is that all of this will be the most important story not only of 2019 but also of 2020.

To contact the editor responsible for this story: Michael Newman at mnewman43@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Tyler Cowen is a Bloomberg Opinion columnist. He is a professor of economics at George Mason University and writes for the blog Marginal Revolution. His books include “The Complacent Class: The Self-Defeating Quest for the American Dream.”

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