The US retains the economic advantage in its rivalry with China

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Not long ago, “most governments had believed that closer economic integration would promote long-term prosperity. Now, integration is seen as a source of risk and insecurity.” This is how London-based Capital Economics introduces an intriguing analysis of “the shape of the fractured world economy in 2024”. Economics and politics always interact. Today, however, politics has become more important. Its concept then is of a global economy being reshaped by fraught relations between the US and China.

Capital Economics argues that countries can be divided into five groups: the US and its close allies; countries that lean towards the US; the unaligned; those that lean towards China; and China and its close allies. The first group consists of the US and Canada, Europe (except Hungary), Japan, Australia and New Zealand. The second group includes, above all, India, but also Colombia, Mexico, Morocco, Turkey and South Korea. The unaligned group includes, significantly, Brazil, Indonesia and Nigeria. The group of countries leaning towards China includes Argentina (true, until a few days ago!), much of Africa (including South Africa), Iraq, Kazakhstan and, suggests Capital Economics, Saudi Arabia. Finally, China’s strong allies include Russia, Iran and Pakistan.

A fundamental distinction exists between the first group and all others. The high-income democracies share core values (although whether they continue to do so will depend on the results of the 2024 US presidential election). The other groupings are defined far more by what they are against than what they are for. Russia and Iran are allies of convenience for China, and vice versa. They share an enemy. But they are still very different from one another. Yet such alliances of convenience can shape both economic and political relationships. The enemy of my enemy may, for a while, indeed be a good friend.

Here then are some relevant data.

The China bloc accounts for half of the world’s (non-Antarctic) land mass, compared with 35 per cent for the US bloc. It is also home to slightly more of the world’s people (46 per cent, against 43 per cent). But it still generates only 27 per cent of the world’s GDP, nearly all of that in China itself, compared with 67 per cent in the US bloc. This is because, crucially, most of the world’s high-income countries are in the latter.

The ways that balance might change is for the US bloc to disintegrate, probably under Donald Trump, or for the Chinese economy to grow faster than Capital Economics now expects. The latter’s pessimism on China’s prospects may be excessive, but it is far from absurd. China does, indeed, face strong headwinds against high growth over the next quarter of a century.

Unsurprisingly, the China bloc is more important in industry than in GDP. Thus, its share of world industrial output was 38 per cent in 2022, against 55 per cent for the US bloc. Whether China’s bloc reaches equality in industry over the next quarter century depends mainly on the performance of Indian manufacturing relative to China’s. In agriculture, the China bloc generates 49 per cent of output, compared with 38 per cent for the US bloc, because it contains many commodity producers.

In 2022, 144 countries traded more goods with China than with the US. The US was the bigger trading partner for only 60 countries. But half of global goods trade was among countries classed as in the US bloc. This wider perspective is really useful. Germany, for example, is widely thought to be the US ally with the tightest trade links with China. But only 11 per cent of its goods trade was with the China bloc in the second quarter of 2023, while 86 per cent was with others in the US bloc, principally its European partners.

In financial activities and capital flows, the US bloc remains dominant. While its place in foreign direct investment has shrunk over the last quarter of a century, it still accounted for 84 per cent of the total FDI stock by investor country and 87 per cent by recipient in 2022. This is because the world’s dominant corporations and the most attractive destinations remain within it. This gap will not close under Xi Jinping.

Some 86 per cent of global portfolio investment also lies within the US bloc and only 2 per cent within the China bloc. FDI between the US and China blocs is three times FDI within the China bloc: Russia and Iran may be China’s allies of convenience, but only fools would put much of their capital in such economically benighted petrostates. Chinese investors are not such fools.

Foreign exchange reserves still predominantly consist of assets denominated in the US currency and those of its allies. In the second half of 2023, these accounted for 87 per cent of foreign currency reserves, only a little down from 89 per cent three years earlier. This is because only these countries supply liquid long-term financial assets. They may not be as safe as they used to be, given the use of sanctions. But no good alternatives exist. China is most unlikely to wish to supply them, since that would require liberalisation and opening of its financial markets, including markets in Chinese public debt.

Many countries wish to see the US and its allies, the dominant powers of the last two centuries, taken down more than just a peg or two. But they are more united and economically powerful than China’s group of malcontents. The event likely to change this balance quickly would be a US decision to tear its alliances to pieces. That would be one of the most dramatically self-harming acts in global history. It would take far longer for the China bloc to surpass the US bloc on all relevant aspects of economic weight. It may never do so.

martin.wolf@ft.com

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