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About the author: George Magnus is a research associate at Oxford University’s China Centre and at the School of Oriental and African Studies in London. He was chief economist of UBS and is the author of Red Flags: Why Xi’s China Is in Jeopardy.
The official readouts of the recent remote meeting between Presidents Joe Biden and Xi Jinping were unsurprisingly different. Biden warned about the “implications and consequences if China provides material support to Russia.” China’s somewhat defiant response rejected “sweeping and indiscriminate sanctions” as dangerous for the world economy. This diplomatic exchange served to emphasize not only the huge sensitivity of sanctions but also that political and economic decoupling is now moving up through the gears.
Financial markets, predictably, didn’t seem immediately fazed. But companies are taking note.
China is in an awkward position. Xi craves stability ahead of the important 20th Communist Party conference late this year. The Chinese economy was already facing headwinds from an overhang of debt, a tipping point in the property sector, employment pressures, and stalled productivity. Covid prevalence has surged, at least by Chinese standards. Lockdowns and restrictions could affect provinces accounting for nearly half of gross domestic product.
Now, China also faces surging fuel, commodity, and food prices in the wake of the invasion of Ukraine, which could take up to 1% off already-anemic growth. The last thing that Xi wants is to become embroiled in a new sanctions row if he is deemed overly complicit in Putin’s war.
Xi’s instinct for now is probably to continue to walk the precipitous path between backing Putin just enough and keeping the wrath of the U.S. and European Union at bay. His own political prospects are closely tied to what happens to Putin, and we should assume that he wants a fellow autocrat to prevail against the West. Yet there are limits. Russia is small beer economically compared with the $1.3 trillion of bilateral trade China does with the U.S. and EU, and the vast infrastructure of dependence on foreign direct investment, access to global capital markets and the U.S. dollar, and the acquisition of crucial technology, know-how, and research-and-development inputs.
In other words, China thrives and depends on engagement in the global economy. If these relationships were to fracture further, no one would benefit. A more isolated China would be a diminished force economically.
The beginning of the war marks a period of decisive change for China’s relationship with the world. China will be determined to “sanction proof” its economy and financial system, if that’s even possible. It, along with its liberal adversaries, will strive to rely less on one another’s products and supply chains in the most sensitive areas associated with broadly defined national security.
Companies in China have gradually, if reluctantly, been drawn into controversial legal and regulatory disputes. While focused on commitments to China’s large markets and middle class, they have had to manage in an increasingly awkward business environment. China has recalibrated its industrial policy and imposed more-politicized regulatory and controlling administration systems. The business environment has also deteriorated in the wake of the trade war, development of entity lists, export controls, blacklisting of companies, market access restrictions, and rows over human rights in Xinjiang and Hong Kong.
Covid restrictions and closed borders have simply made more pressing the need to reconsider the integrity and regionalization of supply chains, to diversify away from sole-source suppliers and ensure that business plans remain functional in the event that even one product or material should be subject to new sanction or regulation.
Competing regulations, laws, systems, and standards have also been driving firms to disengage or decouple in, for example, digital, innovation, and research spaces, as they look at the widening risk of bifurcated systems, standards, and data management.
In areas of high strategic or national security importance, there are already different systems. Firewalls are being erected directly through restrictions on market access, negative lists that restrain foreign investors, and national security measures, and indirectly through the application of party- and state-determined standards and licensing requirements.
We should hope that the kind of macro and financial decoupling that is now in full view in Russia never applies to China, but the gauntlet has been thrown down. Companies will be obliged to pay close attention to contingency plans, diversification strategies, and decoupling of supply chains in some areas, at least as far as China goes. They will also find themselves increasingly subject to competing laws and regulations, for example, over sanctions, monopoly and competition policy, and national security. Companies might be forced to choose whether to follow Chinese laws and antagonize their home governments and shareholders, or to flout them and face an altogether different music.
It is true that the unprecedented interdependence between China and the rest of the world cannot be quickly or easily ended. Nonetheless, decoupling has started and is likely to gather momentum in years to come. The consequences of the war in Ukraine, and the threat of secondary sanctions against China over its support for Russia or, perhaps one day, its actions on Taiwan, mean that for companies the prior alignment of corporate and national interests is pretty much over.
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