Is Decoupling Destabilizing the Global Economy?

Matt Kroenig: Hi Emma! I taught my last class of the semester at Georgetown this week, and I am looking forward to one less responsibility this summer.

Do you have any fun summer plans?

Emma Ashford: I’m taking the kids camping in the Shenandoah mountains next week! The great outdoors doesn’t come naturally to me, so if I don’t show up for this column in two weeks, you should probably just assume that a bear got me.

I want to talk about political economy today. We’re not economists, but there have been a couple of big speeches in the last few weeks—from Treasury Secretary Janet Yellen and National Security Advisor Jake Sullivan—that continue with the Biden administration’s approach of linking national security and economic policy.

And coincidentally, I think I saw you getting dragged on Twitter for expressing views on a similar subject. What was it you said? That China should be grateful to the United States for its economic growth in recent decades?

MK: I tweeted that China’s economy grew over the decades because the United States wanted it to grow as part of its strategy of incorporating China as a stakeholder in the rules-based system. But now that China is challenging the system, the free world is kicking the ladder down. The tweet certainly got a lot of attention (most of it positive, so I am not sure “dragged” is the right description), but let’s start with Yellen and Sullivan because their pronouncements are much more influential than mine.

EA: OK, but the reason I mentioned it is because I think the message of your tweet and the two speeches were surprisingly similar: China should be grateful for U.S. economic leadership, and can continue to grow so long as it doesn’t upset the United States too much. You just put it more bluntly, with far fewer characters than they did.

MK: Yes. My 240 characters were motivated by the same set of discussions and were definitely blunt! If I had known the tweet was going to be read by more than half a million people, I would have selected my words more carefully!

But, yes, China has benefited greatly from the U.S.-led economic order over the past several decades. Washington knew China was stealing intellectual property, forcing Western companies to transfer technology in order to do business in China, and otherwise trampling on the rules of the global trading system. But it was willing to turn a blind eye because its strategy was to engage China in the hope that it would become a “responsible stakeholder” in a rules-based system. The U.S. economy benefited too, of course, with cheap Chinese imports that helped keep inflation down, for example.

But now, Washington realizes its strategy has failed. It is entering an intensifying rivalry with China. It is no longer willing to ignore China’s unfair trade practices, and it is punching back with a selective decoupling (or “de-risking,” which seems to be the politically acceptable term now).

Yellen went to great lengths to explain that the purpose was not to keep China down. I agree with that. But, in reality, this will be a headwind for the Chinese economy. For decades, access to foreign capital, markets, and technology have been key to China’s growth model, and now these things are being taken away.

EA: That feels surprisingly contradictory to me. How do you simultaneously argue that the U.S. strategy isn’t to keep China down, while also arguing that decoupling will slow and harm Chinese economic growth?

It seemed to me that Yellen’s speech had the same problem, writ large.

MK: It is not a contradiction. It is a side effect.

The purpose is to protect U.S. national security and respond to China’s unfair trading practices. There will be an economic cost to both sides, as Yellen pointed out, and I think it will hurt China more. If the Chinese Community Party doesn’t like it, it can stop threatening its neighbors, cheating the global trading system, and practicing genocide in Xinjiang.

EA: Decoupling will also hurt other countries, and potentially make the United States quite unpopular globally. Look, in general, I probably agree with you that some decoupling in strategically important sectors is needed. My concerns are this administration’s subordination of national security imperatives to domestic political economy considerations, which seems both harmful to U.S. economic prospects in the long term, and more likely to undermine America’s global role than to bolster it. It’s protectionist and short-sighted.

But perhaps we should take a step back and talk about what Yellen and Sullivan actually said.

MK: I liked Yellen’s speech overall. She laid out the Biden administration’s economic approach to China, and presented a plan for de-risking.

She essentially presented four main points. First, that the United States and its allies should engage in a hard decoupling from China in areas relevant to national security and human rights.

Second, she said they should take countervailing measures in areas where China is not playing by the rules, such as with its IP theft and forced tech transfer.

Third, she argued that trade could continue in all other ways and this would be good for the United States, China, and the global economy.

I agree with all of those points, and, indeed, have been arguing for a similar framework for years.

Her fourth point, however, I found more problematic. She hopes that the United States and China can cooperate on shared challenges such as debt relief for the developing world and climate change. The Biden administration continues to express hope for cooperation with China, but China does not seem that interested. Beijing is reluctant to take losses on its debt, and its greenhouse gas emissions are the world’s largest and continue to increase.

What was your take?

EA: Look, I appreciated the administration attempting, through these speeches, to actually state the economic and security policies it has been putting into practice for the last few years. And the contours were broadly familiar: industrial policy at home, preferential trade with allies, and sanctions and export controls that restrict Chinese growth in specific sectors.

At the same time, both speeches were misleading about the realities of those policies. Take Yellen’s speech. As you note, she substituted de-risking for decoupling, but frankly there’s little real difference between the two. It’s just an attempt to make the concept sound less threatening so markets aren’t so spooked.

The same goes for her comments on sanctions and export controls. She said that U.S. punitive measures on China would be “narrowly scoped” and “targeted” so they don’t impact China’s economic growth more broadly. But U.S. measures have already targeted China’s biggest telecom firm and barred the export of a whole class of advanced semiconductors to China. And the inclusion of human rights alongside national security concerns in her speech speaks against the idea that only the most essential measures are being considered. We can debate all of those choices on the merits, but they’re hardly narrowly scoped!

MK: Let me make several points. First, and most fundamentally, I disagree that it is a mistake or somehow protectionist to consider national security in economic policymaking. Countries almost always do this and for good reason. After all, the United States could earn revenue by exporting nuclear bombs to other countries, but it does not do that for very good reason. Similarly, Washington and its allies should not export advanced tech with military applications to Beijing.

Second, I agree that decoupling to de-risking is mostly a rebranding exercise—and I think that is a good thing. Many wrongly assumed that decoupling meant completely severing economic ties with China. That was always unrealistic and unwise. But selective decoupling (stopping specific, sensitive economic activity with China, and allowing the rest to continue) was always a good idea in my view, marred by a bad reputation. The term “de-risking” does not carry the same baggage.

Third, and here is where we may agree: I am not sure how narrowly scoped this de-risking will or should be. Clearly, it is not wise to help China’s People’s Liberation Army build weapons. Clearly, it is OK for China to import American soybeans, or for Americans to buy Made-in-China baseball caps. But there is a lot of gray area in between. Where does one draw the line? Some are arguing that medical supplies, aircraft, and other things that are not obviously related to national security should also be on the list.

EA: It’s not protectionist to consider national security in economic policymaking. That’s a core job for any government! What is protectionist is the fact the Biden administration is coupling—no pun intended—its China strategy to its opposition to any kind of traditional free trade agreements and its commitment to a buy America-style industrial policy. Sullivan may have framed it as “moving beyond traditional trade deals,” but that’s not fooling anyone.

For example, the administration has refused to rejoin the successor to the Obama-negotiated Trans-Pacific Partnership, a trade deal that would have liberalized ties with states in the Indo-Pacific and is highly favored by many Asian states as a bulwark against China. And U.S. President Joe Biden made it clear that new trade deals with Britain or the European Union are not on the table.

Simultaneously, Biden has prioritized industrial policy that restricts most of its benefits to U.S.-made products. This is why European states are so angry about the car industry provisions of the Inflation Reduction Act, and why allies such Taiwan are concerned about the subsidies in the CHIPS semiconductor act. Taken together, these present a clear picture: Allies and partners may want more trade, but the United States is not willing to engage in a substantive way.

This isn’t a blanket call for open trade; there is a place for de-risking. I completely agree that Washington shouldn’t be reliant on Beijing for critical national security technologies. Nothing that goes in a U.S. weapons system, for example, should be manufactured in China. But the answer to the dilemma of trade-related risk isn’t protectionism; it’s diversity of supply. Biden doesn’t need to bring all manufacturing home to the United States—something which wouldn’t be economically viable without making us all a lot poorer in any case. He just needs to ensure that the country is trading with a wider variety of partners in order to mitigate the risks of future disruptions.

But that’s basically the opposite of the administration’s approach.

MK: Well, here we may agree, and this gets more into Sullivan’s speech. He was more focused on industrial policy and delivering on Biden’s campaign promise of a “foreign policy for the middle class.”

There is a role for government investments in infrastructure and key technologies that will not receive funding from the private sector. That is how we got the Internet, after all.

But the Biden administration has gone about it in a clumsy way, loading up the bills with unrelated pork that prevented them from winning bipartisan support, and building in protectionist measures that are alienating the United States’ traditional trading partners.

The administration is trying to find fixes to the latter problem now, but it would have been better to consider allies from the start.

EA: Yeah, that was my question for you: I know you’re a big proponent of “ally-shoring” or “friend-shoring,” but does the administration actually seem to be doing that?

There are tensions with Europe over the Inflation Reduction Act, which requires electric vehicles to be made in the United States to qualify for subsidies, potentially undermining European exports to the United States. There are tensions with Taiwan over the CHIPS Act and the role that subsidies will play in the industry going forward. It feels to me like this is protectionism plus decoupling, not ally-shoring plus decoupling.

MK: I agree. As the free world moves supply chains out of China, there can be some re-shoring, but there should be more of a focus on friend-shoring. Some of this is happening naturally through market forces, as companies (such as Apple) look for countries with low-cost manufacturing—in Southeast Asia, for example. But this would work better if it were part of a U.S. and allied government strategy.

My colleague Ash Jain and I have proposed a Democratic Trade and Economic Partnership to build in incentives to manufacture not just in the United States, but friendly countries globally. This makes good economic sense, but it would also be helpful geopolitically to give some of the “hedging” countries in the global south an economic incentive to qualify as a “friend” of the West.

EA: That reminds me of my other complaint about these speeches: They do nothing to bolster the U.S. image in the global south. Sullivan’s speech in particular had many of the hallmarks of what I’ve come to think of as the rather haughty Biden administration messaging on global economic order.

It engaged in the usual hagiography about the liberal order that the United States built after World War II, ignoring that that order was far more open to trade than this administration is. And then he made vague promises about global economic prosperity while talking about implementing specific sanctions or trade policies that will have detrimental real-world economic consequences for poorer countries. His tone-deaf decision to refer to these policies as the “new Washington Consensus” was just one example; after all, the first Washington Consensus is hardly popular in the developing world!

In a nutshell, the message from the administration to the global south is: You owe America for your prosperity, and you’ll be lucky if we don’t undermine it. That’s a pretty awful sales pitch for U.S. global leadership.

MK: Well, I owe you and this column for my prosperity, so please do not undermine that by getting eaten by a bear next week.

EA: On second thoughts, after these speeches, I’m more worried about a bear market than I am about actual bears.

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