CSIS Commentary: U.S. Business Leaders Not Ready for the Next U.S.-China Crisis

 

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U.S. Business Leaders
​​​​​​Not Ready for the Next U.S.-China Crisis

 

By Michael J. Green & Scott Kennedy

 
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It is no exaggeration to conclude that U.S.-China ties have deteriorated to depths not seen since the late 1960s, when the two had no diplomatic ties and were actually shooting at each other in Vietnam. China has long since stopped fomenting revolutionary wars, but from Washington’s perspective (which is increasingly shared by others in Europe and Asia) Beijing’s promotion of state capitalism, disregard for human rights, irredentist claims, and support for Putin collectively represent a deeply dangerous challenge to the existing world order. To Beijing, a declining United States is trying to use every tool in its toolkit to undermine and isolate Beijing and keep China from achieving its rightful resumption as a world power, which is driving China’s approach increasingly in a zero-sum direction.

While the Biden administration has expressed a desire to manage competition, the two governments are barely on speaking terms and when they do talk, it is usually an exercise in frustration. President Biden’s phone call with Xi Jinping in early March was most noted for the warnings the U.S. side issued against Chinese support for Russia’s invasion of Ukraine. U.S. trade representative Katherine Tai has said her conversations with Beijing have yielded no progress on commercial differences. And when the United States recently announced the departure of nonessential personnel from the Shanghai consulate, the Chinese Foreign Ministry accused the United States of not trying to protect lives but of politicizing the pandemic.

There will be no easy exit from this new chapter of Sino-American strategic competition—a chapter that arguably started with Xi’s moves against the South China Sea and neighboring states seven years ago, as the Obama administration was still exploring modalities for a productive bilateral relationship. No political leader in Washington will now argue for returning to that earlier hopeful period in bilateral relations and the thrust of the Biden administration’s Indo-Pacific strategy is properly to strengthening alliances and partnership to deal with a more coercive and ambitious China. Yet at the same time, the current trajectory in the bilateral relationship bodes ill for the ability of Washington and Beijing to manage crises that might emerge in the coming years. Both sides regularly assume the worst intentions of the other: Beijing’s anti-Western social mobilization campaign continues unabated, the quiet dialogue mechanisms that once allowed strategic exchanges between the White House and Zhongnanhai have been replaced by lecturing megaphones.

In the wake of the global financial crisis, natural disasters, Covid-19, and extensive supply chain challenges, corporate leaders have become adept at preparing for “black swans” and the continuity of business contingencies, embracing “just in case” over “just in time” and learning to prepare redundancies and protect key technologies. But the current dynamics in U.S.-China relations suggest that there may be a need to prepare for a new bevy of potential black swans from technology competition to major military contingencies.

Thinking the Increasingly Probable and No Longer Unthinkable

The impediments to war between the United States and China—from the deterrent effect of nuclear weapons to the trillions of dollars in possible economic damage—remain robust. But the escalation ladder from current “gray zone” coercion and diplomatic jostling up towards cyber, technology decoupling, and even military threats is also closer at hand for Beijing, and therefore Washington. In the Taiwan Strait, Chinese military overflights that cross the midline or circle the island are now a regular occurrence. Although there is reason to doubt that Xi Jinping has set a firm deadline for reunification, Beijing may increasingly believe that force is their only option. An accidental collision between ships or jets in the South China Sea is not only possible—it has also occurred. The nuclear submarine USS Connecticut’s collision with an unknown underwater object in October 2021 is a case in point. This incident did not spiral into a larger conflict, but it easily could have. There is now greater commercial and military traffic in the South China Sea than ever, but the United States and China have very few crisis management mechanisms, with insufficient ways to communicate at an operational level in real time.

The U.S. and Chinese economies have become so intertwined over the last 40 years that when Trump first launched his trade war, the idea of decoupling seemed absolutely impossible. Even the restrictions on Huawei looked like a pebble of decoupling in an ocean of connectivity.

Not so anymore. The woven threads of commercial ties have already started to fray. Total merchandise trade has held steady, but processing trading, which highlights movement of goods within supply chains, is down. Equity investment from the United States to China has only dropped a little and U.S. companies still report being profitable, but their angst at their treatment is on the rise. Venture capital deals have steadily fallen. Meanwhile, all manner of Chinese investment to the United States has plummeted. Overall financial flows are still quite high (and perhaps larger than ever), but the storm clouds are gathering, with the 250 Chinese companies on U.S. markets poised to be delisted, and growing concerns in the United States about the downsides of U.S. institutional capital in Chinese markets. Travel is down to a trickle of businesspeople willing to endure lengthy quarantines. The growth of sudden lockdowns, represented most shockingly by Shanghai, is certainly another deterrent to travel.

It is now entirely conceivable that commercial ties could be substantially unravel. One route is through the expansion of defensive regulatory measures that would raise the costs of doing business. Both sides have instituted a range of restrictions and are pursuing analogous programs to achieve supply chain resiliency and reduce their dependency on the other. There are now nearly 1,000 Chinese companies penalized in one way or another by the United States for national security or human rights reasons. The final China bill that emerges out of the Senate-House conference may very well start to require U.S. investments to China to undergo national security reviews the same way the U.S. screens inward investment. And China could start to use, among other tools, its Anti-Foreign Sanctions Law and its own Unreliable Entities List to punish U.S. companies that do not toe Beijing’s line.

The other pathway to reduce ties would be an unintentional escalation of penalties. For example, imagine how Washington might react if Beijing suddenly shut down the cloud computing services of Microsoft or Amazon Web Services (AWS) on the excuse that some customers were inappropriately transferring data abroad in contravention of their data localization rules. The Biden administration would likely have no choice but to retaliate, leading to a potential spiral of ever-growing restrictions that would reduce existing activities and ward off future business.

The possibility of a security crisis and economic decoupling have only been magnified by the war in Ukraine. While U.S. and NATO support for Ukraine may in some ways strengthen deterrence against an attack by the People’s Republic of China (PRC) on Taiwan in the near term, it may also eliminate any hope Beijing had of achieving unification peacefully and further reduce the likelihood of some sort of negotiated settlement.
And the radical expansion of Western commercial restrictions against Russia may be a test run for greater limits on ties with China, particularly if Beijing does not further distance itself from Putin and the invasion.

Everyone should take notice when U.S. treasury secretary Janet Yellen, not known as an über-hawk, highlighting this possibility, recently warned: “The world’s attitude towards China and its willingness to embrace further economic integration may well be affected by China’s reaction to our call for resolute action on Russia.”

Business Is Not Ready

This transition has occurred so fast that global companies that have thrived on doing business with China are not well prepared to adapt to this new normal or to try and stem the tide.  Extended interviews and in-depth crisis scenario exercises with dozens of companies and investors, including to an elite group of participants in the Bloomberg New Economy Forum, about these issues over the past few months, have revealed an unexpected combination of overconfidence and resignation in their views.

When faced with the prospect of a military crisis, some companies believe that they could use their connections to be fully informed and potentially even shape the thinking of decisionmakers so that they avoid the worst outcomes. The cold reality is that once a crisis erupts, the economic policymakers get tossed out of the room and the circle of decisionmakers narrow to those who prosecute war. Companies will be forced to operate largely in the dark, or at least be no better informed that Joe Q. Public, and hence, will have to focus on short-term issues such as protecting their most directly affected employees, bank accounts and other assets, and then just hang on.

When it comes to decoupling, we found both rosy optimists and deflated pessimists. Some assert that commercial decoupling is simply not possible because of the continued extent of ties and the obvious economic harm the West would inflict on itself—lost markets, access to resources and opportunities to innovate—that would come from such steps. In contrast to this view that business needs to do little more than remind Washington the benefits of ties, the alternative view—that there is no use in making this argument because no one will listen—is equally if not more prominent. At the end of the day, most companies are highly risk-averse and want to avoid getting on the wrong side of officialdom.

Although some business associations have taken up the challenge, it is hard to find individual companies that are willing to strongly advocate in Washington for continued engagement or push hard on Beijing to liberalize and constraint state capitalism (let alone push on its actions in Xinjiang and Hong Kong). The result is that global businesses are for the most part keeping their heads down, hoping their China opportunities do not dry up, and aiming for greater home government support to relocate some of their supply chains. The war in Ukraine and the concomitant shift in thinking about China in Washington and like-minded capitals in Europe and Asia only reinforces this posture.

What Is to Be Done?

The good news is that almost all business leaders the authors have engaged on these scenarios were already used to thinking about black swans. Few fought the scenarios even if they had not considered them. The bad news is that very few corporations engaged in China have contingency plans or long-term strategies to hedge against the downside risks of growing geopolitical competition. However, there are few good places to start.

First, corporations should not assume that their immediate corporate, regulatory, or political counterparts in China will necessarily be able to protect them against a national-level crisis. Those relationships might help, but they are no guarantee that business operations will survive.

Second, corporations which tend to keep their head down on geopolitics for obvious reasons will now need to engage both governments more actively on the consequences of our inability to manage crises. This will be far more effective if done collectively through business associations. And the effort will only be effective in Washington if the premise is that there will be geopolitical friction and U.S. national interests matter—but that management of that competition is critical. Fighting the premise will mean that corporations do not get a hearing in the Biden administration or Congress on either side of the aisle right now.

Third, corporations need to think about their operating environment the way geostrategists now are—which is to say that there are multiple players shaping relations with China that have weight in Washington and Beijing. U.S. allies in the Indo-Pacific and Europe are increasingly aligning with Washington on the necessity of pushing back against Chinese coercion and mercantilism However, all these allies from Japan to Germany also seek careful management of U.S.-China relations. U.S. corporations and business associations rarely align their efforts with counterparts in Tokyo or Brussels, but they need to do so now.

Fourth, corporations need to press for a regional economic strategy that stabilizes U.S.-China relations. Before the Trump administration withdrew from the Trans-Pacific Partnership in 2017, the strategy of the United States and its allies was to build a rules-based order in the region that would increase all their leverage vis-à-vis Beijing and offer strong incentives for China to play by the rules. The unilateralist U.S. approach to economic statecraft since then has alienated close allies and left room for Beijing to expand its ambitions for regional hegemony—thus adding to geopolitical friction and uncertainty. The administration’s new Indo-Pacific Economic Framework (IPEF) is a well-intentioned effort to fill that vacuum, but it still falls short of what is needed to substantially restore faith in U.S. economic policy leadership and curb China’s own ambitions to replace the United States as the primary rule-maker in the region.

Finally, corporate leaders need to engage in the kind of scenario exercises that the U.S. military regularly employs. These scenario games are not meant to be predictive, but rather to stress-test current assumptions and point to measures that might be useful in a crisis (for example, who would CEOs need to know in the event of a major technology or military contingency that threatened their operations). No plan survives first contact with the enemy, but no leader succeeds in a crisis if they have not been forced to consider how exogenous shocks would impact their plans.

Michael J. Green is senior vice president for Asia and Japan Chair at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Scott Kennedy is senior adviser and Trustee Chair in Chinese Business and Economics at CSIS.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2022 by the Center for Strategic and International Studies. All rights reserved.
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