How Trade War is Reshaping China

Beneath the headlines, what's happening on the ground in China and what are executives that have to make decisions doing about it? In the era of trade slings and arrows? Should we even be talking about globalization at least as far as we've come to understand the term. Francis Slim from Colberg Cravis Roberts spent some time in China recently and his co author of a penetrating report called China

a Visit to the Epicenter. She joins us from Sydney, where she's head of the Asia Pacific Macro Research Team. Francis welcome. Thank you very much. Dan. I'm very happy to be here and so thank you for the induct What was unique about this trip to China. It's been the epicenter of a lot for quite a while, or at least some of the seismic points. What's going on there right now? Oh, I think you're very right. China

has been the epicenter for a very long time. We have been meet Henry mcbeh and myself have been traveling to China for many years now, and I think what's different now is this intense focus on trade and the tensions going on there where US is imposing tariffs on

China and China is imposing terroffs on the US. So we took a visit to Shanhai um and we're heading to Beijing next to find out what's really happening on the ground, what's the view from China, because a lot of the rhetoric we here is from the US and less from China. So we went there to learn more about how Chinese authorities are thinking about the trade issues. But not just Chinese authorities, you also talk to executives

making daily decisions about how to deal with the headlines. Absolutely, and to me, that's the that's the key way that you understand what's actually going on when you speak to business leaders in China, they tell you what they're feeling on the ground, and that was what was different this time around. Previously, you'd always hear the policies that are being rolled out from Chinese authorities, and it was very clear the direction they were going as it pertained to trade.

There was a vacuum of conversation, so unlike the US, where you're here daily comments coming from d C, you don't hear that coming from China. So when you speak to the business executives, they tell you that things have changed, and that was what was so interesting about this visit, and you were getting that same impression from locals as

well as expatriates. Yes, um, the locals. I think the local business folk had a different view of what was happening, and a very big, long term structural view of the tectonic shifts really that are happening in the global economy and how the center of gravity, the center of economic functions are shifting, and they felt that was the core reason why we had these trade tensions today. The foreign nationals that were in China were more reacting to policies

that were shifting as a result of these tensions. So You've got a good flay or of what locals were feeling and what foreign companies were feeling. You're asking readers to look beyond the prospect of any short term fix to end the trade dispute between the US and China. What's wrong with looking for a fix. This is our view and it's my view as well. I think the reason why the trade tensions are here today is not so much because of trade as it is about broader issues.

And the key issue that's different today is China has come of age. China now can make smartphones. China actually makes more smartphones than some Song and Apple combined. Nobody talks about that. This is what's shifting. China is capable of doing a lot of things the US is doing. The US is trying to slow down in China's progress, and the trade is a tool to make that happen. In my view, a lot of the domestic commentary in the It States does feel like it's in a time warp. Francis.

People talk about sweatshops. People bemoaned that factory producing furniture that was once in North Carolina and now it's gone, oh somewhere in China. In reality, that factory has probably moved on somewhere else from China. If I'm understanding you correctly, that's correct. So maybe about ten twenty years ago, China did have a lot of factories manufacturing low end goods. When they first entered the w t O, they were making t shirts and toys, low end goods with massive factories.

Today it's very different. What has been amazing is that you know that the US developed a lot of the technology. The US developed the iPhone, the US developed the iPad. But what China has done is they have really mastered the use of technology that has been built by the US. And if you look at the progress they have made in terms of uh Internet penetration, the use of phones, and ride sharing and even e commerce, it has just leaped throut the US. Ten years ago they were at zero.

Today their way ahead of the US in terms of the application of new technologies. That's what this trade war is about. We need of the U s fields. They need to slow China down. That's not going to shift and that's why I think the change that's happening UM is more structural in nature. The tensions will be more long tailed than people think because the fundamental reason is that China is now a real competitor to major developed

countries like the US, like Europe and Japan. Does that make China more resilient to a trade war than was the case a few years ago. Yes, absolutely. If you look at the amount of exports as a set of GDP, it's fallen from more than hardly eighteen today, which is not too far from where the US is in terms of its trade exposure, So absolutely makes it more resilient.

There's also a great resolve to continue moving forward. They are continuing to invest in education, they're continuing to invest in innovation, and in fact, as a result of the trade war and the potential of losing supply of these precious semi conductor ships, which is the core of a lot of the trade tensions, they have actually raised a fund to accelerate progress in manufacturing high end semiconductor technology. Francis, you cast serious doubts in this report over the future

of global supply chains. Talk a bit about that place. So if you think about the world twenty years ago, when China first and the World Trade Organization, everyone would grow through expanding their export base, and that was a really good strategy in terms of uh expanding GDP growth and increasing wealth in a lot of emerging countries. That was because the US was a major consuming economy. Today, though the dynamic has shifted. China is a much more

wealthy country. Today. GDP per capital is in the ten thousand range, and they have one point four billion people compared to America's three hundred thirty million. So when you do the math, within five years, China's consuming power will be greater than the US. As that consumption market shifts,

the epicenter of growth and the dynamics they're shift. And that's where I find it fascinating that even though their trade tensions, there are a lot of things that are moving very um rapidly, which makes me very excited about the prospects on certain fields in China. But China also recognizes that they are reliant on some countries for materials and they're trying to make themselves self sufficient. The trade war accelerates that. As you impose tariffs, you create inefficiencies

in the market. Profitabilities hurt in companies, productivity is hurt in countries. If these tensions continue, that the better way would be to insource a lot of the goods right from the manufacturing of things like semiconductor chips right to the end product of the smartphone, and that would all stay within China. That would all stay within China and China's trade partners which are more closely aligned to me. That means that although the US China is West trade

may not grow as fast. In fact, we have seen science that it has fallen off quite a bit. We think that the Asia regional trade will actually pick up because that cooperation between Asian countries will pick up. So there are beneficiaries of the trade tensions today, and that insourcing would come from supplies within that Asia regional supply network as well as manufacturing some of these items on shore in China. So let's say I make widgets in Indonesia.

My widgets go somewhere in Malaysia, then somewhere in Thailand, they find their way to Taiwan, then over to the People's Republic of China where they're assembled and shipped back, and I go to Best Buy in New Jersey and pick up my PC. So how does what you're talking about change that arrangement. The part of the supply chain that shifts is the part that probably goes to the US because that is the trade trade tension that's been

discussed today. That to me, the bigger issue in what's happening is what's happening between how China looks at what trade total trade is relative to how the US looks at trade, and what you're identifying today is key. Right. If you think about what President Trump is talking about in terms of trade, he is only referring to goods sold from China and exported to the US. He's not talking about goods sold to China from US companies that are based in China. And to explain that a little further,

take Apple. For example, Apple sold forty billion dollars worth of iPhones in China last year. None of that is considered trade from US to China. Now, if you talk the i R S that and told the arras now to tax that, that wouldn't fly. But this is how President Trump is looking at the trade issue. On the China side, they said, hang on, we bought four million cars from General motors last year. The US only brought

three million cars from General motors. You didn't count that in your trade surplus or deficit because you made those onshore in China. So when you think about that supply chain, those dynamics will shift going forward um and to me, those are the areas that are most at risk. So the parts of the iPhone and the iPhone itself that is to be sold in China is made in China, and the iPhone that's bought in Brooklyn is put together from a number of places, none of which is China.

Some of it is China, and some of it is the other Asian countries that flow through into China and onto Brooklyn as well. So there there's a lot of supply chain linkages to get to that point right where you have a phone. Like you said, Taiwan, Korea, Japan, they're all part of that supply chain linkage. And if you look at the inter regional trade of Asian electronics in particular, it's massive. Um. For a country like Singapore,

almost of the electronic trade is within Asia itself. It's very hard to isolate it um and and tell you specifically how much of it because if I tell you any percent is to Asia, part of it could be going to Hong Kong before it heads to Taiwan, before it heads to China. But you know that it lives. That ecosystem is within Asia, so it's not a value

add from China. In fact, I believe China says its value add to UH that I phone is much less than the total value exported because of that supply chain linkage. But that comes with other issues as well. Right, So the Asian country is, because of their interlinkages, are also at risk as a result of these trade tensions. Francis, are we talking about the end of globalization, which in the corporate sphere has had a lifespan of say three decades.

Is that now over or is globalization just changing its shape evolving its form. I think globalization is evolving. I think technology is evolving globalization because we're moving towards more of a service based economy globally, and part of that is driven by demographics. The other part is driven by rising incomes globally. As people move up the income chain from low income to higher income, there's less goods consumed

and more services consumed. So I do think globalization is shifting, and if you're only focused on goods, you're going to miss the other part of the picture, which is growing. The other point I would make on why globalization is shifting, and why global trade in particular has peaked is because

normally trade is driven by massive investment cycles. If you look back in time, we've had three massive investment cycles, the U S industrialization cycle back in the nine era, then when you had Japanese and Korean industrialization cycle in the late sixties seventies to eighties, and then when China industrialized most recently post two thousand. I can't think of another economy that could have as big an impact on industrialized ation that could drive global trade for another cycle

in the near future. Not India. I think India has a lot of work to do and it's a very interesting economy. I'm very excited about the potential in India given the changes I've seen in the economy, the reforms that Prime Minister Morey has made. But it does not move as swiftly as China as it is a democracy, Whereas China has moved faster than the US and any other country that I've seen because it's not a democracy.

In fact, if to give you an example on the technology side, how fast it's moved, if you take rides sharing. Uber has been around for more than eight years. It has not reached fifty penetration. China has d D, which is equivalent to Uber. In China, within three years they hit fifty penetration rates. This is true of almost any Internet category you can think of. They just move at the speed of light. I find it hard to think that another economy that's big enough can move as swiftly

as China has. You devote considerable time in your report Francis to talking about Chinese millennials and their impact over the next few decades. I found that surprising because there's a lot of discussion about a demographic bomb that's going to catch up with China from the twenty thirties onwards. Can you reconcile that absolutely? When you look at the headline numbers, the Chinese population is slowing and is shrinking,

particularly the working age population. And we generally focused on the working age population because they're the income earning population and the income spending population. Right, if you think of the population between zero to fifteen who aren't earning an income, they don't really spend the same way. And you think of the population that sixt and above who are retired, they don't spend the same way. So the thrust of your income power and spending power is within the working population.

Now that cohort is shrinking. But within any aggregate, there are always different things to look for. And what's different about China is you also have a backdrop of a growing middle class population. Now, if you take a big step back and look at the projections across the different countries, you'll see that the next generation in the US will

actually be poorer than their parents and grandparents. That's not the case in Asia because of this rising GDP per capital story, rising income growth, rising UH and growing middle income cohort. And that's what makes me excited about this group of millennials because they're the ones who are coming of age and entering this middle income category. As you enter that middle income category, you're spending patterns change, your incomes grow, and that's what we're excited about. Francis, this

is fascinating. We could talk for hours, Unfortunately we can't. I want to close with just one point. You have a fascinating graph in your report which gets at a legacy of two thousand and eight that isn't often discussed in the season of Lehman retrospectives. You're saying global trade peaked in two thousand and eight. That's not something you hear very often. Absolutely, and that was the dynamic I was describing earlier on. There are a number of reasons

why trade grows. One is the industrialization cycle. I don't see that happening against sou Um and the just the opening up of economies which happened UM as the CEO got off the ground and China started opening stores. That linkage between trade and China drove global trade to a peak in two thousand and eight. Together a couple together with the investment cycle. That cycle now has passed UM for a number of reasons. One is China is now

quite fully developed. In fact, they're one of the more advanced countries in terms of making sure that infrastructure is in place for the next few decades. The second reason is credit was freely available and that drove investment and the demand for goods to be traded. Investments are very trade intensive because you need to buy materials to build things. Now that the cycle is shifting towards more of a consumption based cycle and service based cycle, there's less need

for things to be traded. It doesn't mean that there isn't going to be any trade. It just means that the growth will be higher in other sectors which are less trade and commodity intensive. Francis, thanks for sharing this perspective with us, and we'd love to have you back again to talk about what else you find on your travels and in your research. I would love to talk to you again and thank you so much. Dan. Benchmark

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