WHAT THE LATEST ROUND OF CHINA-US TENSION MEANS FOR COMPANIES

While the announcement of the Australia-UK-USA (AUKUS) defence agreement in the Indo-Pacific was hailed by security experts as a game changer, many companies have wondered how this affects their business in the region, if at all. This article hopes to demystify the likely impact of AUKUS on the private sector, including, in particular, international companies who do business across borders in the Asia-Pacific region.

What the fuss is all about? History’s “Thucydides Trap”

The backdrop to public interest in, or concern about, AUKUS centres on the perspective that AUKUS is another step on the road towards a new Cold War between the US and China, a Cold War which may already have started. If indeed relations between China and the US deteriorate and result in either an all-out war or smaller regional military conflicts, the impact on companies could be severe.

Some analysts point to the fact that war is unlikely due to the deep economic linkages between the US and China, linkages which did not connect the American and Soviet economies during their Cold War, which lasted from 1946 to 1991, when the USSR finally collapsed. However, a historical study published in 2002 concluded that economic interdependence between states made militarised conflict between those states more and not less likely. A significant degree of economic interdependence between Germany and the UK and between the US and Japan did not stop the Second World War from breaking out.

The ancient Greek historian Thucydides argued that the rising power and wealth of ancient Athens made war with the other more established Greek powers like Sparta inevitable. The Thucydides trap refers to an old dictum among historians – that an upstart, rising state that challenges the incumbent power of other more established states tends to trigger war.

The Thucydides trap refers to an old dictum among historians – that an upstart, rising state that challenges the incumbent power of other more established states tends to trigger war.

In this vein, many ask if war is inevitable between the US (the established power in the world) and China (whose economic and military rise in the past 30 years has been dramatic). A seminal essay published in 2015 by Graham Allison at Harvard University “identified 16 historical episodes where an established power’s position was disrupted by a challenger. In 12 of those cases, the shift ended in war.”

What AUKUS is

AUKUS is a security arrangement that provides for technology sharing on nuclear submarines amongst the US, UK and Australia, with a view to assembling nuclear submarines in Adelaide for use by the Australian navy by the 2030s or 2040s. Nuclear submarines are something of a strategic game-changer, since they can stay underwater for far longer than conventional ones; they can also carry more weapons, equipment and supplies.

Nuclear submarines would enable Australia, and by extension its AUKUS alliance partners, to project power deep into the Indo-Pacific region from naval bases in Australia, which would become only the seventh country in the world to operate nuclear submarines.

However, AUKUS is not only about submarines. It commits the three countries to broader and deeper technology-sharing for military purposes, in fields such as quantum computing, artificial intelligence and cyber-security. It is possible that this technology-sharing will yield spin-off benefits for home-grown companies in these three countries. Many technological innovations have had their roots in military tech – including the world wide web.

It commits the three countries to broader and deeper technology-sharing ….. It is possible that this technology-sharing will yield spin-off benefits for home-grown companies in these three countries.

For Australia, AUKUS may well prove to be that crossing of a bright red line as far as China is concerned. China is Australia’s largest trading partner – though Japan and Korea (US allies) are in second and third place. Australia’s relations with China and the Western alliance powers are a subject of domestic debate. But China’s spate of alleged cyber-attacks against defence targets in Western countries over the past few years has helped to shift the debate about foreign policy in Australia in an anti-China direction. Beijing’s barrage of punitive trade reprisals following Prime Minister Scott Morrison’s push for an investigation into the origins of the Covid-19 pandemic may have played a role in this shift.

Why AUKUS?

For Western powers, AUKUS is another step on the road towards chillier relations with China. The US and its allies tend to see recent developments such as alleged Chinese cyber-attacks against sensitive military targets, crackdowns on civil liberties in Hong Kong, China’s military build-up in the South China sea and its recent moves on its Himalayan border with India[2] as proof that China will become a strategic rival and possibly even a major strategic threat to their national interests.

The view from China

China’s government has condemned the creation of AUKUS as reflecting an obsolete Cold War mentality and double standards. Shortly after the announcement of AUKUS, China held a joint naval exercise with Russia where warships from both countries circled Japan.

China’s rising economic and military power has profoundly altered the regional and global balance of power. It has launched far more warships in the past few years than other countries. It may soon be the world’s largest economy.

China’s rising economic and military power has profoundly altered the regional and global balance of power…. However, the view from China is rather different. Chinese policy-makers, with some justification, tend to see the US as encircling it through military alliances.

However, the view from China is rather different. Chinese policy-makers, with some justification, tend to see the US as encircling it through military alliances with countries surrounding China – India, Korea, Japan, Taiwan and now Australia, while maintaining a US military presence and activity in some ASEAN states.

China’s dependence on Middle East oil that flows through the Straits of Malacca (sometimes referred to by Chinese strategists as the “Malacca problem”) weighs on their calculations.

The view from ASEAN

Association of South East Asian Nation (ASEAN) states are very sensitive to China-US tensions. ASEAN remains geographically and economically close to China. However, ASEAN states do host a great deal of US foreign direct investment and are home to many US expatriates. Many welcome a strong US involvement in the region to better balance China.

ASEAN countries continue to be somewhat divided between those that lean more to either the US or China…. But ASEAN countries as a whole do recognise that they benefit from engaging both China and the US.

In typical ASEAN fashion, there was no clear, unified response to AUKUS, with Malaysia and Indonesia expressing concern for regional stability while other states expressed more neutral sentiments. ASEAN countries continue to be somewhat divided between those that lean more to either the US or China. A few ASEAN countries actually have territorial disputes with China in the South China Sea while others, notably Laos and Cambodia, are dependent on Chinese investment.

But ASEAN countries as a whole do recognise that they benefit from engaging both China and the US. Hence the bloc is likely to continue to play “balance of power” politics to prevent either from becoming too dominant. In fact, in recent months, President Biden attended an ASEAN summit while Chinese Premier Li Keqiang offered a four-point proposal for East Asian economic-co-operation. China has also asked to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) trade agreement. This underlines the potential for ASEAN to benefit from healthy competition between the US and China.

The view from Europe

The creation of AUKUS was a blow to France, which had a contract to sell submarines to Australia. The French government also expressed disappointment that it had not been informed of, or consulted before about, AUKUS.

The European Union (EU) is still the largest bloc of gross domestic product (GDP) in the world economy. Given the central role played by Germany and France as the leading powers

The European Union (EU) is still the largest bloc of gross domestic product (GDP) in the world economy. Given the central role played by Germany and France as the leading powers within the EU, AUKUS may tend to tilt the Europeans, post-Brexit, away from a military focus on the Indo-Pacific and towards greater military focus on Africa as a region more critical to their interests and where their military assets exert greater sway over events.

The European Union is still the largest bloc of GDP in the world economy. Given the central role played by Germany and France as the leading powers within the EU, AUKUS may tend to tilt the Europeans, post-Brexit, away from a military focus on the Indo-Pacific.

How this evolves depends very much on the approach taken by the US. Interestingly, President Joe Biden tried hard to repair the damage caused by AUKUS to Franco-US ties.

A drift towards military confrontation?

Suspicion of China now appears to have become the default foreign policy stance among both major political parties in the US. Similar trends can be seen in other Western democracies.

For its part, China also appears to be making moves that better prepare it for the possibility of military confrontation with the West and its allies – be it from the construction of military bases in the South China Sea to its military manoeuvres in the Himalayas since mid-2020.

An all-out war seem extremely unlikely in the short-term, given how much both countries would have to lose.

An all-out war seem extremely unlikely in the short-term, given how much both countries would have to lose – particularly at a time when inflation is surging in the US and China’s economy is slowing down and struggling with the systemic financial risk posed by over-indebted real estate companies like Evergrande. However, the possibility of the Thucydides trap rearing its ugly head cannot be ruled out in the medium and long term.

Impact on the global economy

What does all this mean for the economy and for companies doing business across borders?

The risk posed by this growing China-US geo-political tension is that an arms race will divert funds away from productive investment and towards military spending, potentially lowering innovation and consumption. Many analysts believe that the Soviet economy was badly hurt in the late 1980s by excessive military spending triggered by fear of America’s “Star Wars” missile defence program; and that this led to the collapse of the USSR.

However, countries which spend heavily on the military can still see strong economic and productivity growth. The US has a high level of military spending as a proportion of GDP, at close to 4%[1], but still can generate strong GDP, innovation and stock market capitalization growth. Moreover, military research can, on occasion, generate benefits for private sector innovation.

The bigger worry may be if the tension between the US and China leads to economic decoupling or even a trade war; or actual military conflicts, large or small.

Economic sanctions hurt trade, which affects the economy. When countries prohibit their companies from selling sensitive technologies to “rival” countries, as happened when the US government under President Trump imposed curbs on the sale of certain technologies to Chinese company Huawei, that can trigger a tit-for-tat wave of prohibitions that crimp the ability of companies to invest and leverage talent and markets across borders.

In the event of an all-out trade war, China could dump US dollar-denominated financial assets, placing downward pressure on the value of the US dollar and destabilizing the global foreign exchange market. The US, on the other hand, could freeze the assets of Chinese companies in the US. Both countries could curb exports and foreign direct investment to each other. All of that would be very bad for business.

In the event of an all-out trade war, China could dump US dollar-denominated financial assets, placing downward pressure on the value of the US dollar and destabilizing the global foreign exchange market. The US, on the other hand, could freeze the assets of Chinese companies in the US. Both countries could curb exports and foreign direct investment to each other. All of that would be very bad for business.

And economic conflict can spill over into the military realm. US sanctions on oil exports to Japan and the freezing of Japanese assets in the US financial system helped precipitate the Japanese attack on Pearl Harbour in December 1941 that started the Pacific war. In the Indo-Pacific theatre, China-US flashpoints may erupt into hostilities around Taiwan, the South China sea islands, the Korean demilitarised zone or the Pakistan-India border, among other places.

Of all the possibilities for actual war, that surrounding the status of Taiwan is perhaps the most serious. The Chinese government has made it clear that its patience with an independent Taiwan is not without limit. Its actions in the South China Sea, its naval build-up and its advantage in hyper-sonic missile systems that may embody first-strike capability have been seen by analysts as building up its advantages in the event of any military conflict with the US over Taiwan.

 Any military conflict may be short and contained, given the earnest desire that both the US and China may have to avoid a larger confrontation that may turn nuclear.

Even short military hostilities can have devastating impacts on business. Shares prices and sales revenue may collapse, even if for limited periods of time.

But even short military hostilities can have devastating impacts on business. Shares prices and sales revenue may collapse, even if for limited periods of time. The status of employees of American companies in China in the event of a conflict, and vice versa, would be a concern. Assets of companies could be seized. Plant and equipment could be bombed and destroyed, either as collateral damage or deliberately. Consumer brands could face devastating boycotts or state-imposed bans in one another’s country.

What can companies do to protect themselves from a China-US conflict?

Any serious conflict between the world’s top two economies would not leave any major company on earth unaffected. But there are certain steps that companies can take to minimise the fall-out in such an eventuality.

• While it is impossible for companies to avoid market concentration risk given the sheer size of the US and Chinese markets, companies can ensure that their consumer-facing brands are “localized” and perceived to be compassionate local stake-holders, so as to mitigate the risk of consumer boycotts.
• Ensure that supply chains are sufficiently diversified and with sufficient buffer in terms of inventory and forward buying contracts, such that export bans by the US or China would not be catastrophically disruptive.
• Ensure strong cyber-security defences. Amidst the current geo-political tensions, companies, especially those holding sensitive intellectual property, may be prone to hacking.
• Ensure that expatriate staff, especially US citizens in China and Chinese nationals in the US, are not holding such sensitive positions that the company would suffer if they were repatriated (or worse). In fact, localizing the workforce in both countries to the fullest extent possible may help protect the company in the event of a conflict.
• Ensure that all employees in all countries have well-rehearsed protocols in place to ensure security in times of emergency.
• Diversify the location of financial assets and over-reliance on a few financial institutions (or one).
• Put in place plans, such as currency hedging for example, to cushion the shock of sudden and sharp foreign exchange movements.
• Stay alert to opportunities to leverage defence R&D programs to generate commercial innovations.

While US-China military conflict would be a monumental catastrophe for humanity, it is important to realise that humanity has survived terrible disasters – pandemics like the Black Death of the 14^th century, the Spanish flu (1918-1921) and Covid-19 (2020-?), global wars and devastating natural disasters.

What every company seeks, at the end of the day, is a predictable and stable environment to operate in. But at certain points in history, discontinuous, non-linear change comes about. For companies, taking this possibility seriously is half the battle won.

But at certain points in history, discontinuous, non-linear change comes about. For companies, taking this possibility seriously is half the battle won.