The new cold war: a long freeze in global ties

A spectre is haunting world order. As the global economy marches into the new year, there is palpable unease that the clash between two superpowers - China and the US - harks back to the freeze that characterised the Cold War. As former US Treasury Secretary Hank Paulson had recently remarked in Singapore, an iron curtain threatens to create new factions.

"I now see the prospect of an economic iron curtain - one that throws up new walls on each side and unmakes the global economy, as we have known it," he had said to participants of the Bloomberg New Economy Forum held in November.

To be clear, the integrated economic conditions and proxies of Cold War from decades ago are vastly different from the times of today. But there is a familiar ideological and political conflict in how the invisible hand guides capitalism in China, and then, doesn't.

By Mr Paulson's observation, some American businesses have grown weary of waiting on China's market liberalisation. Despite China's entry into the World Trade Organization (WTO) 17 years ago, it has yet to open up fully to foreign competition.

It has preferred to use joint venture (JV) requirements and non-tariff barriers to trade and investment that come in the form of technical standards and subsidies, among other things. But where the real rub lies is in the transfer of technology that should be protected as intellectual property (IP). Some of this transfer from American to Chinese firms has been categorised as outright theft.

In September, an incisive report from The Wall Street Journal documented how US chemical manufacturing giant DuPont tried to block its former Chinese JV partner from extracting its technology, a lucrative trade secret, and had to contend with surprise raids from Chinese authorities. The report suggested that from China's perspective, being able to attain technology from businesses is the price for US corporations looking to access the Chinese market.

There also remains different models of Internet governance and cross-border data flows in this data economy, hurting advances in this Information Age. Data sovereignty, or plainly, the right to transfer data across borders, is now contentious. China also continues to censor Internet searches via its infamous Great Firewall.

Even as data-connectivity agreements among countries will soon become as important as free-trade agreements, analysts are sceptical of a day when globally unified laws on data use and protection will come to pass.

Mr Paulson has added that the concern is not just confined to technologies being transferred and digested. "It is that they are being reworked so that foreign technologies become Chinese technologies through an indigenisation process that many of the multinational CEOs I talk to believe is grossly unfair to the innovators and dreamers at the heart of their companies."

To be sure, there is room to criticise Washington for turning down Chinese investments in the US, when there is no national security risk, especially when these will create American jobs, he adds.

The big risk here is that the integration of trade in goods could come undone, as supply chains are forcibly broken, especially for those that use sensitive technology, he adds. "Such a balkanisation of technology could further harm global innovation, not to mention the competitiveness of firms around the world."

This month's high profile arrest of Huawei Technologies' chief financial officer Meng Wanzhou - who is also the daughter of Huawei's founder Ren Zhengfei - over charges of evading sanctions of Iran, is widely viewed as US-China trade war tensions enveloping the battle for global technology dominance. The arrest has also created a chilling effect for Chinese tycoons travelling overseas: Ms Meng was detained as she switched planes in Canada.

For Huawei, at stake is the trillion-dollar 5G market, a lucrative business that builds up a new superspeed highway for information sharing and communication, with the world tethering to the Internet at will.

Cybersecurity threat

Huawei also stands accused of being a cybersecurity threat, with US, Japan, the UK, Germany and France among the large nations reportedly limiting their use of Huawei technology.

The distancing from the brand will mean, as a start, an erosion of Huawei's 40 per cent market share in Europe, the Middle East and Africa, Bloomberg data showed. Huawei has denied that it is used by the Chinese government to spy on nations, saying that no evidence has been presented to show that it is a spying conduit. A Jefferies report notes that the 60-day period for the US to issue an official extradition warrant for Ms Meng "ties in quite nicely" with the 90-day deadline of US-China trade talks. It adds that the event is "inevitably mixing judicial process with political and economic considerations".

"President Trump would like to set back China's tech ambitions in order to provide the US with a fairer competitive environment, but not at all costs. He is aware of the potential damage a US export ban on Huawei would cause the US tech industry, since China is a very large market for tech components," the report adds.

"The key is what China will have to offer for Trump to intervene. We believe both sides are working on the terms. Our guess: making Huawei more transparent; lower subsidies to tech and higher foreign content in key industries including 5G."

China appears to be sitting up to address the heart of the technology dispute with the US. Two days before Christmas, Xinhua news agency reported that China is planning a single law on foreign investment that would stop government officials from forcing technology transfers through foreign investments in JVs. "This would ensure "fair treatment" for foreign businesses, the report said.

Still, analysts are not hopeful that the 90-day detente on US-China trade tensions, as struck during G20 meetings, would evolve into a permanent truce. This makes it highly probable that the US will still impose 25 per cent tariffs on US$250 billion of Chinese products, they say.

"There seems to be a consensus in the West that China has taken advantages of the global trading system, since its accession to the WTO," Citi says in a report. It points out that given its size now, it is difficult for China to benefit from its earlier designation of a poor emerging market economy, and it needs to meet its pledges in several areas: market access, IP protection, the removal of requirements for technology transfer, as well as the relook at state-owned enterprise (SOEs) subsidies and agriculture trade issues.

"Significant changes in China's trade regime and practices would be needed."

The trade tensions are likely to put China's reform agenda on skates. Citi expects regulators to more quickly issue more approvals for foreign financial institutions looking to expand deeper into China. A HSBC report notes that Beijing has reached a consensus on adopting the OECD's accepted framework of "competitive neutrality" for China's SOE reforms. This means that on principle, no public sector business or agency should have a competitive advantage over the private sector on the sole basis of government ownership.

"The focus in China will be on transforming corporate governance so as to separate the government from the enterprise, especially in matters relating to increasing the transparency of state subsidies."

HSBC also points out that better protection of IP is increasingly in China's self-interest, given the rapid growth of home-grown IP as China aims to lead as an innovation powerhouse by 2020. Against this backdrop, China has adopted measures to raise legal protection for IP, and has upped the cost of non-compliance of regulations, it adds.

Trade tensions have moved beyond streaming threats on Twitter. Maybank noted that the Purchasing Managers' Index (PMI) readings have been sliding for Korea, Taiwan and Singapore, which are key nodes in the supply chain. The PMI indicates economic health as it measures how much businesses intend to make purchases to fulfill expected new orders.

"Disruption to trade may intensify in early 2019 if the US-China tariff war escalates, tipping manufacturing into a contraction," says Maybank.

Maybank has also observed that the divergence in container freight rates between China-US routes, which has risen to a six-year high in early November, and that of China-Europe routes, which remains stagnant, is another telltale sign that Chinese exporters are front-loading orders ahead of the US tariff hike. "There is risk that China's exports may collapse in early 2019."

Singapore's non-oil domestic exports in November slipped 2.6 per cent from a high base a year ago - a surprise drop that carried a warning on dour trade outlook for the months ahead. The drop, which came after October's 8.2 per cent jump, was the first year-on-year monthly decline since March 2018.

There are other signs of stress. The WTO"s World Trade Outlook indicator has fallen below the baseline value in the fourth quarter of 2018, translating to expectations of sub-par growth. And in a poll of investors by BofA-Merrill Lynch, fears of resuming trade tensions significantly outrank other global factors that may spook markets in 2019, such as Brexit. The International Monetary Fund estimates that a full-blown trade war can shave as much as 1.6 percentage points off China's GDP growth, and 0.9 percentage point off US GDP growth annually over the next two years.

Asean for a moment

Amid all this, the Asean region is "a study in resilience", HSBC says. "Given all the financial turbulence in 2018, growth remains impressive."

Maybank notes that for Asean, exports to China and US account for about 14 per cent and 11 per cent of total exports, respectively, making them their two largest markets. In time, the existing China-centered supply chain network will gradually break up and become more dispersed across Asia, says Maybank. "Vietnam appears to be capturing the lion's share of the shifting supply chains and is often cited as a 'mini-China' and production alternative to China," it says, noting that foreign direct investments are flowing into the region.

But critically, while Asean will benefit over the longer term from trade diversion, Asean's estimated net gains would be far smaller than China's loss, Maybank says.

And due to the disruptive force of automation, Asean has pressing structural issues on the labour front. Oxford Economics and Cisco have estimated that by 2028, 28 million fewer workers - more than 10 per cent of the current Asean-6 workforce - will be required to produce the same level of output as today. Asean-6 refers to Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam.

To be sure, many sectors in Asean will experience a net increase in their demand for jobs by 2028 because the rise in spending power - assuming increased productivity - should more than offset the jobs directly displaced by technology.

But the overall shock in labour markets means emerging economies will need strong fiscal muscle to retrain workers for the digital age, and to create social safety nets such as social security and unemployment benefits.

"Asean members will feel the effects of the Fourth Industrial Revolution acutely," Børge Brende, president of the World Economic Forum (WEF), and Justin Wood, head of regional agenda for Asia Pacific at WEF, have said in a report in September. "The demographic expansion is happening just as many existing jobs will be substituted by intelligent automation and AI. Systems of taxation that rely on labour income will come under pressure. National budgets will be challenged at exactly the moment when Asean members must increase their investment in reskilling labor forces and developing infrastructure for this new age."

Mr Brende and Mr Wood from the WEF say that amid digital disruption, Asean needs a "genuine" single market for services to buttress growth in the digital economy. Digital platforms, AI, and cloud-based services, function best at scale - their hope is that new technologies "do not recognise national borders".

Analysts are watching how traditional trade pacts formed within regions would form new economic blocs. The China-led Regional Comprehensive Economic Agreement may be sewn up next year, boosting the supply chain shift towards the region. That being said, companies need time to shift factories to this region.

But whatever the calculations, a trade war is widely accepted as a net loss for global economies. Trade barriers today, as brought on by battles over technology, shrink the pie, which can hold back growth and investments needed to tackle structural issues that will be inevitable with the rise of the machines.

Singapore's Prime Minister Lee Hsien Loong has warned that if trade tensions persist, Asean would be under pressure to pick a side.

"I hope it does not happen soon," Mr Lee had said in November at the close of the Asean summit. He has noted that if the global economy pulls apart into different blocs, amid hindrance to trade, investments, and technologies, Asean will be put in "a difficult position".

As it stands, the BofA-Merrill Lynch December Fund Manager Survey suggests that investors are approaching "extreme bearishness". A net 53 per cent of investors polled expect global growth to weaken over the next 12 months, the worst outlook on the global economy since October 2008.

Mr Paulson has warned of a long winter in chilled ties between US and China, even as he urged the new-age disarmament. "The US-China strategic interaction is by far the most consequential in the world. I am very sobered by the trajectory we are on now," he has said. "If the US and China cannot find a way to develop a workable consensus, it will pose a systemic risk of monumental proportions - not just to the global economy, but to international order as we know it, and to world peace."