Title: US-China Business Council President Craig Allen on the Economic Implications of the Chinese Spy Balloon Incident

GJIA: The past few weeks in regard to US-China relations have been particularly volatile, especially in the aftermath of the surveillance balloon intelligence incident. In your opinion, how significant is this event for US-China economic relations at large? Is current coverage of the incident potentially overemphasizing its implications?

CA: While the balloon’s transit over the Contiguous United States and Alaska was only a few days, the impact was quite long-term. The reason for that is that ordinary Americans, who generally do not think about China at all, learned that up in the sky there was a balloon. It brought at an almost personal level that China might be a threat to them; psychologically and politically, within the domestic US political system, this balloon certainly had resonance. Some in Congress opposed to the President criticized him fiercely for not shooting it down immediately, so this became a little bit of a football between the Democrats and the Republicans—I suspect it still is.

I would say that the balloon incident happened at a very bad time. February 24th is the anniversary of Russia’s invasion of Ukraine, and China’s support for Russia generally, and with regard to the kinetic conflict in Ukraine, is really coming under greater scrutiny. At the same time, the Administration is subtly shifting its Taiwan policy. Earlier in February, we had visits in Arlington from Taiwan’s Foreign Minister. There are a lot of things in play here, and the National Security tensions are increasing, which, generally speaking, is not good for the business or the economic world. Businesses have to operate with the allowance of both governments, and this has become more difficult in the context of the bilateral relationship. Bilateral trade has been remarkably resilient. US exports were up 17 percent in 2020, 21 percent in 2021, and in 2022 only up 1.6 percent, but they were still up. So US exports over the course of 3 years were up forty percent, and that’s remarkable when you think about it. Despite the tariffs and bilateral tensions, trade between the two countries continues, and decoupling seems too difficult an exercise to complete successfully.

GJIA: In a US-China Business Council forecast held in February, Minister of the Chinese Embassy in the United States Xu Xueyuan emphasized the important role that US-China economic cooperation plays in bilateral relations by serving as a stabilizer, and she urged that both nations should not allow the incident to offset efforts in maintaining the stability of US-China relations. Despite the incident, trade flows seem to be mostly unaffected between the two countries. Thus, do you believe that it is possible

for the two nations to maintain positive economic relations in the face of such a polarizing incident? What actions should the nations take to accomplish a seemingly challenging goal?

CA: I would start by saying that the great bulk of our trade bilaterally is in products that have no relevance to national security. From US exports, it would be agricultural products, energy products, consumer goods, chemicals, machinery, services, etc., and that would be even more true of US imports. American farmers, workers, and ranchers—and I dare say every single American consumer—benefits from this trade.

That said, there are very legitimate discussions concerning national security and sensitive items. For example, we would all agree that both semiconductors and aerospace have national security implications and are legitimate areas for government regulation. But in both countries, there is a tendency to overstate the importance of the national security regulations, as they pertain to trade in a way that helps advance protectionist measures. This is not an abstract concept at all, and indeed, China and others took the United States to the WTO on the Section 232 actions that President Trump took on steel and aluminum, and they won. Unfortunately, the United States named steel and aluminum to be security sensitive items and refused to comply with the WTO. In my view, that’s over-stretching the argument on national security. The problem is that once one country starts doing this, everybody starts doing it; that balkanizes both the high-tech trade and trade in data.

We need to be careful here on a global basis not to needlessly inflate national security concerns, as they become a huge impediment to innovation, growth, and greater prosperity. For example, there are those in Washington who are talking about the need for national security controls on biotechnology. I think that that is an overstatement. Although it is possible to reverse engineer viruses or bacteria for warfare, the other 99.999 percent of the used cases are civilian and we should have free trade in them and control the risks.

If everything is national security, nothing is national security. You have to rightsize the national security arguments and make sure that the measures that you’re taking on the national security front do not impact your national interests: including prosperity, the innovative ability of your citizens, and rule of law. Let’s be careful not to overuse the national security arguments.

GJIA: Chinese Foreign Ministry spokesperson Wang Wenbin remarked that China will use appropriate “countermeasures” as an answer to the American response to the balloon incident. There have been arguments that the blowback of the incident may specifically drift into supply chain politics and lead to further economic retaliation. Some contend that trade between the United States and China could decrease in the following years, as companies look to avoid supply chain disruptions by shifting production to less geopolitically risky locations. How should American businesses navigate this increasingly complex, dynamic landscape? What long term steps should they take to insulate themselves from future obstacles that may arise in US-China relations?

CA: We could analytically divide the question into two parts. One is foreign direct investment from the United States, and we could add Europe and Japan, or anywhere, into China, and the other one is supply

chains. The fact of the matter is that largely as a result of the COVID restrictions—not entirely, but as the number one driver —that there is a rethinking of both foreign direct investment and supply chain links to China. Firstly, let’s talk about the concerns and the reasons. The lack of face to face has really been enormously negative in the relationship. That lack of ability to travel has led to a reduced will to invest. On the investment side, what we are seeing is that large companies who are in China for China are continuing with their investments and they are full speed ahead. We have a number of large projects that are moving very well.

Companies that are in China for Asia, perhaps using China as one part of their supply chain, are also expanding. They’re pretty happy with their markets. Those companies that are in China for exports back to the United States are absolutely looking at second, third, alternatives, and working on diversifying their supply chains.

But, when you get up to the national security sensitive industries, it becomes much more complicated. Companies have to consider a good number of factors. Will they be given a level playing field in China, or will the government prefer Chinese competitors in a form of import substitution or a foreign investor substitution mode? I think that there remain concerns, despite assurances by the Chinese government, that that is a problem. The Chinese government has a very aggressive industrial policy. For the most part, foreign companies do not have access to those subsidies, and one needs to be careful about them. The regulatory environment in China is also very important, and it differs significantly across industry.

When you focus on supply chains, I think it’s just healthy to remember that supply chains are always in flux. But what we’re seeing is that the movement of supply chains out of China has been accelerated. I’d say that COVID is probably the most important factor. But I don’t expect that to change because ,at the same time, you have a difficult regulatory environment. Perhaps most importantly, wages are increasing. We have to remember that the Chinese workforce has plateaued; so there is a labor shortage in China, and particularly for certain types of labor. There are 100 other countries that have labor cheaper than China. So, many of the companies who were there with cheap labor are moving those factories out of China, and I think that that would particularly be true of companies in Korea, Japan, Taiwan, and Hong Kong who originally moved their operations to China for cheap labor. Now, thirty years later, they’re moving them out of China to other places with cheaper labor. Mexico has done very well. There has been a lot of Chinese investment in Maquiladora. Countries such as Cambodia, Vietnam, Malaysia, Bangladesh, Ethiopia and Thailand have also done very well. It’s not evenly spread, but a good number of countries are taking up the vacuum of labor-intensive manufacturing. There are important changes in global supply chains, which is something that is worthy of watching very carefully.

GJIA: As a result of the incident, some investors have been wary about conducting business in China, concerned about the effects of future geopolitical shocks on their investments. However, as China re-opens its economy, many believe the region still offers incredibly promising growth potential. Indeed, in a recent piece in the Wall Street Journal, you contend that US businesses should maintain a strong presence in China’s fast-growing market. Could you elaborate on why you believe the benefits of currently investing within China would outweigh the potential risks? What do you believe will be the general forecast for the rest of this year in regard to Chinese growth?

CA: It’s useful to look in the rearview mirror just for a second and remember that for the last twenty years on an annual basis, China has contributed approximately thirty percent of global growth. That’s amazing, and American companies have done very well as a result of that growth, and we’re proud of that. Going forward, we need to be very sober about our growth projections, and reasonable forecasters predict the Chinese economy will grow 3.5 percent on the low end, and up to 5.5 percent on the high end — but this is on a 17 trillion-dollar economy. The Chinese economy is approximately the size of the EU, but the EU is probably growing at 1 or 2 percent, so China is still delivering outsize growth. Therefore, if you’re an American company and you wish to be a global leader, there’s an imperative that you must be a leader in China. In relative terms, for the foreseeable future, China is going to continue to put out a large percentage of global GDP growth. That’s just a fact. We want to be a part of that growth. We want to grow American jobs, American exports, and American competitiveness on the back of that growth.

Companies must be in China to take advantage of the economies of scale, and that’s not going to change. China will remain at about 20 percent of the world’s population for some time. Gradually that’ll decrease, but for the time being, China is very important. China not only has that scale, it has a talent pool that’s very deep, and the United States does not let companies take advantage of that pool while other countries can, then we’re going to be out-competed. We need to be on the field and playing ball and competing hard if we are going to be globally successful.

This transcript has been lightly edited for clarity and length.

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Craig B. Allen is the President of the US-China Business Council (USCBC), a nonpartisan, nonprofit organization that provides advisory services to over 250 corporations. Before joining the USCBC in 2018, Mr. Allen served as the United States ambassador to Brunei Darussalam. He received a B.A. from the University of Michigan in Political Science and Asian Studies in 1979. He received a Master of Science in Foreign Service from Georgetown University in 1985.

Image Credit: Chase Doak, Wikimedia Commons