IPQ

Oct 26, 2022

Europe in the Age of US-China Great Power Competition

China is trying to make itself less dependent on US-centric networks by creating its own alternative ones. This will create challenges for Europeans.

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US Secretary of State Antony Blinken meets Chinese Foreign Minister Wang Yi during a meeting in Nusa Dua, Bali, Indonesia July 9, 2022.
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Germany benefitted greatly from the international security and economic order created in the aftermath of World War II. The Bretton Woods System (1944) and the General Agreement on Tariffs and Trade (1947) laid the foundation for a rules-based, multilateral economic regime. The quarter century that followed the end of the Cold War, marked by American unipolarity, saw the extension of this regime to include China and Russia.

Today the reemergence of great power competition between the United States and China is increasingly undermining global multilateral economic governance. Both Beijing and Washington are trying to limit their geo-economic vulnerabilities vis-à-vis one another. Being particularly vulnerable vis-à-vis its strategic competitor, China is not only trying to reduce its bilateral dependence on the United States. It is also trying to make itself less dependent on US-centric networks by creating alternative, China-centered ones.

Over time, this will create challenges for countries that are economically reliant on both the US and China. In extremis, such countries may be forced to decide which network to be a part of if one side or the other threatens them with exclusion from the respective networks—an unpalatable choice. In a less extreme scenario, larger countries may be able to negotiate privileged access to both networks. But this will only be applicable in the case of economically important players, such as the European Union. Both China and America will want Europe to participate in their respective network, because it enhances the power and reach of their networks.

Nevertheless, the emergence of alternative governance regimes will represent challenges over the longer term and should induce Berlin and Brussels to accelerate their efforts to make its various dependencies and network-related vulnerabilities more manageable so as to provide them with greater “strategic autonomy.”

Asymmetric Interdependence and Network-Based Power

Geopolitical competition has led both Beijing and Washington to “securitize” and weaponize their foreign economic policies. Securitization seeks to limit one’s economic vulnerabilities. It is defensive. Weaponization seeks to exploit others’ vulnerabilities. It is offensive. In a bilateral relationship, the economically less dependent (and therefore less vulnerable) party is able to impose—or credibly threaten to impose—relatively greater costs on the more dependent (more vulnerable) party.

So-called asymmetric interdependence is thus a source of political-economic coercive power for one side and a source of vulnerability for the other side. Power and vulnerability are also embedded in networks, not just in bilateral relationships. A country that controls—or exerts substantial influence over—economic-financial networks can exercise even greater power than in a simple asymmetric bilateral relationship.

For a start, it can do so by deterring so-called third-party spoilers (and “black knights”) from undermining bilateral measures targeting another country. It can also do so by coercing third parties to align their policies with those of the coercer, thus imposing even greater costs on the party being coerced. A country that is highly dependent on a network controlled by an antagonist has an incentive to reduce its reliance on this network and, if this is possible, to create an alternative network.

Decoupling is generally understood as a policy that severs economic-financial ties in an attempt to reduce bilateral vulnerabilities. But even if country A manages to reduce its bilateral dependence on country B, it may yet be vulnerable to coercion due to its reliance on networks that are controlled by country B. Today, US-Chinese competition is about exploiting and limiting bilateral vulnerabilities as much as it is about leveraging or neutralizing the power embedded in economic-financial networks. With Washington continuing to exert significant power over many important economic-financial networks, Beijing is keen to reduce its dependence on US-controlled networks and to establish alternatives to them.

Securing Trade Routes

US-Chinese security relations are characterized by a classic security dilemma. China’s attempts to reduce its vulnerability by enhancing its military capabilities are seen as a threat by the United States, which leads it to enhance its capabilities in turn, and so on. China’s policies of pushing out the security perimeter in the East and the South China Seas and of trying to break through the first island chain by laying claim to Taiwan represent an attempt to deny the United States and its allies the control over network chokepoints critical to Chinese seaborne trade, such as the Strait of Malacca. By providing or denying China access to crucial sea lines of communication, Washington can exert network power at a relatively low cost, namely by controlling critical nodes or chokepoints.

US control of this crucial network of seaborne communication is precisely what China is trying to contest. China’s naval strategy has shifted from “near seas defense” to “far seas protection” in order to secure crucial sea lanes. Asymmetric capabilities are meant to deter the US navy from operating or at least from intervening in the near seas, while the construction of a blue water navy aims to secure crucial seaborne trade routes beyond the first and second island chains.

China’s naval strategy is flanked by economic policies, such as the Belt and Road Initiative (BRI), which seeks to reduce China’s dependence on seaborne trade through the construction of regional and even inter-continental energy and transportation networks, while at the same time strengthening Beijing’s naval and security infrastructure along its major trade routes, connecting China to the Middle East (Djibouti, Pakistan, Sri Lanka) as well as out into the Pacific. China’s geo-strategy is in part informed by its dependence on critical imports, such as food and energy, and hence its vulnerability to the interdiction of physical trade.

Managing Trade Dependence

China is more dependent on international trade than the United States is. And China is also more dependent on bilateral trade with the US than the US is on bilateral trade with China. This means that interdicting the physical movement of goods aside, China is vulnerable to coercive US trade policies.

China is thus trying to reduce both its bilateral as well as network dependence on the United States, while laying the foundations of a more China-centered regional trade network. China has been seeking to set up bilateral and regional free trade agreements, like the Regional Comprehensive Economic Partnership (RCEP), which brings together the 10 ASEAN countries as well as China, Japan, South Korea, Australia, and New Zealand. (The trade pact is shallow, but it is a start.) In the guise of “dual circulation”—a policy aimed at increasing domestic at the expense of foreign demand—China is also trying to reduce its overall dependence on international trade.

Washington, having abandoned the Trans-Pacific Partnership (TTP, but being aware of its diminishing influence in Asian trade, has been trying to counter Beijing’s attempts to create a more China-centered trade regime in Asia through new initiatives, such as the Indo-Pacific Economic Framework (IPEF), which President Joe Biden launched in May. This is meant to preserve and increase US network power.

Dealing with Technological Vulnerabilities

China is also very vulnerable to US export control policies. US policy is increasingly focused on denying China access to “critical and foundational technologies.” With the help of the so-called foreign direct product rule, Washington is able to not only prevent American companies from exporting critical technology to China. It can also prohibit non-US companies that use US technology to produce designated goods from exporting them to China. By controlling a critical node of global technology production networks, the United States is able to prevent China from acquiring key technologies, thus strengthening US coercive power.

Meanwhile, China has intensified efforts to wean itself off technological reliance on America. Beijing’s “Made in China 2025” and “China Standards 2035” policies are meant to turn China into a technological leader in its own right and to set future global technology standards in order to reduce China’s vulnerabilities and over time create a China-centered network. Meanwhile, the US remains deeply concerned about its own technological vulnerabilities, as the passage of the recent CHIPS and Science Act, which subsidizes the development and the onshore production of advanced semiconductors, as well as the various initiatives to cooperate more closely with its allies in terms of supply chain security, with the EU-US Trade and Technology Council as a key forum.

To prevent China from acquiring advanced US technology, Washington has complemented its export control policies with tighter restrictions on Chinese investment in the United States. (Washington is even considering introducing outward investment screening in order to preempt the risk of “technological leakage” to China.) Washington has also imposed limits on US financial investment in military companies and companies tied to human rights abuses. But such measures are more symbolic than effective, as China does not depend on American financing. Meanwhile, China has always maintained tight control over inward foreign direct investment, particularly in sectors deemed critical to national security, including technology, recent liberalization efforts in selected sectors, such as finance, notwithstanding.

Creating Parallel Monetary and Financial Governance Regimes

Nearly eight decades after the creation of the Bretton Woods system, Washington remains the single most influential actor in the international monetary and financial realm. The United States is the largest shareholder of the International Monetary Fund and the World Bank, which gives Washington significant influence. It is also the largest shareholder of the Asian Development Bank (in which it holds the same share of voting rights as Japan).

Not surprisingly, China set up an Asian Infrastructure Investment Bank (AIIB), where Beijing is the dominant shareholder. Chinese government and state-controlled banks and companies have lent extensively to developing economies through the BRI, making China the world’s largest official lender—larger than the multilateral World Bank. The reasons for China’s foray into official international finance are multifaceted (including exporting excess industrial capacity, diversifying foreign assets, upgrading and recentering regional transportation networks). But laying the foundation of a parallel regional financial regime (or network) with China at its center is undoubtedly an important driver.

The United States continues to be the most influential actor in international private capital and currency markets, providing Washington with power and rendering Beijing vulnerable. For a start, China as an “immature creditor” is practically forced to hold its international assets in renminbi, while the United States is able to issue international  liabilities in dollars thanks to its “exorbitant privilege.” Even though China is the creditor and the US the debtor, it is Washington that has leverage due to Beijing’s dependence on the dollar as a the dominant means of international payment.

The international financial system remains largely dollar-based. Washington’s ability to prevent countries from engaging in dollar-denominated transactions, and, even more so, its ability to weaponize international dollar-based financial networks through secondary dollar sanctions makes Beijing feel very uncomfortable. (Washington and Brussels’ decision to freeze Russia’s international reserves will have done nothing to alleviate Chinese concerns.) Once again, the dollar provides the United States with substantial network power, not just bilateral power, as it effectively allows Washington to deter third countries from engaging in dollar-based transactions with a targeted party or country.

Beijing has been trying to enhance the role of its own currency by internationalizing it. It managed to have it included in the International Monetary Fund’s special drawing rights basket. But underdeveloped domestic financial markets, extensive capital controls and continued government intervention in Chinese financial markets have so far held back the rise of the renminbi as an alternative to the dollar. Similarly, the creation of Cross-Border Interbank Payment System (CIPS) as a future potential alternative to SWIFT (which is an inter-bank financial messaging system, not a payments system) as well as the creation of a digital yuan should be seen as first steps to reduce China’s vulnerability and lay the foundation of an alternative monetary regime not controlled by the United States.

US-Chinese competition is systemic in the sense that its outcome will reshape the structure of the international system. But it is also systemic in another sense: over time it will see the emergence of, and competition between, alternative economic governance regimes and networks. It is no coincidence that China has launched the Global Security Initiative or other initiatives, such as the Global Development Initiative, as alternatives to what it regards as US-dominated regimes. And when the EU speaks of China as a “systemic rival promoting alternative models of governance” or the United States in its recently released its National Security Strategy refers to China as a “competitor with both the intent and, increasingly, the capability to reshape the international order,” it shows that everybody is aware of the power and vulnerability embedded in security, economic, and financial networks.

What This Means for Germany and Europe

The consequences for Europe are profound. Not only will US-Chinese great power competition drive (selective) decoupling, it will also over time lead to the emergence of parallel networks. To what extent they will overlap and to what extent China and the United States will use their power to exclude, or threaten to exclude, each other as well as third parties, will vary. Undoubtedly, China has a long way to go before it will be able to offer viable and attractive alternatives to current US-centered networks. But this does not mean that it will not get there eventually.

As US-Chinese geostrategic competition intensifies, both Beijing and Washington will become more inclined to weaponize their respective networks. This will affect third parties, even where they are not directly targeted, if only because it is imperative to prevent “third-party spoilers” from undermining weaponization measures.

Intensifying full-spectrum competition, involving military, trade, financial, and technological power, will increase the risk that Germany and Europe will become the focus of American and Chinese attempts to align with their respective policies as well as to not align with their rival’s policies. In the event of a military confrontation, both the United States and China will make maximum use of their network power.

It is therefore important for Germany and Europe to strive for greater autonomy by reducing their susceptibility to third parties’ network (and bilateral) power. Russia’s war against Ukraine has demonstrated how costly bilateral economic dependence can be. In all fairness, the EU has already launched a “trade defense” strategy, which is meant to make Europe less susceptible to trade coercion. Brussels is also trying to reduce its dependence on critical imports, such as raw materials, technology, and—following the outbreak of economic warfare between the EU and Russia—energy through a combination of diversification and “reshoring.” A revived European industrial policy is meant to make Europe more “autonomous.”

The EU has also strengthened coordination among member states’ inward investment screening and export control policies to make them less politically exploitable by third parties. In its diplomacy the EU is seeking to coordinate policies with the United Sates to mitigate shared supply chain and technological vulnerabilities vis-à-vis China in the EU-US Trade and Technology Council. Finally, eurozone members intend to strengthen the architecture of the euro, which will help strengthen EU-dominated monetary and financial networks and reduce the ability of third parties to weaponize their networks at the expense of European interests.

All told, Germany and Europe would be well-advised to accelerate current efforts to make their various bilateral and network dependencies more manageable so as to limit vulnerabilities and concomitant costs in view of intensifying US-Chinese geo-strategic competition and conflict.

Markus Jaeger is a fellow at the German Council on Foreign Relations (DGAP) and an adjunct professor at Columbia University.