A hard look at soft power: The new tools in the US-China battle

The US is using its soft power against rising adversary China. What are the potential opportunities and risks for investors?

Aug 1, 2019

19 minutes

A soft approach to diplomacy

A country’s ‘power’ used to be measured in terms of the hard assets that could be called upon to achieve strategic goals, particularly in a military context. Such tools are becoming increasingly archaic in a globalised world where winning in battle scarcely guarantees success in the war of public opinion. Today, ‘soft power’ is the tool of first recourse to achieve diplomatic aims. The US has increasingly relied on this kind of power to check its rival Russia. It now uses the same with rising adversary China.

China has come of age as a clear strategic competitor to the US, as the country arguably now has the critical reach required to create its own ‘pole of influence’. Donald Trump often dominates the headlines on recent tensions between the two countries, but we believe this is just a distraction from the underlying substance of this changing relationship.

Figure 1: Major economies’ share of global GDP

Major economies’ share of global GDP

Source: International Monetary Fund (IMF) database, 2017.

Supplementing hard power

A ‘superpower’ is ‘a country that has very great political and military power’ . Clearly, people often evaluate the strength of a ‘superpower’ in terms of military superiority, or ‘hard power’. But what defines a ‘superpower’ today, in our view, is its power and influence globally. Russia and China are clearly military superpowers, with strong influence over their nearby neighbours. However, that influence tends to diminish significantly further afield. In contrast, the US has demonstrated its enormous power and reach over the past year and it is interesting to note the tools it is using to fortify its influence.

Settling old scores

Longstanding rival Russia has repeatedly found itself on the receiving end of America’s ‘soft power’. In April 2018, the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) announced sanctions on seven Russian oligarchs and the companies owned and controlled by them, alongside 17 senior Russian government officials, a state-owned Russian weapons trading company and its subsidiary, a Russian bank. The reason given for these sanctions was general Russian government actions in Crimea, Eastern Ukraine, Syria and “attempting to subvert western democracies, and malicious cyber activities”. This is just one example of the sanctions imposed by the US on Russia.

Tool against new rivals

In tandem with challenging its rival Russia, US policymakers have also targeted their ‘soft power’ instruments towards an arguably much more potent geopolitical adversary, China.

The first target of America’s new stance towards China was ZTE Corporation, the country’s second largest telecommunications firm and the fourth largest seller of smartphones in America. In April 2018, the firm was sanctioned by the US Department of Commerce, which banned US firms from dealing with the firm. What was critical for ZTE was its reliance on US-sourced components such as ARM chip architecture (used to design chips that power its mobile devices) from companies Qualcomm, Maynard, Acacia, Oclaro and Lumentum, alongside using Google’s Android operating system. The threat to the existence of ZTE was only averted by the personal intervention of China’s President Xi Jinping and the ban was lifted in exchange for a US$1.4 billion fine.

ZTE, however, proved to be only a warm-up act to the main event, with the US next setting its sights on Huawei Technologies. During 2018, the US exerted significant pressure on its allies to reduce or eliminate the purchase of Huawei’s telecoms equipment, citing concerns about the potential security and strategic risks of using its technology. In May 2019, the US placed Huawei on an ‘Entity list’ once again excluding US companies – and those using US IP – from doing business with Huawei, a hammer blow to the company’s supply chain. In August 2019, US government agencies were banned from doing business with Chinese technology companies, including ZTE and Huawei, over what it says are security threats. The use of ‘soft power’ as a nimble negotiating tool is patently apparent here and also in the setting of tariffs.

Tariff time

President Trump’s actions on trade come from his sincerely and long-held view that ‘free trade’ has seen America being taken advantage of by its more mercantilist competitors.

In August 2017, Trump ordered a probe into Chinese IP theft. In April 2018, the US unveiled plans to impose 25% tariffs on US$50 billion of Chinese imports. By September 2018, a 10% tariff on a further US$200 billion of Chinese imports was imposed. Tariffs were increased to 25% on these US$200 billion of goods in May 2019, with threats to impose tariffs on the remainder of China’s exports to the US.

Figure 2: The US-China tariff timeline

The US-China tariff timeline

Source: Peterson Institute for International Economics, BBC research, Investec Asset Management 23 August 2019.

In August 2019, the US said it would place a 10% tariff on the remaining US$300 billion of Chinese imports into the US. Market volatility has been driven by the course of these negotiations. America’s liberal use of both sanctions and tariffs is unprecedented and evidences the striking reach of its ‘soft power’.

US: Addressing the trade imbalance

America’s ‘soft power’ arsenal has been the tool of choice in implementing the Trump administration’s policies: addressing America’s trade imbalance. In respect to the US trade deficit with China, President Trump has a point. The US imported US$505 billion of goods from China in 2017, but only exported US$130 billion of goods in return. This huge imbalance does appear distorted and perhaps unsustainable in the long term. However, this imbalance needs to be considered in the context of the mutual dependence of businesses in the US and China within global supply chains. A sizeable proportion of the profit that America (and especially US Big Tech) generates depends on these global supply chains.

China: Establishing international competitiveness

In the US, if a foreign firm wishes to establish a company then as long as it complies with the relevant laws and regulations it is largely free to do so. Not so in China. The Organisation for Economic Co-operation and Development (OECD) ranked China as the third most restrictive out of 64 nations on regulating foreign investment. However, China has become more open, as it was nearly 2.5 times more restrictive in 1997 compared to 2018.

Figure 3: China’s Foreign Direct Investment Regulatory Restrictiveness Index

China’s Foreign Direct Investment Regulatory Restrictiveness Index

Source: OECD, FDI Regulatory Restrictiveness Index Database, 2018.

China’s capital market reform

Similarly, China is opening up further to foreign securities, asset management, life insurance and banking companies, seemingly in response to American pressure. Alongside this development towards international competitiveness, potential opportunities are emerging. An example of this is life insurer AIA Group where the market is becoming excited about its expansion potential in China, that could see a trebling of its coverage of the market. China is also encouraging tech companies to list at home, as reflected in the launch of the Nasdaq-style tech ‘STAR’ board that experiments with more flexible rules that increase its competitiveness against other global stock markets. This is to aim to draw in international investors through boosting the credibility of its equity market, by tackling headwinds such as market volatility and governance potholes.

It is clear that America’s wielding of its ‘soft power’ has galvanised China’s mettle in this ongoing rivalry and led the superpower to develop significantly in many respects.

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In Part 2, we will examine how the US-China relationship is likely to develop, and the potential opportunities for investors as China opens further and increases its financial and technological power.

Authored by

Archie Hart

Emerging Market Equity

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