Many academic studies suggest that sanctions on China or the severing of Sino-US economic ties are likely to have less of a quantitative impact than might be thought, at least in the medium to long term. But that’s a theory best left untested.
CAMBRIDGE – As the global economic consequences of ongoing Western-led sanctions against Russia become clearer, are we seeing a preview of what a trade and financial break with China would look like? Perhaps, but many academic studies of the net benefits of globalization suggest that sanctions on China or the severing of Sino-US economic ties would probably have less of a quantitative impact than one might think, at least in the medium to long term. .
This is true for both the United States and China, which are large and relatively diversified economies. So while an economic break with China may hurt the United States and Europe less than one might suppose, sanctions on China might also not prove as effective as measures against Russia have been.
To get an idea of the magnitude of the effects involved, consider the current debate in Europe about restricting Russian gas imports. Judging by the hesitancy of European politicians, one would think that cutting off energy supplies from Russia, which provides about 35% of Europe’s natural gas, would doom the continent to an epic recession. But careful academic studies, including one by UCLA economist David Baqaee and co-authors, estimate that the negative effect of such a step on the particularly vulnerable German economy would likely be well below 1% of GDP, or 2% at a extreme scenario.
As with many similar thought experiments about the gains from globalization, much depends on one’s assumptions about the flexibility of an economy, about alternative sourcing (Germany can tap into US reserves and liquefied natural gas), and about how sticky the preferences are. The fact that Europe can use its gas reserves and LNG imports from the United States gives it time to adjust, and in the long run the costs of not relying on Russia for energy would be small indeed.
Using a very different methodology, the European Central Bank reaches a very similar conclusion. It is true that both studies acknowledge great uncertainty and policy issues: a Europe-wide mechanism for sharing gas resources would equalize the burden. But if one believes that the real economic impact of cutting Russian power is so modest, then it is difficult to understand Europe’s reluctance to do so now.
That said, the effects of deglobalization, like the effects of globalization, tend not to be equally distributed. Europe’s caution may well have a lot to do with pressure from lobbyists representing the regions and industries that will be hit hardest by a Russian energy embargo.
China, of course, is not Russia. Its economy is ten times greater; in the last three decades, it has moved to the center of world trade and finance. As the key supplier of intermediate inputs in manufacturing, as well as the final link in the Asian supply chain, China has literally become the world’s workshop. As an importer, it is now even more important than the United States in sectors ranging from European staples to luxury goods.
China has more than $3 trillion in foreign exchange reserves and is one of the largest holders of US government debt. Your savings and portfolio preferences have long been an important factor in today’s very low interest rate environment. So wouldn’t world output fall massively if geopolitical tensions suddenly forced China into economic isolation, perhaps along with a host of other autocracies, including Russia and Iran?
Interestingly, canonical trade and finance models do not predict such catastrophic outcomes, at least not in the medium to long term. For example, a recent study found that decoupling global value chains, which would be hit hard by a reduction in trade with China, would cost the United States just 2% of GDP. For China, the cost may be higher, but still only a few percentage points of GDP.
While the literature on financial globalization is also extensive, the bottom line is the same: opening up to international lending and investment generally benefits a country, but the gains are quantitatively smaller than might be expected, especially where regulation is weak. .
It can be concluded that the impact of an economic split between the United States and China would be greater if it were assumed that deglobalization would lead to a drastic reduction in the variety of goods available to consumers, higher markups by local monopoly suppliers, and fewer “creative destruction” in the economy. . Still, it’s not easy to show that the effects of trade sanctions would be as crippling for the United States or China as they have been for Russia’s much smaller and less diversified economy.
More subtly, but perhaps just as importantly, global financial pressures can sometimes force even autocratic governments to adopt better policies and institutions, central bank independence being a prominent example.
In 2014, after Russia’s illegal annexation of Crimea, fears of a global bond market reaction to the resulting sanctions apparently discouraged President Vladimir Putin from firing central bank chief Elvira Nabiullina when she raised interest rates to painful levels to combat inflation. At the event, she was widely credited with averting the financial crisis and default. The current state of the Russian central bank is such that Putin is rumored to have rejected Nabiullina’s resignation after the invasion of Ukraine.
My best guess, while acknowledging the difficulty of proving this point, is that too much deglobalization could easily be disastrous, particularly by undermining innovation and dynamism. But many academic studies estimate a smaller-than-expected quantitative impact of an economic breakup between the United States and China. That’s the theory, at least. It would be much better not to try it.
The author
Former Chief Economist of the International Monetary Fund, he is Professor of Economics and Public Policy at Harvard University.
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