Geopolitics and investment

China has designs on Europe. Here is how Europe should respond
As Chinese investment pours into the European Union, the Europeans are beginning to worry

EUROPE has caught China’s eye. Chinese investments there have soared, to nearly €36bn ($40bn) in 2016—almost double the previous years’ total. Chinese FDI fell in 2017, but the share spent in Europe rose from a fifth to a quarter. For the most part, this money is welcome.

Europe’s trading relationship with China has made both sides richer.

However, China is also using its financial muscle to buy political influence (see Briefing). The Czech president, Milos Zeman, wants his country to be China’s “unsinkable aircraft-carrier” in Europe. Last year Greece stopped the European Union from criticising China’s human-rights record at a UN forum. Hungary and Greece prevented the EU from backing a court ruling against China’s expansive territorial claims in the South China Sea. Faced with such behaviour, it is only prudent for Europeans to be nervous.
And not only Europeans. The terms on which the emerging undemocratic superpower invests in the outside world are of interest to all countries—particularly if other things, such as foreign policy, may be affected. Americans, increasingly consumed by fears that China poses a commercial and military threat, should be mindful of competition for the loyalties of its oldest ally. For everyone’s sake, it matters that Europeans gauge their welcome to China wisely. Just now, they do not.

A sense of perspective
Many of China’s plans in Europe are just what you would expect of a rising economy. Some investments are private, profit-seeking and harmless. Acquiring technology by buying innovative firms, including in Germany’s Mittelstand, is reasonable, too, so long as deals are scrutinised for national-security risks. There are also things that China, unlike Russia, does not want, such as to undermine the EU or sow chaos by furtively supporting populist, xenophobic parties. It would rather Europe remained stable and open for business. On issues such as climate change and trade, China has acted more responsibly than the Trump administration, seeking to uphold global accords rather than chuck grenades at them.

Some Europeans take this to suggest that China is a useful counterweight to an unpredictable Uncle Sam. That is misguided. Europe has far more in common with America than China, however much Europeans may dislike the occupant of the White House. Moreover, China has used the EU’s need for unanimity in many of its decisions to pick off one or two member states in order to block statements or actions of which it disapproves—as with human rights.

Other Europeans seize on such examples to jump to the opposite conclusion. They fear that Chinese lucre will one day undermine Europe’s military alliance with the United States. Fortunately, that is a long way off, as the French and British navies have shown by joining America and Japan to challenge China in the South China Sea. Until China itself becomes a democracy, of which there is no sign, Europe will surely remain closer to its traditional allies.

Europe thus needs to take a path that avoids the extremes of naivety and hostility. It should avoid mimicking Chinese protectionism. It might sound “fair” to subject Chinese firms in Europe to the restrictions European firms face in China, but it would be a mistake. The permeability of European societies and economies to ideas and influences is a strength.

But such openness also makes them vulnerable. Hence, governments should vet investments case by case. Montenegro should not have allowed its debts to China to become so perilously vast. Hungary and Poland should have looked harder at certain Chinese infrastructure projects that offer poor value for money or were never properly completed.

Europeans could do more to substantiate their talk of “reciprocity”, or the mantra that the EU and China should treat each other as each wishes to be treated. They could, for example, introduce new instruments to make it clearer who is buying stakes in firms and thus whether they are doing so fairly.

They should also increase funding for impartial China research. Transparency should be demanded from political parties, universities, think-tanks and lobbyists. Sometimes Chinese cash buys unsubtle happy talk. More often, it leads to self-censorship and punch-pulling from even prestigious academies.

And Europe should aim to speak as one. None of its states alone can face down China but, acting together, they could do so for decades to come. The EU could, for example, use qualified-majority voting (QMV) rather than unanimous votes on some subjects sensitive to China, such as human rights. This would not work for everything—most EU nations would balk at giving Brussels a veto over how they deploy their military forces. But QMV would make it harder for China to paralyse the EU by picking off one small member at a time. The EU could also co-ordinate investment-screening processes by member states. And it could take better care of those southern and eastern countries particularly vulnerable to China’s influence and provide alternative sources of investment for the projects they deem important. A little more intra-European solidarity would go a long way.
What money can’t buy
America has a role to play, too. Ideally the Trump administration would stop treating Europeans as free-riders on American power who deserve a good kicking. On trade, especially, the EU is a powerful potential ally in getting China to abide by global norms. America should also work more closely with European governments to set up common standards of transparency, graft-busting and the prevention of influence-peddling—which would make it harder for China to impose its own rules on small countries. At a time when standards for IT and artificial intelligence risk splitting into a Chinese camp and an American one, Europe can help find a middle path.

As China rises, the benefits for the world of an independent, open and free Europe will only increase. Conversely, a Europe weakened and divided by the world’s most powerful authoritarian regime would exacerbate problems far beyond the EU’s borders. Europe must not let that happen.

Strong global growth conceals emerging market fragility

Tiger index points to strains as IMF set to warn against escalating trade conflicto

Chris Giles in London

© Bloomberg

The global economy’s continued strength is concealing fragility in emerging markets and a lack of firepower to deal with future shocks in advanced nations, according to the latest update of a tracking index compiled by the Brookings Institution think-tank and the Financial Times.

Momentum in the global economy remains strong, if a little weaker than hoped at the start of the year, but severe strains have already been seen in Argentina and Turkey and these are beginning to ripple out to other emerging economies.

Professor Eswar Prasad, a senior fellow at Brookings, said: “While conventional growth indicators look relatively healthy for most countries, weakening business and consumer confidence bode poorly for growth prospects in many of them, especially the major emerging markets.”

The Tiger index, which tracks a wide range of official economic data, financial market prices and confidence indicators and compares them with their historical values for the largest economies, suggests that global growth has come a little off the boil.

Christine Lagarde, managing director of the IMF, indicated last week that the fund’s growth forecasts were likely to be revised down this week at its annual meetings in Bali, Indonesia. The composite Tiger index has similarly come off its recent highs, reflecting slightly weaker data in Europe and emerging economies.

With the US economy notably strong, pushing unemployment to its lowest level in almost 50 years, and other advanced economies still growing faster than long-term sustainable rates, the short-term concern in the global economy is centred in emerging economies.

These have hit a rough patch, Mr Prasad said, suffering from outflows of money, depreciations of their currency and therefore an increase in the burden of foreign currency denominated debt.

“As in the past, their domestic and external vulnerabilities tend to get exposed when global financial conditions tighten and the US dollar strengthens,” he added.

“Other countries such as Indonesia and South Africa that share some of these vulnerabilities have also been subject to capital flow and currency volatility.”

While China’s economy has remained reasonably robust, its policymakers have faced the difficulty of deciding whether to stimulate credit growth again in response to a mild slowdown with the dangers that this would further increase already dangerous debt levels or accept a weaker outlook.

Evidence of the impact of trade war on economic momentum is, as yet, hard to see, Mr Prasad said, but it has added to policy dilemma by damping growth in the largest Asian economy.

India is now the world’s fastest growing significant economy, but it too is caught up in the concerns about confidence in emerging economies as a result of the postponement of many reforms.

In advanced economies, the long upswing has been welcome in lowering unemployment to pre-crisis levels in most economies, but that has not repaired all of the damage of the crisis, leaving them vulnerable to a new shock.

“Policymakers may be left with little room to respond aggressively to a slowdown in growth as the expansionary phase of the global business cycle winds down amid an increase in economic, trade, and geopolitical uncertainties,” Mr Prasad said.

The IMF will use the annual meetings to urge countries not to go further down the route of trade conflicts and instead to concentrate on implementing reforms to boost productivity growth so that the expansion can continue without either petering out or beginning to generate excessive inflation.

With Ms Lagarde berating countries for the protectionist moves of the past year and what she called drift in policy reforms, the theme of the meetings in Bali will be an attempt to rebuild trust, co-operation and enthusiasm for a new multilateralism among the leading players in the global economy.


Brazil is shaping up for a unique kind of financial crisis

Chronic governance failings mean it is in a battle with itself

RUDI DORNBUSCH, a renowned economist who died in 2002, said there were two sorts of currency crisis. The pre-1990s kind is slow. It starts with an overvalued exchange rate, which gives rise to a trade deficit. Foreign-exchange reserves are gradually run down to pay for it. When they are gone, the game is up. The currency drops. The finance minister loses his job. But life goes on much as before. The world does not collapse.

The second sort of crisis is the first sort on steroids. A country that might once have blown some World Bank loans on bad policies is able to tap global capital markets for billions of dollars to misuse. Domestic banks join the party. The economy booms. When the flow of capital suddenly reverses, the currency collapses. Bankruptcy is widespread. The damage is big enough to affect others.

Brazil would seem to demand a third category. Elections this month will decide its next president and the character of its congress. They will thus shape the response to a slow-motion financial crisis. The drama is likely to be played out in the currency market. The impact might be far-reaching. But Brazil shows no signs of an old-fashioned balance-of-payments crisis. It at not the mercy of global capital. Its crisis is, in essence, a battle with itself.

Compare Brazil with Argentina and Turkey, both in the eye of market storms this year. They fit the template for a currency crisis. Both had run large deficits on the current account, a broad measure of the trade balance. These were financed by foreign borrowing, much of it in dollars. Both suffer high inflation. Both had skimpy foreign-exchange reserves. Brazil is different. Its current account is broadly in balance. Inflation is close to a record low. Its plentiful currency reserves dwarf its dollar debts.

Brazil’s problem is that its government finances are on a dangerous path. Public debt has risen from 60% to 84% of GDP in just four years. That owes a lot to a collapse in revenues after 2013. A brutal recession did not help. But the budget had been flattered by windfall receipts from a mining boom and credit-fuelled consumer spending. Those will not be repeated.

The third way

That means spending cuts are needed to fix the public finances. The government wage bill has grown rapidly. But over-generous pensions are a far bigger problem. They already account for 55% of non-interest public spending. The cost will go on rising as Brazil ages. Things would surely be worse were it not for a constitutional amendment in 2016, which caps the rise in public spending. An attempt to reform pensions was aborted when the president, Michel Temer, was implicated in the corruption scandals that have seen one of his predecessors impeached and another sent to jail.

In a different Brazil, politics would seek to reconcile the claims of bondholders (who are almost all Brazilian savers; see chart), pensioners, well-paid government workers and the rest of the country. Instead, to make the sums add up, the last of these groups has suffered a squeeze on public services and living standards. And the corruption crisis has engulfed the governing class.

The front-runners for president are polarising figures who might struggle to steer pension reform through congress. The crunch point might come next August, if not before, says Arthur Carvalho of Morgan Stanley. A budget for 2020 must be submitted then. If pension reform is not in place, a big squeeze will be needed elsewhere for the country to stay below the spending cap, he says. Or the cap itself will have to be lifted.

Bondholders would take fright. Though foreigners hold little of Brazil’s debt, there would still be capital flight, a falling currency and rising bond yields. As Brazilian savers anticipated the inflation and chaos that would result from soaring public debt, they would seek to escape it.

Savers elsewhere in Latin America have long used dollar accounts as a shield from inflation. This would be novel for Brazilians, says Mr Carvalho. But because short-term interest rates have been slashed to reflect subdued inflation, the opportunity cost of pulling money from Brazil has rarely been lower.

Nothing is ever entirely new. The symptoms of Brazil’s past crises were high inflation and external deficits. But below the surface, the underlying problem was lax fiscal policy, says Armínio Fraga of Gávea Investimentos, a hedge fund, and a former governor of Brazil’s central bank. In the slow-burning sort of crisis, said Dornbusch, a mid-course correction can prevent the worst. Brazil might yet manage that. If it cannot, its decline is likely to speed up dramatically.

China’s Private-Sector Rescue Looks Like Anything But

Xi Jinping has vowed to take care of China’s troubled private-sector companies. That actually seems to mean more state control.

By Jacky Wong

An investor sits at a brokerage house in Beijing.
An investor sits at a brokerage house in Beijing. Photo: Mark Schiefelbein/Associated Press

Chinese President Xi Jinping has pledged “unwavering” support for the country’s struggling private companies. That may not come in the form entrepreneurs desire.

Along with recent efforts from top policy makers to talk up local stock markets, Mr. Xi’s comments—published over the weekend in state media—indicate high anxiety in Beijing. But that concern likely isn’t much about stock prices themselves, given share ownership still makes up only a small percentage of household wealth in China.

Instead—as in 2015, when Chinese stocks cratered—the worry is more to do with the high level of leverage in the market, and what that could mean for China’s financial system. The difference this time is the prevalence of major shareholders in listed companies that have pledged their stakes in return for loans. Three years ago, the problem was retail investors bingeing on margin loans to buy stocks. Some 4.3 trillion yuan ($620 billion) worth of Chinese stocks is now being used as collateral for borrowing, according to Wind—equal to about 9% of the whole market.

Most of these loans have been taken out by shareholders of small and private companies, instead of big state-owned enterprises. Goldman Sachsestimates total share-pledged loans outstanding could amount to $290 billion—about half of which could now be at risk of margin calls, given that Chinese stocks have dropped almost 30% since January.

Beijing could use brute-force policies to stem any further selloff triggered by margin calls, for example by banning brokers from selling loan collateral into the market. But borrowers are still going to find it hard to repay or roll over their loans, especially as private companies have fared particularly badly amid the Chinese economy’s slowdown.

One other solution so far has been for state-owned companies to step in. They have already spent $6.2 billion this year on buying up big stakes in 39 private companies, according to Goldman, with slightly less than half of those deals happening just in the past two months.

These stake buys might help avoid defaults on these share-pledged loans, in turn benefiting the banks and brokerages that have lent to them. The flow-on effect is less control over companies for private owners, a trend that is also consistent with the growing influence of the state-owned sector in China under Mr. Xi. The Chinese leader’s “support” for the private sector might just mean another leg up for state control.

Economic View

Surprising Truths About Trade Deficits

By N. Gregory Mankiw

James Yang

President Trump has put trade policy at the center of his agenda. A case in point is the revised trade agreement with Mexico and Canada, announced on Monday. Yet it is hard to be sanguine about this accomplishment, in part because the changes are so modest but mostly because the president’s overall approach to international trade is so confused.

Mr. Trump’s confusion is understandable. Economists have spent centuries studying trade, debunking common myths and arriving at some surprising truths.

Let’s review, both for the president and ourselves, some conclusions about trade that most economists accept but, upon first hearing, are not at all obvious.

Bilateral trade deficits don’t matter.

When Mr. Trump discusses our trade relations with another nation, he often points to the bilateral trade balance — the difference between the value of our exports to that nation and the value of our imports from it. If imports exceed exports, we are running a bilateral trade deficit, which Mr. Trump interprets as a sign that we are the relationship’s losers. 
To understand what’s wrong with that inference, consider some of the many bilateral trade deficits that I run. Whenever my family goes out to dinner, the restaurateur gets some money, and we get a meal. In economics parlance, the Mankiw family runs a trade deficit with that restaurant. But that doesn’t make us losers. After all, we leave with full stomachs.

To be sure, I would be happy to have balanced trade. I would be delighted if every time my family went out to dinner, the restaurateur bought one of my books. But it would be harebrained for me to expect that or to boycott restaurants that had no interest in adding to their collection of economics textbooks.

I can run persistent trade deficits with restaurants because I run trade surpluses elsewhere. Take The New York Times, for instance. It pays me more for my columns than I pay it for my subscription. That’s a bilateral trade surplus for me and a bilateral trade deficit for The Times. But nonetheless, we both gain from the relationship.

The overall trade deficit matters but not for what it says about trade.

If we add up all the bilateral trade balances with other countries, we get the nation’s overall trade balance — the difference between the value of all United States exports and imports. For many years, the United States trade balance has been negative, meaning that total imports have exceeded total exports. Mr. Trump believes this trade deficit is a sign that other nations have been taking advantage of us.

To see the folly in that conclusion, consider again the Mankiw family. Our overall trade balance is the sum of all our bilateral trade balances with everyone else — restaurants, The Times, and so on. The end result equals the difference between our income and our spending. 
If our overall trade balance is positive, we are spending less than we are earning, meaning we are saving. If our overall trade balance is negative, we are spending more than we are earning. In the language of economists, we are dissaving.

Whether a trade deficit represents a problem depends on whether our spending is prudent or profligate. When a family takes out a loan to buy a car, it runs a trade deficit, but that need not be a reason for concern, as long as it can afford the car in the long run.

On the other hand, if a family runs a trade deficit by persistently living beyond its means, that’s a problem because debts eventually come due. But in this case, the trouble comes not from disreputable trading partners but from poor financial planning. If you eat at expensive restaurants too often, blame yourself, not the restaurateur.

Similar reasoning applies to countries. Nations run trade deficits when their spending on consumption and investment, both private and public, exceeds the value of goods and services they produce. If you really want to reduce a trade deficit, the way to do it is to bring down spending relative to production, not to demonize trading partners around the world.

Many of the president’s policies will increase the trade deficit.

Mr. Trump thinks the trade deficit makes us losers in international trade, so he wants to shrink it. But many of his initiatives actually push in the opposite direction.

The tax cuts, for example, tend to increase private spending, by both households on consumption goods and businesses on investment goods. Reduced business regulation should also stimulate investment spending. Because the trade deficit represents an excess of spending over production, this increased spending results in a larger trade deficit.

Movements in the exchange rate help explain the link between spending and the trade deficit. As spending in the United States increases, the Federal Reserve will need to raise interest rates to keep inflation in check. Higher interest rates attract capital inflows from abroad, causing the dollar to appreciate. A stronger dollar makes our exports more expensive and our imports cheaper. 
All this isn’t to say that the president’s policies are necessarily misguided. The tax bill should be interpreted on its own merits — whether it makes the tax system fairer and more efficient and whether it brings in enough revenue to finance the government. And each regulatory change should be evaluated based on its costs and benefits.

What these policies do to the trade deficit is, at most, a secondary concern. In many ways, the trade deficit is a fake problem. Our elected leaders should look elsewhere to gauge the success of their policies.

N. Gregory Mankiw is the Robert M. Beren professor of economics at Harvard University. You can run a trade deficit with him by buying his book Principles of Economics.