U.S.-China: more decoupling ahead?

Geopolitical Drivers and Historical Context

• U.S.-China tensions have intensified due to the trade war (ongoing since 2017), the downing of a suspected Chinese spy balloon, rising rhetoric, and President Biden's planned investment curbs ahead of the G7 summit.
• Graham Allison characterizes the current state of relations as "very bad," representing the worst period since Henry Kissinger and Zhou Enlai's diplomatic reopening over 50 years ago.
• Allison attributes rising hostilities to a "Thucydides Trap," where a rapidly rising power (China) threatens to displace an established ruling power (U.S.), noting that 12 of the last 16 such historical cases resulted in war.
• Historical data cited indicates China surpassed the U.S. as the world's top manufacturing center by 2010 and currently holds the largest GDP by purchasing power parity, having grown from roughly one-quarter of the U.S. in 2000.
• Psychological identity factors exacerbate the rivalry: the U.S. perceives the challenge to its "American Century" as a disruption of its natural order, while China views its ascent as a restoration of its historical status as the "Middle Kingdom" following the "century of humiliation."
• Allison predicts that relations will likely deteriorate further before improving, driven by "rising power syndrome" (demanding more sway) and "ruling power syndrome" (resentment of the challenger's legitimacy).
• Despite the high risk, war is not inevitable; Allison argues that "extraordinary diplomacy" and "strategic imagination," similar to strategies used during the Cold War, can prevent conflict despite the structural pressure toward war.
• Both leaders, Joe Biden and Xi Jinping, are motivated to avoid war due to its catastrophic potential, though domestic nationalism and populism in both nations complicate the path to extraordinary diplomacy.

Strategic Framework: "Rivalry Partnership"

• Allison advises policymakers to adopt a "rivalry partnership" (or "coopetition") framework where states compete in strategic domains while cooperating on existential threats.
• Incentives to Compete: The U.S. seeks to constrain China's rise in Asia, maintain economic dominance, and secure leverage in supply chains (e.g., advanced semiconductors vs. green energy/EVs).
• Incentives to Cooperate: Mutual Assured Destruction (nuclear arsenals) makes winning a war impossible, creating a compulsion to avoid conflict.
• Global Commons Cooperation: Climate change ("mad climate world") and integrated financial systems ("mad financial world") create shared existential risks that necessitate joint action, referencing the successful U.S.-China cooperation during the 2008-2009 crisis.
• Allison suggests leaders list competing incentives against cooperative ones on opposite sides of a page to visualize the necessity of balancing both imperatives.

Economic and Investment Trends

• Bilateral trade remains at historically high levels, driven by strong U.S. household consumption, but remains significantly below the trajectory it would have followed under a "business-as-usual" 2015 baseline.
• Foreign Direct Investment (FDI) flows from advanced economies to China have declined sharply; Chinese data indicates a significant downturn in inflows at the end of the year.
• FDI resilience is concentrated: in the past three years, approximately 80% of total foreign direct investment flows to China were accounted for by only 10 U.S. and 10 European companies, while most others have withdrawn or paused investment.
• Chinese FDI inflows to the U.S. have plummeted from a 2015-2016 high of ~$50 billion annually to roughly $5 billion or less, due to Beijing's capital outflow concerns and U.S. national security restrictions.
• Two-way portfolio flows have underperformed relative to expectations due to Beijing's delayed financial reforms (exchange rates, capital account assurances) and U.S. geopolitical constraints.
• MSCI inclusion of China in global portfolios has not yet realized its potential, as policy reforms lag behind the inclusion itself.

Policy Outlook and Decoupling Risks

• Dan Rosen predicts President Biden's upcoming executive order on investment curbs will primarily function as a notification regime rather than a prohibition, targeting specific sectors like artificial intelligence and quantum computing.
• Rosen notes the executive order is inherently temporary and can be reversed by a future administration, meaning it is unlikely to "kneecap" American investment in China entirely.
• A deeper driver of decoupling is the systemic divergence between the U.S. and Chinese economic models, specifically China's lack of progress toward market economy norms since 2015-2016.
• U.S. companies face hesitancy to engage due to an inability to conduct standard commercial due diligence in China and the government's increasing direction of the economy over market mechanisms.
• Despite decoupling trends, Rosen argues total separation is not inevitable, as national security concerns only cover a fraction of the total economic relationship.
• China has a historical precedent for radical policy shifts (1978, 1984, 1992, 1998, 2013), suggesting Beijing may adjust policy if current growth models become unsustainable.
• Current economic indicators point to near-zero productivity growth and an inability to sustain the current development pace, potentially forcing a future policy redirection similar to the post-"zero COVID" shift.
• Rosen anticipates that unless Beijing implements a "decisive redirection" toward marketization, organic hesitancy among U.S. firms to deepen engagement will persist regardless of new regulatory barriers.