Trade is 'the biggest source of friction' between the U.S. and China: Analyst

President Biden and Xi Jinping have agreed to hold a virtual summit. Atlantic Council GeoEconomics Center Director Josh Lipsky joins Yahoo Finance Live to discuss.

Video Transcript

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AKIKO FUJITA: President Biden and Chinese President Xi Jinping have agreed to hold a virtual meeting by the end of the year. The tentative agreement came after a six-hour meeting between national security advisor Jake Sullivan and China's top diplomat. Trade tensions and China's encroachment on Taiwan among the topics that are likely to be discussed here. But the Chinese economy also in focus, largely because of the signs of distress we've seen in the property sector, which is, of course, the very sector that has helped fuel the kind of growth we've seen out of China.

Let's bring in Josh Lipsky, he's the director of the Atlantic Council's GeoEconomics Center. And Josh is out with a new report, 'China Pathfinder,' which I know, Josh, you worked on with the Rhodium Group, that really looks at the growth trajectory of the Chinese economy. It feels like the bottom line in this report really is a country that's sort of conflicted in the direction it wants to take the economy. What was most surprising to you?

JOSH LIPSKY: I think you're right, Akiko, and thanks for having me. So when you think about it, what we tried to do was an eight-month study, we did a deep dive into China's economy looking back over the past decade to chinapathfinder.org, you can see it behind me as well. And what we try to mark here is have they made market-oriented reforms over the past decade? Because that story gets so muddled and what we're seeing now with Evergrande can confuse that narrative as well.

And we wanted to go really granular in the data, look at market competition, look at trade, look at innovation, look at portfolio flows. And one thing that surprises me is on trade. This is what we heard this week from Ambassador Tai, this is the biggest source of friction between the US and China on trade.

But in our study, China does best on trade on the six metrics we use to assess them against open market economies. They're closer to OECD norms on trade than almost any other category, we look at. And in fact, on tariff barriers, China had a lower rate in 2020 than the US. So while there's a lot of gap for China to make up and huge ways where they are failing to have market-oriented reforms, and we can talk about them, there are some surprising findings in this study as well.

AKIKO FUJITA: Yeah, I mean, the other thing that you point out, when you look at the overall economy, you say China's economy is on shaky ground largely because of the debt that it has piled up in the process of the type of growth we've seen over the last decade or so. It feels like in the last few months the reporting has suggested President Xi is really looking to or prepared to slow growth in exchange for the quality of growth. What does that mean for these growth scenarios that you've laid out?

JOSH LIPSKY: Yeah, so you know, if you look at this from the report, and this isn't all just our estimates, this comes from the People's Bank, and the IMF and others, there's the sort of more moderate approach, where slowdown is going to be 6%, 5%, get to the middle of the decade, maybe 4% but the People's Bank's own stress test saying COVID continues, severe lockdowns, other financial stress like Evergrande, could slow down growth to as low as 2% in some scenarios, important to caveat that but some scenarios. And just try to wrap your heads around what that would mean from a geopolitical perspective, from a flows perspective, from a trade perspective, from an investment perspective, 2% growth, something we haven't seen in China in decades. And I do think these are the conversations happening now internally within China.

Are there reforms they can take that would prevent this from happening? But what volatility does that introduce to their system? That's always been the trade-off for China. In the past, they've been able to have it both ways. They could control, and they could have growth. And I think what our study says at the most basic level is, that's not going to be the same calculus in the 2020s.

ZACK GUZMAN: Yeah, Josh, and of course, you know, if I may use the phrase, it takes two to tango here. And when we talk about trade, you know, President Trump made it a big point of emphasis in his trade war with China. We've seen little in regards to how President Biden wants to work with Xi Jinping so far. As Akiko said, we're going to see the virtual meeting between them. When you look at that, I mean, how much does that maybe weigh in terms of the US relations there in really opening up, being more open when it comes to trade if the US is increasingly kind of taking a more closed approach?

JOSH LIPSKY: Yeah, and this is a core issue of the study, Zack, because we benchmarked against 10 OECD economies here. And you can learn a lot about China when you do that. But you can also learn a lot about those other countries when you do that. And if the message the US is taking from China over the past decade is that we need more industrial policy, we need more subsidies, we need to be more protectionist, that growth calculation isn't going to pay off for China, and it's certainly not going to pay off for the United States.

And so it would be a mistake to read what's happening within China's economy and try to mimic that in any way. I think we've unfortunately moved in that direction a little bit. But it's not the right policy to pursue and it doesn't-- what's interesting about our study is we're going to do this every year. So while China's line might move closer or further away from OECD norms, the US line might move further away from itself on trade and other issues a year from now. And that's something we should be wary of.

AKIKO FUJITA: Josh, there's a lot of questions about what this new approach, if we want to even call it that, from President Xi is likely to mean for the tech sector, particularly in China. We have seen it grow incredibly with names like Alibaba, as well as Tencent, really competing on a global level. I know you looked into the VC investments within the country as well. How much of that do you think has actually shifted as a result of the broader market dynamics in this perception that China is not going to allow these companies to freely grow in the way they have?

JOSH LIPSKY: What's so interesting about the study is it sometimes confounds what you think, right? So here you have China 2010 VC as a percent GDP 0.1, basically negligible. Look where China is now, three, you know, number three, just behind the UK and the US. So it's important to understand that you know, the Chinese government is funneling a lot of money into VC through their domestic, it's something we try to parallel here actually to Zack's other question, with the spending bills we're talking about in Congress. So China has made significant progress there on the VC point in particular.

They've also made significant progress on market competition, you guys were talking about Tesla earlier, right? So Tesla's ability to sell cars within China, something you wouldn't have seen a decade ago. So it's important for us in the US I think to have a nuanced and sort of more grounded perspective on China's economy and not just take the Evergrandes of the world and say well, that's it, the system is over. Or that's it, they're going to have unparalleled success for the coming decade. Neither is really true.