CAMBRIDGE – As the global economic fallout from the current Western-led sanctions against Russia becomes clearer, are we watching a preview of what a trade and financial rupture with China might look like? Perhaps, but many academic studies of globalization’s net benefits suggest that sanctions on China or a break in Sino-American economic ties probably would have a smaller quantitative impact than one might think, at least over 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 rupture with China may hurt the US and Europe less than one might assume, sanctions on China also might not prove nearly as effective as the measures against Russia have been.
To get an idea of the magnitude of the effects involved, consider the current debate in Europe on restricting Russian gas imports. Judging by European policymakers’ hesitancy, one might 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 German economy, which is particularly vulnerable, would likely be well under 1% of GDP, or 2% in an extreme scenario.
As with many similar thought experiments on the gains from globalization, much depends on one’s assumptions about an economy’s flexibility, about alternative sourcing (Germany can draw on reserves and US liquefied natural gas), and about how sticky preferences are. The fact that Europe can use its gas reserves and LNG imports from the US gives it time to adjust, and in the longer run the costs of not relying on Russia for energy would be small indeed.
Using a very different methodology, the European Central Bank comes to a broadly similar conclusion. True, both studies acknowledge great uncertainty, and policy matters: a Europe-wide mechanism to share gas resources would even the burden. But if one believes that the actual economic impact of cutting off Russian energy 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 distributed equally. Europe’s caution may well have much to do with pressure from lobby groups representing regions and industries that will be most affected by an embargo on Russian energy.
China, of course, is not Russia. Its economy is ten times larger; over the past three decades, it has moved to the center of global trade and finance. As a critical supplier of intermediate inputs in manufacturing as well as the final link in the Asian supply chain, China has literally become the workshop to the world. As an importer, it is now even more significant than the US in sectors ranging from basic commodities to European luxury goods.
China has over $3 trillion in foreign-exchange reserves, and is a major holder of US government debt. Its savings and portfolio preferences have long been a major contributor to today’s very low interest-rate environment. So, wouldn’t world output fall massively if geopolitical tensions suddenly forced China into economic isolation, perhaps together with a group 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, one recent study found that decoupling global value chains, which would be hugely affected by a reduction in trade with China, would cost the US only 2% of GDP. For China, the cost might be higher, but still only a few percentage points of GDP.
While the literature on financial globalization also is extensive, the bottom line is the same: Openness to international lending and investment generally benefits a country, but the gains are quantitatively smaller than one might expect, especially where regulation is weak.
One can conclude the impact of a US-China economic split would be bigger by assuming that deglobalization would lead to a dramatic reduction in the variety of goods available to consumers, higher markups by local monopoly suppliers, and less “creative destruction” in the economy. Still, it is not easy to show that the effects of trade sanctions would be as crippling for either the US or China as they have been for Russia’s much smaller and less diversified economy.
More subtly, but perhaps as important, global financial pressures can sometimes force even autocratic governments to adopt better policies and institutions, with central bank independence being a leading example. In 2014, after Russia’s illegal annexation of Crimea, fear of a global bond-market reaction to the resulting sanctions apparently discouraged President Vladimir Putin from firing the central bank head, Elvira Nabiullina, when she raised interest rates to painful levels to fight inflation. In the event, she was widely credited with having prevented financial crisis and default. The Russian central bank’s status today is such that Putin is rumored to have refused Nabiullina’s resignation in the wake of the Ukraine invasion.
My best guess, while acknowledging the difficulty of proving the point, is that an overshoot in deglobalization could easily be disastrous, particularly in undermining innovation and dynamism.
But many academic studies estimate a smaller-than-expected quantitative impact from a US-China economic rupture.
That is the theory, at least. It would be much better not to test it.
Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist of the International Monetary Fund from 2001 to 2003. He is co-author of This Time is Different: Eight Centuries of Financial Folly and author of The Curse of Cash.