Geopolitics

Alan Dupont, CEO of the Cognoscenti Group

At the Foothills of a New Cold War

Pandemic Reveals Fault Lines

The world is at the foothills of a new cold war as the coronavirus pandemic has revealed the geopolitical fault lines that have developed in recent years in the relationship between the United States and China.

This new cold war will affect corporations in many economies around the world as they are faced with the effects of reshoring the manufacturing of essential products, the race for technological dominance and mounting trade tariffs, according to a geopolitical specialist.

“I think the coronavirus has exposed the existing tensions between the US and China in particular and exacerbated them. The coronavirus itself hasn’t been the cause of the problem, it just has made things worse,” Alan Dupont, CEO of the Cognoscenti Group and Adjunct Professor at the Climate Change Research Centre at the University of NSW, says in an interview with [i3] Insights.

“The big geopolitical story of probably the last four to five years is the worsening relationship between the US and China, which is of course the critical relationship for everybody. It was patched up briefly in January when they had that interim trade deal, which we called the ‘skinny trade deal’, and things were looking like they were recovering and getting back on track, but of course the coronavirus arrived and what that has done now is giving sustenance to the hawks both in China and the US, who are arguing for a decoupling of their economies.

“So the decoupling momentum is now gathering steam and my concern is that the trade and technology wars that have broken out between the US and China have now turned into a broader geopolitical conflict, which has brought us to what I call ‘the foothills of the new cold war’.”

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The decoupling momentum is now gathering steam and my concern is that the trade and technology wars that have broken out between the US and China have now turned into a broader geopolitical conflict, which has brought us to what I call ‘the foothills of the new cold war’

The tensions have been brewing for some years, but before the pandemic broke out, Dupont was still relatively optimistic about the ability to defuse the situation. But he believes the coronavirus pandemic has pushed the world from being on the brink of a new cold war to actually being at the beginning of one.

“I’d like to be optimistic, but I find it very hard to be so. In fact, I’m becoming more pessimistic. I was hopeful two or three months ago that we could find circuit breakers to make sure it didn’t develop into a full-blown cold war and I think that was a 50/50 proposition then, but now with the coronavirus it is virtually impossible to happen, even if Trump doesn’t win the election,” he says.

“This seems to be the one area where there is complete bipartisan consensus in the US: China policy. The Democrats in many ways could even be tougher on China than Trump has been. And the Chinese are becoming more nationalistic, more assertive, more coercive and so it is difficult to see things getting better in the next year or two.”

This means systemic risk has now spiked to unprecedented levels, not just in relation to China, but for the global economy as a whole, he says.

“We haven’t experienced anything like this before. Even back in the heights of the first cold war, yes, things got pretty hairy there in ‘62 with the Cuban Missile Crisis, but the key difference is that it wasn’t necessarily an economic contest per se. It was played out all politically and geopolitically,” he says.

“But because this is being played out in the trade, economic and tech domains, the points of conflict and tension are multiple and continuous. There hasn’t been a day gone by where there isn’t some kind of tension over something.”

Technology is one clear area where the tensions are high as both the US and China realise dominating the various technological ecosystems will play a large part in who will dominate the future economy.

“The country that is able to be ahead in a whole range of key technologies, ranging from artificial intelligence, quantum computing and semiconductors right across to new materials and new manufacturing techniques, will dominate the world. These are the strategic industries of the future economy,” Dupont says.

“It is a much more even contest between China and the US than it was between the US and the Soviet Union, where the US was by far the dominant tech power. And the reason the Soviet Union lost was because it couldn’t compete with the US economically or technologically.

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The country that is able to be ahead in a whole range of key technologies, ranging from artificial intelligence, quantum computing and semiconductors right across to new materials and new manufacturing techniques, will dominate the world. These are the strategic industries of the future economy

“The Chinese have learned from the mistakes of the Soviet Union and they are determined to beat the US at its own game.

“In order to do that, China has recognised that not only do you have to be competitive in terms of the hardware and software that is the architecture of the future economy, but you also have to be a rule setter.

“What I mean by that is the country which is dominant in tech also sets the tech rules for the global standards. The internet is a classic example.

“If you want to be running the future internet, not only do you need to have the software and the hardware to be competitive and preferably number one, but also you’ve got to be able to set the standards and that is what China is trying to do.

“It wants to get its proposal through for New IP, the new internet protocols. If it gets its standards up, it is going to supplant the existing western design standards and it will be a different kind of internet and that will enormously enhance China’s standard-setting powers in a key technology.”

The Tech Stack

Technologies today don’t exist in a vacuum; they are no longer single products to be sold in retail stores. Many new technological products today exist in an ecosystem of services that enhance the experience and allow for cross-selling.

Dupont argues the dominant player of the future will need to control the whole ecosystem of products and services, the so-called ‘tech stack’.

“The Chinese have been very smart to recognise that it is no good to sell a mobile phone that everybody likes and then to become the number two mobile phone provider in the world. That is all terrific, but if they really want to be number one, they have to capture whole microeconomies,” he says.

“For example, let’s go with communications technology. Not only do the Chinese think ‘we need to have the best mobile telephones, best 5G systems, both the hardware and the software’, but [also] ‘we need to ensure that we are a one-stop shop for all services and capabilities related to that’. So all the systems and devices to make the tech ecosystem work.

“And to dominate that you need to dominate everything; this is what the ‘tech stack’ means. It is not enough to be number one in one or two of these things; you need to be number one in everything and dominate the whole ecosystem. Then you are basically invincible; that is the thinking.”

The Chinese government is aware it isn’t there yet and still relies on the US for a number of key technologies, particularly semiconductors.

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[Semiconductors] is an area where the US has a clear lead and it is not going to give it up. This has forced Huawei and others to diversify their sources of semiconductors and that is very difficult because the US is now closing all its doors on that,

“This is an area where the US has a clear lead and it is not going to give it up. This has forced Huawei and others to diversify their sources of semiconductors and that is very difficult because the US is now closing all its doors on that,” Dupont says.

“The bottom line is that eventually the Chinese will come up with their own semiconductors, but the gap with the US is so great that they probably will never catch up. They are going to have an inferior product and as they will find themselves cut off from western technology, suddenly it is going to get much more difficult and costly for China.

“That is something they haven’t confronted before and that is going to feed through into their economic performance. It is going to cost them a lot of money. It is going to reduce their productivity at a time when they face a decline in the labour dividend because the country is getting a lot older very rapidly.

“So the window of opportunity to become number one is narrowing very rapidly and [Chinese President] Xi Jinping knows that. If he doesn’t get there in the next three to five years, I don’t think he is going to get there. So the next three to five years is becoming quite critical. Who is going to become number one in this century?”

Reshoring

The technological race might have been simmering for quite some time, but the pandemic has made many countries realise the extent of their dependence on Chinese products, and Dupont believes this realisation will cause a move to reshoring the manufacturing of key products.

“The US woke up one day to find that 90 per cent of the pharmaceuticals used in its medical system come from China. What that has done is made the US start to look at sovereign capabilities and national resilience,” he says.

To a certain degree, this conversation is also taking place in Australia, which largely depends on China for its exports. Achieving a greater diversification of supply chains and export markets makes sense, but it also means a retreat from globalisation.

“Globalisation has brought a lot of benefits, but the downside is the fact that we have these just-in-time supply chains, which reduce our national resilience when you have a crisis, such as a pandemic,” Dupont says.

“Suddenly, you want all this stuff, but it is in global supply chains so you can’t get it, or you depend on another country which might decide not to give it to you. So the conclusion is that we need to make this stuff ourselves.”

It is an example of a broader trend towards economies decoupling from each other, but where this might lead us is a different question altogether, he says.

“The issue now is not whether decoupling is going to take place – it definitely will – but how far is it going to go. At the extreme end of this is autocracy, where everyone makes everything themselves,” he says.

“Well, I don’t think anyone is going to go down that route, so the debate is now, and this is a global debate, what are the things that we need to make ourselves and have in our country to have national resilience, and what are the things that we can still rely upon the global supply chain for?

“We still need to do that, because in a globalised world, even if there are some downsides to this, there is also a lot of upside. You don’t want to throw out the baby with the bathwater.”

This move towards decoupling will have a significant impact on corporations as they will need to understand the risks they are facing from the disintegration of supply chains. Will they still have access to all of their products and materials and at what cost?

“Where this ends is going to make an enormous difference to every single company, commercial enterprise and investor in the future,” Dupont says.

“The balance of self-reliance and reliance on the global supply chain is shifting towards great national self-reliance. But how that plays out in detail is the key to understanding what the future economy is going to look like and how it is going to work.

“The pandemic has made just about every country realise that for a future pandemic you are going to need to have a whole range of capabilities in the production of medical equipment, clothing and pharmaceuticals.

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The pandemic has made just about every country realise that for a future pandemic you are going to need to have a whole range of capabilities in the production of medical equipment, clothing and pharmaceuticals

“Then there will be other areas, let’s take energy for example, and Australia is having this debate. We are one of the few countries in the world that doesn’t have global energy stocks, strategic petroleum reserves.

“So now the government has finally bitten the bullet by saying: ‘Yes, now we are going to have one.’ So if you look at energy, countries are going to say: ‘Well, if we have some sort of geopolitical crisis in the Middle East, then we need to make sure that we have reserves of oil, petroleum, in the country.’ Do we have that capability now? A lot of countries don’t.

“The interesting thing is that previously most of these decisions were primarily commercial decisions based on cost. What is the cheapest and quickest way of getting Product A to the country? It is buying Chinese stuff, because it will be here tomorrow.

“Now, I think there is going to be more of a national security approach to these decisions, where you might be prepared to consider higher cost premiums, so you pay more, but you have it inside the country and it is a sovereign capability.

“That is going to change quite fundamentally how you look at just about anything that you are going to buy and anything that you are going to import these days. That still has to play out, but I don’t think a lot of businesses have recognised that yet.

“This plays, for example, into the debate about Huawei and telecommunications infrastructure. A couple of years ago, the business community took the view that they wanted Huawei technology because it is the best and the cheapest.

“That was essentially the way most of the world was going until somebody said: ‘Well, hang on, that makes us dependent on a system that we don’t necessarily trust and, therefore, we need to diversify away from Huawei, or exclude it entirely from our telecommunications system.’

“The momentum for that kind of thinking is now developing a lot of steam because countries have seen how China leverages off its control of key commodities and items for geopolitical purposes. And that is exposed even more by the coronavirus.

“For example, we now have incurred punitive tariffs on our barley and probably our meat and other commodities. We are being taught a lesson by China to have the temerity to have an independent investigation into the pandemic, which China sees as being unhelpful to it and it being driven by the US.

“So this is something that the coronavirus is really complicating: the relationship with China. But it is also driving the imperatives for diversification away from China and greater national resilience and decoupling.”

In the end, the world will return to a form of polarisation along geopolitical fault lines, not unlike the eastern and western blocs seen during the first cold war. But there will be differences too, Dupont says.

“I don’t think it is going to be as rigid as during the first cold war. But the division that is likely to develop in the future is much more fluid and contested,” he said.

“Countries might sit on the fence and go with China on some things, but go with the US on others. But it will be increasingly difficult to do that and ultimately they will have to choose one or the other.

“For example, Australia … it is pretty clear which side of the fence we will be on, because our system, our democratic system, is so diametrically opposed to China’s authoritarianism that it is inconceivable that we would go with China against the US. I can’t see how that would play out. The same with Europe.

“So there you can see the geopolitical fault lines develop quite rapidly and that is going to, potentially, cause the death of globalisation, or at least severely limit the benefits that come from globalisation, which is in nobody’s interest.”