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For all the hubbub about the US-China trade war, trade is a fraction of China's economy

If China and the world were to diminish their engagement with each other, significant value could be lost for both, write Jonathan Woetzel and Jeongmin Seong in Quartz.

Trade tensions between China and the United States have rumbled along for months. There have been false dawns, and a great deal of rhetoric.

Some of the world’s institutions have warned of the consequences. The head of the World Trade Organization warned of the worst crisis in global trade since 1947, and the International Monetary Fund said that a full-blown trade war between the world’s two largest economies could make the world a “poorer and more dangerous place.”

So it’s somewhat ironic that trade is in fact no longer the main driver of the Chinese economy.

Domestic consumption > international trade

As recently as 2008, China’s net trade surplus accounted for 8% of GDP; by 2018, that figure was only about 1.3%—less than either Germany or South Korea, where net trade surpluses generate between 5% and 8% of GDP. The US isn’t far behind its Eastern neighbor: In 2018, US had a trade deficit of about 3% of GDP, down from 5% in 2006.

Instead, China’s economy today is driven by domestic consumption. In 11 of the 16 quarters since 2015, consumption has contributed more than 60% of GDP growth. In addition to becoming the world’s biggest market for online retail, the country now represents more than 30% of global market in luxury goods, automotive, consumer appliances, mobile phones, and spirits.

China’s working-age individuals today also have higher disposable incomes than their parents. They are so numerous and their incomes rising so rapidly that they have the potential to reshape global consumption as the baby boomer generation did in the West—the richest generation in history.

Chinese urban consumers are devoting a greater share of their income to discretionary spending, such as transportation and communication, education, and health care. Spending on food declined from 50% of total household consumption in 2000 to 25% in 2017. This is already similar to urban consumers in developed countries today—Japan at 26%, South Korea at 29%, and the United States at 17%.

A brief history of China’s trade

While the Silk Road figures prominently in the Western version of the East, China effectively closed itself off to the outside world following the burning of Zheng He’s ships in the 16th century, preferring isolated imperial splendor to the cut and thrust of commerce. In the words of emperor Qianlong to the English ambassador George Macartney in 1793, “I set no value on objects strange or ingenious, and have no use for your country’s manufactures.”

This of course did not work out so well for the emperors, who suffered imperialist invasions and the so-called “century of humiliation.” Nonetheless, this essentially isolationist tendency (as reflected in low levels of cross-border trade) persisted right up till the so-called “economic opening to the outside world.” This is when former Chinese head of state Deng Xiaoping broke with centuries of tradition in the late 1970s to declare it okay to open the window to the outside world, even if some flies might be let in.

Deng’s announcement—and, more to the point, his policies of reform—kicked off perhaps the greatest explosion of trade on the planet. China’s GDP per capita rose from $184 to $9,780 from 1978 to 2018, even as trade (both import and export) rose by 233 times over the same time.

Growth of trade has had a regional effect, creating an increasingly integrated Asia with China at its core. Today, China’s neighbors are the ones who depend on China for their export markets—and as an increasingly competitive source of supply. More than half of China’s imports are from Asian countries, compared with less than 10% from the US over the past decade. Asia’s share of China’s exports increased from 31% in 2006 to 36% in 2018 while the US’s share of China’s exports declined from 21% to 19% during the same period.

But China and the US still need each other—and the world

Although both the US and Chinese economies are large and domestically driven, both also have critical interdependencies. China depends on technology imports: It imported $313 billion of electronic integrated circuits in 2018, dwarfing its $239 billion of crude oil imports. Around half of its technology import contracts, including IP and technical services, comes from just three countries: the United States, Japan, and Germany.

While China is catching up with more than $279 billion in annual R&D spending in 2017, it still imported more than $29 billion in IP while exporting just $5 billion in the same year. These imports provide the critical components and knowledge that powers China’s electrical vehicles, guide its high-speed trains, and keep its people healthy through provision of pharmaceuticals.

The world and China also have a substantial economic stake in each other. Foreign companies have expanded their presence in China enormously. Between 2000 and 2017, the number of foreign-funded enterprises operating in China increased from 203,000 to 540,000; at the end of this period, these firms employed around 14 million workers, up from only 3 million before. They account for 43% of China’s exports. Our analysis of top 30 brands in the largest 10 consumer categories in China found that multinational corporations have over 40% market share, creating a critical set of well-known brands to Chinese consumers, a large Chinese employment base, and a large share of global profits.

Given China’s shift toward domestic-consumption-driven growth and trade tensions, could a measure of disengagement be in prospect? If China and the world were to diminish their engagement with each other, significant value could be lost for both. Conversely, further deepening of their integration with each other could produce large benefits.

Less engagement between China and the world could mean higher tariffs, limited trade and technology flows, and remaining gaps in addressing key global challenges. More engagement could see China importing more from the rest of the world, greater flows of technology, and improved access to Chinese service sectors; reaching solutions to global issues would be more likely. In both scenarios, different stakeholders could experience upsides and downsides.

However the future relationship unfolds, businesses exposed to China’s economy should prepare for what appears likely to be an uncertain period ahead.

This article appeared first in Quartz.