China Brief: China, the Indo-Pacific and Canada’s West
Issue 102 | April 2024

In this issue: Balancing security risks and economic opportunities as tensions remain tight, an Australian case in rapprochement, a new interactive BRI tool, Vietnam and the Team Canada trade mission, and more.

Ugly news? Not in trade data

In our last issue we flagged some potential for improved ties following Minister Joly’s meeting with China’s Minister of Foreign Affairs Wang Yi on the sidelines of the February Munich Summit. But the intervening period hasn’t offered much hope. From the Winnipeg biolab controversy to foreign interference, Canadians are getting a steady dose of ugly news. The just released defence policy update sums it up: “China is an increasingly capable and assertive global actor looking to reshape the international system to advance its interests and values, which increasingly diverge from our own on matters of defence and security.”

This doesn’t sound like there’s much room for engagement, but such conclusions aren’t supported by the trade data. In an analysis of Canada’s Q3 2023 trade with China, the U of A’s China Institute found that while export growth is slowing it’s not declining either. The short story here is that Western Canada’s key commodity exports are still moving into China and are driving the outbound relationship. The picture over the last two years shows that trade is more or less stable.

So what’s going on? How can a Western Canadian company figure out if it should still seek business opportunities?

It’s the political & institutional nexus stupid!

A deeper understanding of China’s political and institutional nexus and how it interacts with national security and the economy is needed for Western Canadian businesses to determine how best to engage amidst rising geopolitical tensions and shifting trade policy parameters.

China’s model evolves and shifts, but its essence is that key strategic sectors are subject to heavy state control or influence at one end of the spectrum. Think banking and finance, energy, utilities and telecommunications, sectors which are largely dominated by national level state-owned enterprises. At the other end, where strategic considerations lose the trade-off to economic dynamism or state interests are minimal, there exists market-oriented regulations and fierce competition that characterize consumer goods and export-oriented sectors.  There is also a mushy middle where private sector players are used as instruments for party-state objectives or where local level SOEs operate. This is a broad category that encompasses everything from large ICT firms to sectors with sprawling supply chains like automotives and aerospace. Here government programs, like Military-Civil Fusion, and industrial policies become increasingly relevant.

From the perspective of market-based competition, a foreign firm operating in one of the two strategic groupings will find themselves disadvantaged in China. But this has proven difficult to address as some of these biggest challenges with China and the WTO (e.g. forced technology transfer, SOEs, subsidies, and discrimination) do not always stem from it outright breaking the rules, but rather exploiting gaps in a system that was designed by and for countries with very different institutional settings. This means that the governments of liberal market democracies have started to take shifting the parameters of engagement into their own hands.

National security and long-term economic competitiveness

A useful approach for navigating this shift involves thinking through how a proposed project fits in terms of national security risks and long-term economic competitiveness.

National security risks in the relationship largely stem from the lack of trust between liberal market democracies and China. These can filter through commerce via espionage, backdoor control systems, or the inadvertent aiding of military development, which largely implicates technology and critical infrastructure. This is why, when you look at federal government restrictions like the Investment Canada Act and Research Security initiatives, the intent is to focus largely on technologies that could have dual-use implications.  The U.S. calls this building a high fence for a small yard. This approach makes sense but could also drive unintended consequences such as organizations attempting to skirt the rules. Examples of this include UofA’s joint AI lab with Huawei; Canadian mining companies moving headquarters out of Canada; or more generally disincentivizing foreign mining firms from listing on the TSX. The other challenge is when economic-based threats to national security are conflated with economic competitiveness, a murkier web to disentangle.

For the most part it’s up to Canadian companies to decide if engagement with China is in their best interests, but we’re likely to see greater government intervention in this space via industrial and trade policy. Critical minerals, electric vehicles and the broader clean-tech sector are high on the government’s radar in this regard. Governments around the world are concerned about the long-term sustainability of their economies (and employment) if China develops massive scale through subsidies and other forms of protection, and in turn are moving towards emulating China with their own interventions, which China ironically decries.

But long-term economic competitiveness cuts the other way too. For Western Canadian businesses that focus on exports of commodities and consumer goods, avoiding China does not make sense as it is a large market and source for growth. Even in some technological sectors there exists space for business depending on the nature of the technology, the form of the business relationship, and protection of intellectual property.

Australia attempts to balance security and economic interests

If Western Canada’s relationship with China matters to you, then one of the big things to watch is Australia. From governance model to export structure, Australia shares many commonalities with Canada. This makes us great pals, but is also means we’re economic competitors (not just in China but in the Indo-Pacific writ large) when it comes to resource and agriculture exports. Australia has historically been active engagers with China, outpacing Canada in most respects. For example, they were able to conclude a Free Trade Agreement that came into force way back in 2015 as Canada looked on in envy.

Australia’s economy boomed on the back of China’s economic rise, roping in a nice trade surplus driven by resources. But then things started to sour. Australia’s increased integration with with China was accompanied by greater scrutiny of some of the accompanying challenges that a small open liberal market democracy faces when chumming up with a politically divergent China. The Aussies racked up all sorts of stories that should sound familiar to Canadian audiences. A foreign interference scandal rocked the country catalyzing a foreign agent’s registry in 2018. Foreign investment rules were tightened. Following the outbreak of the pandemic, Australian PM Scott Morrison called for an investigation in China’s role, which seemed to be the camel that broke the straw’s back. China fired back, targeting some key Australian export interests (echoing Canadian canola producer and exporter experience during the Meng Wanzhou affair) and the Chinese embassy in Canberra unofficially released the “14 points” document outlining why China is upset with Australia.

The relationship remained in the doghouse until spring 2022 when a new Australian government produced toned down rhetoric and rapprochement guided by PM Anthony Albanese and Foreign Minister Penny Wong. Fast forward to today and Australia just hosted Chinese Foreign Minister Wang Yi, the highest ranking official to visit since 2017. This accompanied the removal of tariffs on wine, one of the commodities targeted by China in the aftermath of souring relations. While industry proponents are celebrating this move, others are less sanguine. The removal of wine tariffs were accompanied by Australia dropping the WTO case it launched China. This may sound like a no brainer, though it was likely subject to debate within the Australian government. Continuing the WTO case would have put China in the spotlight. Some observers note that this enables China to avoid the scrutiny and a plausible finding that China derogated from the rules making it more difficult to establish WTO precedents to challenge economic coercion.

While such moves may not support efforts to challenge coercive trade restrictions, it does allow Australia to pursue its interests through improved ties with China in an attempt to find a delicate balance in this shifting geopolitical and strategic environment. Australia is adeptly leveraging its unique position seeking a path to seize economic gains from China while balancing security initiatives led by the U.S. Whereas in the wake of 9/11 Canada was able to find a special place in U.S. policy in building continental security, Australia has taken Canada’s place as U.S. attention moved towards the Pacific, as evidenced by its participation in AUKUS and “the Quad” (and in the case of the former, Canada sees what’s going on and is trying to elbow its way in.) If this balance can hold, then it could provide evidence that commercial engagement is still possible amidst rising security tensions – or rather signaling that such engagement is all the more important.

In case you missed it!

An eye on global infrastructure

For the those keeping an eye out on global infrastructure, Australia’s Lowy Institute put out an interactive tool that looks at the state of China’s Belt and Road Initiative’s megaprojects in Southeast Asia – and the picture isn’t as pretty as the Lowy’s graphics are! China has committed to 24 infrastructure megaprojects in the region, however what was promised and what’s being delivered are significantly different. There’s $50 billion gap in project financing with “more than half allocated to projects that have been cancelled, downsized, or otherwise seem unlikely to proceed.”

However, Lowy doesn’t place all the blame on Beijing. The pandemic, political instability, and the hiccups and headaches that come with megaprojects are all having an impact. It’s also serving as powerful feedback for China to adjust its approach to improve governance standards and develop more moderate ambitions if it wants to secure the viability of one of Xi’s key foreign policy projects. And China has room to adjust, as Lowy estimates that to cover the current project financing gap, China is likely to disburse roughly $19 billion in funding for the region over the next few years.

Spotlight on Vietnam

Vietnam was in the spotlight in March as International Trade Minister Mary Ng led a Team Canada trade mission through March 27-29, just days after a political shake-up with Vietnam’s President abruptly resigning (the second such resignation within a year). While the country continues to be seen as politically stable and attractive to firms and governments pushing diversification away from China, high-level political infighting serves as a reminder of political risks associated with doing business abroad. And given Vietnam’s proximity to China and their tight regional supply chains, governments need to be realistic about the limitations of a strategy to decrease dependency on China.

Cleantech, forced labor laws and an industrial policy collision

Battling climate change has been touted by the Canadian government as one of the areas where Canada can cooperate with China. At the same time the government has implemented measures to confront China on areas of concern, including human rights and forced labour. The two, however, bump head-to-head when it comes to solar panels and China’s dominance of global manufacturing with reports that CBSA is cracking down and detaining solar panel imports from China (see the latest on forced labour in the North America Brief 17!)

But the concerns with solar panels (and clean-tech more generally) aren’t confined to human rights. China’s leading market position was established on the back of industrial policies that led to a glut in supply that forced exits of many global competitors – and continues to put pressure on those remaining – while at the same time driving down the cost of this renewable technology. Such concerns haven’t disappeared either, with the EU recently launching an investigation into unfair competition in some solar procurements involving Chinese entities.

Nathan Gardels, editor of the thought-provoking Noema Magazine, worries that that this conflux of confrontations with China risks weaponizing climate change and instead argues for a “practical partnership of rivals” in the cleantech space. The idea being that where the climate is involved, the West and China should put aside geopolitical competition and restrictive policies. However, there are others that see geopolitics as a key premise for a domestic cleantech push.  The Centre for Net-Zero Industrial Policy argues in a recent report that geopolitical considerations could provide the thrust of a Canadian clean-tech policy program. The case of solar panels is thus challenging Western governments when it comes to trade-offs on major policy objectives such as cheap decarbonization and strategic competition. Depending how this plays out, we’ll get some proof in the pudding on where priorities lie.

Jeff Mahon, Executive in Residence, Trade and Trade Infrastructure