The Thucydides Trap and the Challenges facing China’s Rise

Examining the Thucydides Trap including factors impacting China’s economic and geopolitical growth

Shanghai Lujiazui civic landscape: Deposit Photos

Thucydides, a fourth-century BC Athenian historian and general, wrote a book about the Peloponnesian War, a conflict between Athens and Sparta. He concluded that the war was inevitable due to the growth of Athenian power and the fear it caused in Sparta. This idea, the Thucydides Trap, has been generalized to suggest that when a rising power challenges a dominant power, war becomes unavoidable.

The concept of the “Thucydides Trap” re-emerged in recent years, with some authors suggesting that the U.S. and China were likely to go to war based on Thucydides’ observations. However, comparing the economic power of China and the U.S. solely based on the size and growth rate of their GDPs can be misleading. China’s larger population should be taken into account, and when considering per-capita GDP, the U.S. still surpasses China.

The export boom in Asia started in the 1960s, led by Japan, and was followed by Taiwan, South Korea, and China. Each country developed its own export capabilities. However, China, despite its late start, has faced challenges in reaching the high-end market and relies on importing high-end components. On the other hand, Japan, Korea, and Taiwan excel in high-value manufacturing goods, such as advanced computer chips.

Massive inequality and limited consumption

China’s focus on expanding its workforce and factory output, rather than raising worker incomes, has contributed to its growth but has also led to massive inequality and limited consumption. The Chinese approach contrasts with the Western emphasis on using technology to raise productivity and wages. Additionally, China’s reliance on low-cost unskilled labor and its demographic challenges, resulting from the one-child policy, pose long-term problems for the country.

Russia’s war on Ukraine is not a clear example of a rising power challenging the U.S. and NATO. Russia has been a declining power for decades and has used outdated weapons in the conflict. The beating Russia has faced in Ukraine has surprised many and may have disappointed Chinese leader Xi Jinping, who may have hoped that Russia could distract the U.S. and NATO while China pursues its own long-term plans. After all, Russia has carried out some successful invasions in the past couple of decades, even if they haven’t recovered much of the lost Soviet Empire. But China itself hasn’t been in a war of any consequence since its 1979 border clash with Vietnam.

I.P. Theft

The U.S. announcement of broad new limits on sales of semiconductor technology to China has been viewed by some as a war-like gesture. However, China’s technological gains have often involved theft of intellectual property, according to foreign firms and individuals who have worked there and invested their own money.

They say that enforcing intellectual property rights in China is difficult for foreigners due to local judicial protectionism, difficulties in obtaining evidence, small damage awards, and a perceived bias against foreign firms.

China also forces foreign joint-venture operators to share their designs and patents with local partners, who may then go off and sell copies elsewhere in China or Asia. Many accept the demand, just to get access to the vast Chinese market.

More ambitious Chinese businesses may simply buy a copy of a competitor’s product and reverse-engineer it if that’s all it takes: just pirate the technology, in other words. In The End of the World is Just the Beginning, however, Peter Zeihan wrote,

“Or, if we’re being brutally honest, to successfully reverse-engineer the products of others: Don’t get me wrong, I don’t feel great when I see a new story about some Chinese spy successfully funneling American military technology to Beijing. But please keep it in perspective. China didn’t figure out how to make a ball-point pen without imported components till 2017. The idea that China can get a set of blueprints and suddenly be able to cobble together a stealth bomber or advanced missile system is a bit of a scream.”

Demographics is a key negative for China

China’s demographic situation is a significant long-term problem. The one-child policy and forced migration from the interior to the coast have resulted in an aging workforce and a shrinking labour pool. As retirees increase, the government will face challenges in supporting them with reduced tax revenue and a smaller labour force.

The key indicator of future population is the number of children the average woman has in her lifetime. The “replacement number” that keeps population stable is 2.1 children. The UN estimates that China’s rate dropped to 1.16 in 2021 from just under 3.0 in the early 1980s, and 2.5 as recently as 1990. After decades of government family-size control, the new legalization of larger families has not yet caught on.

China’s shrinking population is part of what is referred to more and more as “the New World Disorder”– a play on the term “the New World Order,” which refers to the globalization of world trade since the end of World War II.

Russia’s invasion of Ukraine is part of this Disorder. Like many nations, it is also experiencing population decline, but far milder than China’s.

Peter Zeihan’s book, The End of the World is just the Beginning, is a great introduction to the subject. Everything he writes makes sense to me, but that doesn’t mean future trends will turn out the way he expects. For example, technological advances in aging, productivity and other areas may yield new ways of dealing with bad demographics.

I’m optimistic about the market in the coming year. I also remain optimistic about the remainder of the 2020s. But there will be rough patches, just as there have been from 2008 through today.

We may find ourselves in what we’d call a “two-tier market”: The top tier tries to take advantage of new technology. This may hurt current cash flow, but it will help maintain or speed up growth. The lower tier tries to save money by sticking with old processes and old ways of doing business, and tweaking them to cut costs. They keep falling further behind.

We suspect that recognizing the two tiers will work better for investors than trying to predict future market trends.

Our three-part Successful Investor approach is the best way to make money in the stock market

At TSI Network, we recommend using our three-part Successful Investor philosophy to make money no matter what happens in the market:

  1. Invest mainly in well-established, mostly dividend-paying companies;
  2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities);
  3. Downplay or avoid stocks in the broker/media limelight.

What are your opinions on the subject, is World War III on the way, or is Thucydides Trap dependent on many more factors than perceived power?

Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books. This article was published on July 23, 2023 and is republished on the Hub with permission.

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