Will America and China Manage to Escape Thucydides' Trap?

A COLD WAR BETWEEN THE US AND PRC IS ALREADY UNDERWAY, WITH THE TWO GREAT POWERS ENGAGED IN A TRADE WAR THAT COULD ESCALATE INTO MILITARY CONFLICT. GEOPOLITICAL POLARIZATION IS LEADING TO THE FRIENDSHORING OF SUPPLY CHAINS, STAGFLATION AND REDUCTION OF THE GLOBAL GROWTH POTENTIAL

by Brunello Rosa, Adjunct Professor

Geopolitical developments have been at the forefront of public attention over the last few years. The overarching theme is the decoupling between the incumbent global hegemon (the USA), and the rising power (China), which is challenging the global order that has been in place since the end of World War II. The rivalry between the US and China is played on several turfs, in particular on trade, technology, and global supply chains.
The trade war has resulted in a series of tariffs, sanctions, additional duties and barriers to trade that have led to the beginning of a process of deglobalization or slowbalization for the first time since the 1970s, when the current phase of globalization started. The tech war is being fought on a number of battlegrounds, including in big data, artificial intelligence, quantum computing, chip production and cyberwarfare. The fragmentation of global value chains has resulted in the overhaul of existing supply chains and the creation of new trade routes, both maritime and terrestrial.

Graham Allison, Harvard professor and policy advisor to several US presidents, has wondered whether the US and China will be able to “escape Thucydides’s trap,” i.e. the open conflict that almost inevitably erupts when an incumbent power is challenged by, and therefore fears, a rising one. In twelve out of the sixteen historical episodes analyzed by Allison, the two major rival powers of the day proved unable to avoid the trap in which Sparta and Athens first fell into. Whether America and China will follow a different fate remains an open and fraught question.

But while hot war, i.e. direct military confrontation between the US and the PRC, cannot be ruled out in the not-too-distant future, a new Cold War is already unfolding between the two countries, dubbed Cold War 2. This confrontation is leading to a decoupling between the two world’s superpowers. The ensuing polarization of the world is leaving four regions of the global economy vulnerable to becoming terrain for proxy wars. These regions are: Central and Eastern Europe, the Middle East, Latin America, and Africa.
Unfortunately, in each of the areas cited above, conflicts have already emerged: the war between Russia and Ukraine in Eastern Europe; the military escalation in Gaza and the Red Sea in the Middle East; the epidemic of military coups in Africa’s Sahel (Burkina Faso, Mali, Gabon, etc.); territorial disputes in Latin America (for example between Venezuela and Guyana) as well as domestic instability in countries like Ecuador.
What are the economic consequences of these geopolitical developments? A polarized world, characterized by deglobalization and balkanization of global supply chains, with the erection physical and non-physical barriers to trade and immigration, is a world in which the growth potential of any economic activity is severely diminished.

In a polarized world of this kind, the best strategy to react to these phenomena is the friendshoring of economic activities. With tariffs and barriers to trade, this will also be a world in which prices of goods and services will be higher than they were previously. Especially considered the public and private actors are also simultaneously committed to the costly transitions in the digital, energy, and environmental realms.
At the same time, the workforce is demanding higher compensation to offset not just the higher prices of the last few years, but also recoup part of the purchasing power lost to capital owners and managers in the last few decades, when the share of national income going to profits, rents and interests increased to the detriment of the share going to wages and salaries.

A world in which potential growth is lower and price inflation is higher is one that is inherently stagflationary. Monetary policy can only partly avert the consequences of this. The largest role will be left to governments, and their fiscal and regulatory responses.