Geoeconomics Bi-Weekly: New Studies Highlight the Changing Geoeconomic Landscape

Newsletter by Chris Borges, Kirti Gupta, andAndrea Leonard Palazzi

Published April 19, 2024

State of the Global Economy

After credit ratings agency Fitch Ratings revisedChina's credit outlook downward last week citing"uncertain economic prospects," China received some much-needed positive news. On Tuesday, China's National Bureau of Statistics announced a GDP increaseof 5.3% in the first quarter of 2024 compared to Q1 2023, exceeding analyst expectations and keeping pace with China's ambitious goal of 5% growth in 2024. This growth was largely export-drivenas China copes with a highly indebted property sector low consumer spending. Factory investments in Q1 increasedalmost 10% from the prior year, while Chinese exports rose7% on an annual basis in January and February. Actual trading volumes, however, are likely higher as the glut of Chinese products is depressingprices, frustrating foreign businesses that are now strugglingto compete with Chinese manufacturers. This export-based growth model seemsto be working for now, but its returns may diminishas the renminbi strengthens and exporters' margins shrink.

In the United States, inflation came inhotter than expected for the third straight month. The Consumer Price Index (CPI) registeredan annual price increase of 3.5% in March, up from 3.2% in February, while Core CPI remained steady at 3.8%. U.S. job and wage growth also remained hot. The United States added303,000 jobs in March, well over expectations of 200,000, while unemployment fell from 3.9% to 3.8%. Annual wage growth for the 12 months ending in March was 4.1%-the lowest annual increase since June 2021, yet still aboveinflation. Combined, the new data dampenexpectations of an interest rate cut this summer. Inflation remains above the Fed's 2% target, while strong employment and wage growth may providethe Fed with more leeway to maintain high interest rates without risking a recession. The Federal Reserve's next interest rate decision comes on April 11th.

Meanwhile, the European Central Bank (ECB) held interest rates steady for the fifth consecutive meeting, though ECB Governor Christine Lagarde alludedto impending rate cuts barring any major surprises. March CPI in the Eurozone registeredan annual price increase of 2.4%, down from 2.6% in February, while annualized Core CPI fell from 3.1% in February to 2.9% in March. This new inflation data, along with findings from a quarterly surveyof European economists, strengthen the possibility of rate cuts at the ECB's next meeting on June 6th.

If the inflation mismatch across the Atlantic leads the ECB to cut rates before the U.S. Federal Reserve, this historically unusualsituation must be carefully managed. Some analysts contendthat a diverging monetary policy from the United States could lead to a resurgence of inflation in the Eurozone as it could weaken the Euro and make imports more expensive.

Around the World

New study from New York Federal Reserve estimates over $130 billion in collateral damage to U.S. firms from semiconductor export controls: Since the United States first announcedrestrictions on exports of advanced semiconductor technologies to China in October 2022, U.S. semiconductor firms have warnedthat the restrictions would hurt their businesses. As U.S. firms can no longer sell many of their products to the Chinese market, they are concerned that they will lose revenue that is critical to keeping pacein the highly innovative, competitive, and globalized semiconductor industry. Last week, the N.Y. Federal Reserve publisheda study quantifying exactly how much collateral damage the export controls are causing. Per their estimates, U.S. semiconductor firms lost $130 billion in stock market capitalization due to the export controls, and experienced drops in bank lending, profitability, and employment. In 2022, the year before the export controls took effect, China accountedfor 31.4% of all semiconductor purchases, with U.S. firms capturing53.4% of the Chinese market.

Supply chain and national security concerns drive large economies to rapidly implement industrial policies: Over the last several decades, industrial policy-targeted interventions such as tariffs, subsidies, and tax breaks designedto strengthen specific industries-largely fell out of fashion. Industrial policyis expensive, has many points of failure, and can increase geopolitical divisions, while economists have long debated its benefitsand downsides. But despite the uncertainty, rising geopolitical tensions are spurring nations to quickly adopt industrial policy initiatives. According to a study from the International Monetary Fund, more than 2,500 industrial policies were introducedworldwide in 2023, roughly three times the number in 2019. The recent surge has mainly been driven by large economies, with China, the European Union, and the United States accounting for almost half of all new policies in 2023. Per the study, the new measures were primarily implemented to foster supply chain resilience and address security concerns, in addition to climate mitigation.

United States announces $13 billion in subsidies for semiconductor giants Samsung and TSMC in bid to re-shore leading-edge chip manufacturing: Speaking of industrial policy, one of the more ambitious goals of the United States' CHIPS and Science Act is to produce20% of the world's leading-edge semiconductors by 2030. Leading-edge semiconductors are criticalcomponents of advanced technologies such as artificial intelligence, smartphones, and defense systems, and the United States producesalmost none of these chips today. To change that, in the last two weeks the Commerce Department announced $6.6 billionin subsidies for Taiwanese chipmaker TSMC and $6.4 billionfor South Korean chipmaker Samsung. The two companies intend to use these funds to build and expand facilities in Arizona and Texas, including facilities to build leading-edge semiconductors. Over 90% of the world's most advanced semiconductors are manufacturedin Taiwan today, a major geopolitical flashpoint.

Economic ties and geopolitical tensions pull nations in opposite directions, as evidenced by German Chancellor Olaf Scholz's trip to China: As nations have become increasingly interconnected, economic considerations naturally play a greater role in foreign policy decisions. But sometimes foreign policy objectives and economic considerations pull countries in opposing directions, as Germany, the world's third largest economy, is experiencing today. Many companies in Germany's export-oriented economy are highly relianton access to China, which is Germany's largest trading partner. However, Germany is also a member of the European Union, which is concerned by China's export practicesand deeply troubled by its ongoing support of Russia. In a visit to China this week, German Chancellor Olaf Scholz attemptedto balance these interests by echoing European concerns while also promoting increased business ties. China is the largest trading partnerof over 120 countries, including U.S. allies Japan, South Korea, and the EU, which may make these actors hesitant to take too tough a posture on China despite geopolitical differences.

Indian Prime Minister Modi expected to win third term as foreign firms remain cautious of investing in the world's largest nation: Indians are largely optimisticabout their economy, and for good reason. Over the last decade, India's economy has doubledwhile its stock market has tripled. And as rising geopolitical tensions make investment in China increasingly risky, India is becomingan attractive alternative. But, despite all this, foreign direct investment (FDI) in India is lagging. Since 2016, FDI has actually decreasedas a percentage of India's GDP. It's against this backdrop that nearly 970 million Indians-10% of the world's population-head to the polls today in the world's largest democracy. Current prime minister Narendra Modi's BJP party is expected to win, but the BJP has much work to do to meetits ambitious goals for growth. Modi's interventionist approach to the economy may be chillinginvestment. And despite growth, over 90% of India's 1.4 billion people are estimatedto live off less than $3,500 per year, while many traditional pains of doing business in India lingersuch as excessive red tape. The election takes place over 44 days, with results announcedon June 4th.

What we're watching

• April 23 - The U.S. Federal Trade Commission (FTC) voteson a proposed rule banning non-compete agreements in most situations. While many non-compete agreements for lower-wage workers are superfluous, there are certain scenarioswith higher-income workers where they protect trade secrets and promote innovation. The rule is expected to be adopted by the FTC, then challenged in court.
• April 30 - U.S. Federal Reserve meets to decide on interest rates
• May 15 -Singapore's prime minister Lee Hsien Loong will resignafter nearly 20 years at the helm, in the 3rd leadership transition since the financial hub's independence in 1965. Deputy prime minister and finance minister Lawrence Wong will take over as prime minister, as Singapore attempts to maintain its delicate geopolitical balance between east and west.

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