Why the China-U.S. rivalry is at a crucial turning point—and what it means for business

As Chinese companies continue their rise in the Global 500, the competition between the two economic superpowers is intensifying.
August 10, 2020, 8:30 AM UTC

Rarely do relations between great powers degenerate as quickly as they did when the U.S. and China skirmished in late July. When the U.S. ordered China to close its consulate in Houston within 72 hours, it looked like punishment for alleged theft of COVID-19 research and other valuable information by Chinese hackers; the Justice Department had announced charges that same day. Or perhaps it was a further response to Beijing’s crackdown on Hong Kong, for which the U.S. had already revoked the city’s special status in trade relations. 

But the State Department said the real reason was what it asserted were years of “massive illegal spying and influence operations.” So why close the consulate at that moment? Virtually all analysts say the timing reflects the presidential election, as President Trump and former Vice President Joe Biden vie to appear the tougher man on China. Certainly this was not routine diplomacy theater. It was unprecedented. In the 41 years of formal relations between the two countries, the U.S. had never ordered the closure of a Chinese diplomatic facility. 

Both sides replaced boilerplate umbrage with vituperation. The U.S. “will not tolerate the PRC’s violations of our sovereignty and intimidation of our people,” declared a State Department spokeswoman. A Chinese foreign ministry spokesperson shot back that the shutdown was “an outrageous and unjustified move which will sabotage relations between the two countries.” A day later, Secretary of State Mike Pompeo said the U.S.-China relationship should be based on a principle of “distrust and verify” and dismissed “the old paradigm of blind engagement with China.” The day after that, China ordered the U.S. to close its consulate in Chengdu, a major business hub in southwest China, another unprecedented move. 

And to think that just last December, when the U.S. and China signed a phase 1 deal to start unwinding the trade war, President Trump said the U.S.-China relationship “might be the best it’s been in a long, long time.”

The consulate confrontation marks a particularly clear and dramatic advance in a trend the whole world will feel: the intensifying competition between the world’s two largest economies. It adds heavily to a broader uncertainty, a combination of highly consequential unknowns that together will redirect our future. They’re distilled in two big questions, both of which arose in the late-July collapse of relations: Where will the U.S.-China rivalry take us? Which country will emerge from the COVID-19 pandemic with the least long-term economic and social damage? Both questions, moreover, are intertwined with a third: Which of two starkly different presidential candidates will America choose? Together, their answers will mark a turning point in the world’s progress.

New data, presented in Fortune’s 2020 Global 500 ranking of the world’s biggest corporations, reveals a landmark change in the U.S.-China rivalry. For the first time, there are more Global 500 companies based in mainland China, including Hong Kong, than in the U.S.—124 vs. 121. If you include Taiwan, the total for Greater China is 133. 

The reversal of leadership reflects long-running trends. The number of U.S. companies in the ranking has been declining every year since 2002, when it was 197. The number of Chinese companies has been increasing every year since 2003, when mainland China placed 11 on the list.

Of the three questions in the triple turning point, the future of the U.S.-China relationship arguably holds the greatest world-historical significance. Harvard China expert Graham Allison frames the relationship as “an inherent, deep, structural rivalry,” a rising power threatening a solidly dominant power. The U.S.-China rivalry is dangerous, Allison tells Fortune, in large part because it’s deeply emotional, particularly for those Americans who feel that the nation’s rightful and only place is to be “No. 1” in the world order. Allison has famously called it “Thucydides’s trap” after the ancient Greek historian’s recounting of how Sparta’s response to the threat of Athens’s rise led to a 30-year war. 

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While the U.S. and China are a long way from that, the current situation is bad and deteriorating fast. “Every topic that matters is getting worse,” says Ian Bremmer, founder and president of the Eurasia Group consulting firm. “Huawei, Hong Kong, the South China Sea, Taiwan, the U.S. withdrawal from the WHO over China, you name it.” 

Most experts agree that over the past year the relationship has fallen into a self-reinforcing downward spiral. “I’m sitting in Washington, and it feels as if we’re in the center of this hurricane and there’s only one direction we’re heading in,” says Scott Kennedy, an expert on Chinese business and economics at the Center for Strategic and International Studies. As Beijing aggressively pushes territorial claims on the Indian border, over Taiwanese airspace, and in the South China Sea—actions intended as messages to the U.S., diplomats say—the U.S. has pressured allies to ban telecom equipment from Huawei (No. 49 on the Global 500) and has even pondered banning U.S. travel by members of the Chinese Communist Party and their families, an estimated 270 million people, including the CEOs of nearly every important Chinese company.

The shift in the Global 500 is significant because this rivalry is founded on economic might. Analysts can quibble over which country’s economy is biggest. The U.S. remains well ahead when the comparison is based on currency exchange rates, with 2019 U.S. GDP of $21.4 trillion vs. China’s $14.3 trillion. But based on purchasing power parity, a measure that adjusts for the countries’ differing price levels, China is slightly ahead of the U.S.—$21.4 trillion vs. $20.5 trillion as of 2018, the most recent year for which the World Bank has data. The gap is probably wider now and continuing to widen. That’s the measure that counts, says Allison, because it shows “who can build the most drones” or fund the most research. 

It also makes China the world’s largest market for increasing numbers of products and services. It “will be the first market where new products are launched,” says Kennedy, “so Chinese consumers will have a greater say in the direction of industries. The American market may not be large enough to be where products are scaled up.”

For that and other reasons, U.S. companies will be highly unlikely to leave China. A billion prospering consumers cannot be forsaken by any business that hopes to remain globally competitive. In addition, few companies will want to remove China from their supply chains entirely. While trade tensions and the pandemic have shown many companies worldwide that they were too reliant on Chinese suppliers, Chinese companies often have manufacturing expertise that can’t be found elsewhere. Besides, foreign companies that ditch China—in favor of India and Vietnam, for example—may find that China becomes less welcoming when those companies want to sell to the Chinese market.

China’s economic strengths are sobering, but to understand this rivalry fully, GDP alone is too gross a measure. The critical field of conflict is technology, the foundation of economic growth and national security. Since the founding of the People’s Republic, Chinese leaders, including the President, have declared a national policy to “catch up and surpass” the developed world’s technology. For China’s leaders, “technological progress is not only a means to economic and military prowess,” writes Harvard’s Julian Baird Gewirtz, “but also an ideological end in itself—offering final proof of China’s restoration as a great power after decades of struggle.”

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And tech is where the two countries are most noticeably decoupling. Huawei is the world’s No. 1 maker of 5G networking equipment and, as of this year’s second quarter, the No. 1 maker of phones. But its products are virtually outlawed in the U.S., and its CFO has been under house arrest in Canada for 18 months on U.S. charges of bank fraud, wire fraud, and theft of trade secrets, charges she and the company vigorously deny. For its part, China has effectively banned some of America’s most ubiquitous tech giants, including Google and Facebook. “We’ve gone from a more integrated world to a Splinternet,” says Bremmer. “Tech is by far the crux of the competition right now, the most important piece and the most dangerous.”

The technology war is being fought on many fronts—A.I., 5G, voice recognition, facial recognition, fintech, and others. A.I. is the most important because it turbocharges all the rest. A recent article coauthored by Allison and an anonymous U.S. tech industry leader argues that China is far more advanced in A.I. than the U.S. national security community realizes—noting the advantages China gains by having a population four times the size of the U.S. “In A.I., brainpower matters more than computing power,” they write, and China graduates 1.3 million STEM students annually vs. America’s 300,000, and 185,000 computer scientists vs. America’s 65,000. Even in the U.S., of every 10 computer science Ph.D.s graduating, three are American and two are Chinese; most Chinese postdocs will eventually return home.

But if China seems like an economic and technological steamroller about to squash the U.S., it isn’t. A closer look shows that despite China’s strengths, this rivalry’s future remains highly uncertain. 

Start with those 124 mainland Chinese companies in the Global 500. Though they outnumber U.S. companies, they’re smaller, accounting for only 25% of total Global 500 revenue vs. America’s 30%. A large majority of the Chinese companies—68%—are state-owned enterprises; they didn’t get big by winning in the rough-and-tumble competition of open markets. While the list includes Chinese tech behemoths that compete internationally—Alibaba Group, Huawei, Lenovo—it also includes many purely domestic businesses; several are coal miners or electric utilities.

The nature of these companies makes a big difference to their power in the strategic rivalry. The key question is this: How have they grown so large? “Was it by innovation, smart managerial practices, and good corporate governance,” asks Kennedy, “or have they gotten there through the power of the Chinese mercantilism and largesse from Chinese state-owned banks?”

Even China’s eventual accession to the title of World’s Largest Economy may not be as inevitable, or at least not as imminent, as many people believe. If both countries were to continue to grow their GDP (calculated at market exchange rates) at their 2019 nominal rates, China wouldn’t pull even with the U.S. until about 2050, writes Ruchir Sharma, Morgan Stanley Investment Management’s chief global strategist, in a recent Foreign Affairs article. If China’s growth slowed by just one percentage point, it wouldn’t catch up until 2090, meaning “few Americans alive today are likely to be around to see the United States fall to second place.” 

The most probable future is what some analysts are calling Cold War II. It won’t be like the first cold war; the USSR was a much weaker economy than the U.S. and scarcely traded outside Eastern Europe. But it’s a conflict, already underway, in which the adversaries field every weapon but bombs and bullets while also interacting civilly on some issues of mutually beneficial trade. “In commodities such as liquefied natural gas and agriculture,” says Bremmer, “the U.S. and China will be doing business with each other.” Just as they did last year, when the U.S. exported $13.8 billion of agricultural products and $3.1 billion of oil and gas to China.

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A new look at the top

For the first 29 years that Fortune compiled our Global 500 ranking of the world’s biggest companies, the U.S. never failed to finish No. 1. Well, the winning streak is finally over. This year’s list features 124 companies based in mainland China, including Hong Kong. Add in Taiwan, and there are 133 in Greater China. The U.S. falls to No. 2, with 121.

Infographic by Nicolas Rapp
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The next front in the standoff may be the phase 1 trade deal. “Can it hold until the election?” Bremmer asks. “Trump will be blaming China an awful lot. It may be tempting to break the deal,” even though consumers, the finance industry, the agriculture industry, and others would suffer.

Which raises another of the great questions, the identity of the next President. Policy analysts agree that under a President Biden, the tone of the U.S.-China relationship would change. If he were able to lower the temperature, both sides could gain room to negotiate. He would also be more likely than Trump to enlist European and Asian allies, say Eurasia Group analysts, to present a united front in negotiations with China. At the same time, the U.S. policy stance would likely remain confrontational. Politically, says Bremmer, “the only policy issue on which there’s broad bipartisan agreement is that there should be a tougher line on China.” 

At this triple turning point, we’re left without answers—only with the certainty of a less stable world. Relations between the two great powers are fraying, leading who knows where. But the scenarios aren’t all bad. Maybe China and the U.S., rationally pursuing self-interest, will manage their relationship as corporate-style competition. Multiple effective vaccines—from the U.S., China, and elsewhere—could vanquish COVID-19 in less than a year. In that scenario, economies would revive, people could hug each other again, and global anxiety would unclench at least a bit. 

In an unstable world, even the extreme scenarios—good and bad—seem plausible. Planning is harder; bets are riskier. In all of our lives, there’s less room for error.

A version of this article appears in the August/September 2020 issue of Fortune with the headline “And then there were two.”