The United States and China reached an agreement yesterday on a dispute over alleged Chinese export subsidies. In exchange for the U.S. government dropping a case it was pursuing through the World Trade Organization, China agreed to end subsidies that the U.S. claimed were promoting exports and hindering imports of steel, wood, IT products, and other manufactured goods.

Details of the case aside, the announcement shows how trade disputes with China can be resolved without resort to threats of retaliatory tariffs. This is not the first time China has changed its trade laws in response to pressure from the United States through the WTO. In 2004, China dropped a discriminatory tax refund on domestically produced semiconductors after the U.S. government filed a complaint.

Today’s announcement is another vindication of resolving trade disputes with China through a rules-based system rather than through threats of unilateral retaliation. China’s accession to the WTO in 2001 not only committed China to lowering trade barriers on a broad range of goods and services; it also brought China into the generally effective WTO dispute settlement mechanism.

In two weeks, Treasury Secretary Paulson, U.S. Trade Representative Susan Schwab and other cabinet members will meet with their Chinese counterparts in Beijing as part of the ongoing Strategic Economic Dialogue. As today’s announcement verifies, the SED represents the right approach to encouraging China to continue its evolution toward a more free and open economy.