U.S.-China Trade Deal Trumps U.S.-China Trade War

Amid increasing tensions between Washington and Beijing over economic and security matters, Chinese President Xi Jinping is in Florida today and tomorrow for meetings with President Trump.  Although economic frictions between the world’s two largest economies are nothing new, the safeguards that have helped prevent those frictions from sparking an explosion and plunging the relationship into the protectionist abyss may no longer be reliable.

As I noted in this recent Cato Free Trade Bulletin: 

Never have the U.S. and Chinese economies been more interdependent than they are today. Never has the value of the bilateral trade and investment relationship been greater. Never has the precarious state of the global economy required comity between the United States and China more than it does now. Yet, with Donald J. Trump ascending to power on a platform of nationalism and protectionism, never have the stars been so perfectly aligned for the relationship to descend into a devastating trade war.

What are those safeguards and why might they no longer be reliable?

First, U.S. multinational business interests that used to favor treading lightly with China, and provided a policy counterweight to U.S. import-competing industries advocating protectionism, have grown disillusioned by the persistence of policies that continue to impede their success in Chinese markets. Many think a more aggressive posture from Washington, even if that makes matters worse for them in the short run, is overdue.

Second, the pro-China-trade lobbies in Washington have grown sheepish in their advocacy on account of an economic study that went viral last year, ascribing massive U.S. jobs losses to trade with China, and because many fear political retribution from challenging Trump’s assumptions.  Full-throated support for the relationship has become conditional support.

Third, now more than ever before, U.S. policymakers, media, and the public are less inclined to look at the bilateral economic relationship in isolation from the strategic and geopolitical aspects of the relationship.  Segregating the issues in the past allowed us to focus on the win-win elements of trade, where there was broad enough agreement that mutual benefits could be derived, without being distracted by the issues where the United States and China are less likely to agree.  Today, our economic frictions are viewed through the prism of our geopolitical differences – and that makes trade disputes more difficult to manage.

Fourth, probably more so than at any time since 1989, there is political “appetite” for a trade war. By that I mean that both Trump and Xi could extract some domestic political capital from the initiation of trade hostilities. Trump’s base and plenty of business and other interest groups believe China has it coming and—after all—as Trump suggests, China has much more to lose from a trade war given its $350 billion trade surplus with the United States. Meanwhile, Xi’s difficulties righting the Chinese economy, which has been suffering its slowest growth in 25 years, threaten him and the party with a crisis of legitimacy.  Being able to blame domestic economic woes on protectionist or otherwise aggressive foreign policies would enable Xi to tap into a vast reservoir of Chinese nationalism, and would reduce the burdens of reform that confront him today.  But make no mistake: a trade war between the United States and China would have profoundly adverse consequences in both countries and—depending on its course—could devastate the global economy. So there’s that.

Fifth, there are a number of legitimate gripes about Chinese AND U.S. trade policies that can no longer go unresolved. Beijing and Washington have been tightening the vices on one another’s companies in a number of different ways, and in some cases violating established rules.  The focus of Trump’s criticism of China has been its currency policy, which has been a non-issue for nearly a decade.  As is often the case, the politics lags the economics, but Chinese suppression of the value of its currency is simply irrelevant (as an economic matter).  In fact, over the past two years, China has burned through $1 trillion of foreign reserves, purchasing Chinese renminbi on currency markets to prevent its value from depreciating further.

Among the list of potentially legitimate gripes made about Chinese policies are:

• Massive subsidization of industries
• Relatively high tariffs on goods imports and barriers to the provision of services by foreigners
• Widespread restrictions on foreign investment in a multitude of Chinese industries
• Forced transfer of technology imposed on foreign companies seeking to establish presence in China
• Indigenous innovation policies that grant preferences to companies that develop and register intellectual property in China
• Insufficient enforcement of intellectual property rights
• Barriers to digital trade, including web filtering and blocking, and restrictions on data flows and cloud computing
• The continued prominence of state-owned enterprises, which don’t face the same market constraints that private companies face
• Discriminatory application of China’s Anti-Monopoly law
• Scope for discriminatory application of China’s new Cybersecurity Law and National Security Law

Among the list of potentially legitimate gripes made about U.S. policies are:

• Continued discriminatory, non-market economy treatment of Chinese companies in U.S. antidumping cases
• Discriminatory application of the U.S. countervailing duty law, which punishes Chinese exporter (and U.S. importers) twice for the same alleged infraction
• Opaque and possibly discriminatory procedures at the U.S. Committee on Foreign Investment in the United States (CFIUS), which reviews and can block proposed acquisitions of U.S. companies by foreigners on grounds of threats to national security
• Proposed expansion of CFIUS’s remit to include an economic security element, a food security element, and to extend covered transactions beyond acquisitions to include green field investments
• The unofficial, but commercially consequential blacklisting of acquisitions by and products made by certain Chinese information and communication technology companies

Many of the complaints about Chinese policies could have been addressed through the Trans-Pacific Partnership had President Trump not withdrawn the United States from that agreement. In fact, the TPP offered the clearest path to compelling favorable changes in China’s economic policies because China would have seen most of its major trade partners join the TPP, and would have had no better alternative than to join itself.  That’s where the leverage (in the form of a carrot, not a stick) to compel China to play by the rules resided.  And, for now at least, that leverage is squandered.

So, absent any obvious remaining carrots, some in Washington and around the country are encouraging a more strident tack with China.  In today’s Washington Post, Rob Atkinson from the Information Technology and Innovation Foundation, calls for what looks like some form of international sanctions against China.  It seems a sure path to trade war.

A better idea, as articulated by my colleagues Simon Lester and Huan Zhu in this new paper, would be to launch bilateral trade negotiations to accomplish resolution of some or all of these issues in a very direct manner.  Simon and Huan argue:

If the United States wants to promote the liberalization of Chinese trade and investment policy, it needs to engage with China in a more positive way. To this end, it should sit down with China and negotiate a new economic relationship, one that goes beyond the terms of the WTO. In particular, the United States should initiate formal negotiations on a trade agreement with China. Negotiations of this kind will be a challenge, especially with a president who has been so critical of China. However, negotiations offer the best hope for addressing concerns about China’s economic policies and practices.

Of course, like all trade negotiations, this one would be politically difficult.  But considered against the alternatives, a bilateral trade deal is well worth serious consideration.