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America’s strategic China blunder

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United States Trade Representative Robert Lighthizer with Chinese Vice Premier Liu He with Treasury Secretary Steven Mnuchin at the Xijiao Conference Center in Shanghai, China, 31 July 2019 (Photo: Reuters/Ng Han Guan/Pool).

In Brief

From tariffs and the blacklisting of Huawei to democracy and human rights concerns over Hong Kong and Xinjiang Province, the United States raised the heat on China to a boil. A so-called Phase I trade deal lowers the immediate threat of tariffs but doesn't end a deep-rooted structural conflict. Washington is caught in the grips of a ‘China deceit’ narrative, convinced that China has broken a solemn pledge made at the time of its WTO accession in late 2001 to mould itself in the image of the West.


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This narrative is at best patently naive or at worst an outright fabrication. There was literally nothing in China’s WTO accession protocols that guaranteed anything close to such a system-changing commitment. Yes, China has not lived up to all its WTO promises — especially regarding subsidies of state-owned enterprises. But to turn such complaints into a sense of intense moral outrage risks a policy blunder of epic proportions.

All this has an eerie sense of deja vu. Just as it did some 30 years ago with Japan, the United States is now blaming China for trade deficits of its own making. Nations suffering from a shortfall of domestic saving grow only if they run trade deficits in order to attract surplus foreign saving. Courtesy of the Reagan budget deficits which depressed US saving, the first half of the 1980s saw Japan accounting for 42 per cent of America’s mounting merchandise trade deficits.

Today, chronic post-crisis budget deficits, exacerbated by outsized Trump tax cuts, have led to an even more serious shortfall of domestic saving. This time, it’s China that has grabbed the lion’s share of America’s external imbalances — 47 per cent of the trade deficits over the past 6 years.

It is absurd to believe that a Phase I trade deal with China, which features a narrowing of the US–China bilateral trade imbalance, will fix this problem. Reflecting a net domestic saving rate of just 2.4 per cent of national income in 2018, the United States had merchandise trade deficits with 102 nations. There can be no bilateral China fix for America’s multilateral trade problem.

All that will occur is trade diversion — shifting the Chinese piece of the US trade deficit to others. Without addressing the saving problem — not exactly the outcome that falls out of the ominous US budget deficit trajectory projected by the Congressional Budget Office — Phase I will backfire because the trade diversion away from China will go to higher cost producers, effectively a tax on American consumers.

The US strategy toward Huawei is equally flawed. While hardly the perfect actor, Huawei has been vilified as the greatest threat to US national security since the KGB. But this conclusion is largely based on the presumption of intent taken from a surprisingly short list of serious transgressions — against Cisco (settled out of court in 2004), T-Mobile (2017) and alleged Iranian–North Korean sanctions violations (2018). For that, Huawei has been added to the dreaded ‘entity list’ that closes off its access to US markets and suppliers.

This approach underscores the strategic miscalculation of a decoupling from China. Blacklisting Huawei effectively untethers the company from the US sphere of influence, as both a source of demand as well as a choke point in its supply chain. That encourages further impetus to China’s push for self-sufficiency.

And that is exactly what is now happening.  Huawei’s latest smartphone, the Mate 30, was just released without any US components. China has reportedly ordered an outright ban of foreign computers and software from its government offices. These are unmistakable signs that China is capable of moving down the path of self-sufficiency much more quickly than conventional US wisdom believes. For the United States, that spells nothing short of a loss of control over a key aspect of its relationship with China.

There is a far better way for the United States to frame its China strategy. The goal should be aimed at engagement — not decoupling or containment — in order to provide incentives for cooperative behaviour and penalties for uncooperative behaviour. Three policy options would go a long way in that direction.

First, the United States should reverse its 2017 decision to opt out of the Trans-Pacific Partnership (TPP), a multilateral pan-Asian trade agreement. As an outsider, China would then have great incentive to join. That would require Chinese compliance with tough TPP standards on labour practices, environmental remediation, food safety, intellectual property rights and subsidies.

Second, the United States should restart negotiations on a bilateral investment treaty with China. Both nations would gain significantly by having fair and open access to the other’s markets. Significantly, providing US multinationals with direct access to the extraordinary growth potential of a consumer-led China would be a huge opportunity for US growth.

Third, both nations should commit to macroeconomic adjustments that would narrow their saving disparity and related trade imbalances. The United States needs to save more and that can only occur with a long-term reduction of its budget deficit. China needs to save less, using its surplus to fund the nation’s social safety net, which would temper insecurity and boost discretionary household consumption.

Yes, the US body politic has lost its patience with China and can hardly be expected to embrace such an agenda with open arms. But ultimately it boils down to a clear choice between a destructive and costly confrontation on the one hand and a tough but constructive engagement on the other. China now understands much better what is at stake if the conflict continues to deepen. Unfortunately, the United States is at the other end of the strategic engagement spectrum. That, too, could change. Presumably, that’s what presidential elections are all about.

Stephen S. Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China (Yale University Press, 2014).

This article is part of an EAF special feature series on 2019 in review and the year ahead.

3 responses to “America’s strategic China blunder”

  1. The last two sentences of this analysis are the most salient. There is no way the US is going to change its approach to its relationship to China as long as Trump is president. He has taken Reagan’s naïveté about economics in general and trade in particular to a whole other level off unreality. Trump’s arrogance means he will never acknowledge he is on the wrong track regarding China. Instead, he will bluster, threaten, and blame. The most recent ‘deal’ suggests that he realizes he needs to shift his actions leading up to the election in November. If he remains in office, he will double down and insist that ‘winning the trade war’ is both easy and in the best interests of the USA. Don’t bother him with the facts. He is absolutely sure he is right.

  2. Very good article. Stephen Roach has been magnificent in repeating the argument against the significance of trade deficits for trade policy – one can only conclcude that people who do not want to learn, cannot learn. His analysis of the ‘China deceit’ issue is spot on. In simple terms, the US is punishing China for things China has not done.
    But in the three recommendations, this article leaves out the important point that both the US and China need the WTO to discipine their conduct and the rest of the world need the WTO to discipline the conduct of both China and the USA.
    In addition, there is no mention in the article of the extent to which the US behaviour is being driven by protectionist interests in the USA, particularly the US steel and aluminium industries.
    For years these industries have received protection in the form of anti-dumping duties, and importantly inflated anti-dumping duties based on methods of calculation of very doubtful legality under WTO law. It is no coincidence that as the end of the 15 year implementation period on the anti-dumping provisions in China’s accession protocol came nearer, the US “China deceit” narrative gained in popularity as did the notion that the WTO Appellate BOdy had egregiously overstepped its authority. To that can be added the notion that the WTO is in need of drastic reform because the WTO rules cannot cope with China. That is wrong. There may be other arguments relating to digital trade that do warrant some additions to WTO rules but the existence of China’s state driven economy does not lead to a conclusion that WTO rules are inadequate.

    This paper needs a 4th recommendation that the rest of the US economy needs to tell the US steel and aluminium (and some other manufacturing industries) to pull their heads in (in the langauge of the paper, the US body politic needs to lose it patience with the US steel and similarly protectionist industries) The lobbying of the protectionist industries is causing damage to the US economy, to the world economy and to the world trading system. The US needs to shift its focus to its adjustment policies (largely the provision of public goods but also other policies like the severing of connections between employment and access to health insurance.)

    And a 5th recommendation, that all WTO Members should protect the integrity of the WTO rules and the WTO system. This includes working together to stamp out overzealous use of anti-dumping rules to inflate dumping margins and dumping duties. (The first WTO panel report on the concept of ‘particular market situation’ two weeks ago was a good step in the right direction.) And it includes giving priority to market access negotiations in order to reduce the margins of preference under bilateral and regional agreements. One cannot achieve or maintain a non-discriminatory trading system by giving priority to negotiations on subsidies and leaving market access to be driven through discriminatory agreements – to some extent the CPTPP and RCEP are part of the problem rather than part of the answer and it is critical that the WTO negotiations on market access keep moving to reduce the margins of discrimination under BRTOs.

    The world does need to respond to other aspects of China’s behaviour but the current US approach to the trade issues will make it harder not easier to achieve anything on the other legal and political issues.

  3. Very interesting and informative article, not a huge WTO brainiac myself – but i was intrigued by the following statement, on the Chinese Cyber warfare – “But this conclusion is largely based on the presumption of intent taken from a surprisingly short list of serious transgressions”. I am as Stephen Roach, totally surprised that not more evidence has been brought forward on the state and military sponsored industrial espionage conducted globally. There is no business, that I have been in contact with over the past 10 years, who has not been under attack, and I cannot understand that not more diplomatic pressure is directed towards putting an end to it. We all know who is behind the attacks and we even see some cases where Chinese spies are caught with the hand in the cookie jar. Still the west is helping China onwards, and even in my own country, Denmark, there is a tendency to now wanting a disturb the trade situation with these “minor” transgressions. We are not talking a small number of companies hit, some 65 per cent of German manufacturing and technology firms were hit by cyberattacks in 2016, compared with 62 per cent in the U.S. and 50 per cent in the U.K., according to insurer Hiscox Ltd.
    Even though US and China reached an agreement in 2015 that was supposed to curb state-sponsored cyber attacks on both sides.
    We still today see a huge number of attacks and it does not look like China is going to stop this policy before they have achieved the Chinese government’s “Made in China 2025” plan.

    But is the “free world” ready to take action and pressure China to start doing something about this criminal behavior.

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