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Trade: Parade of Broken Promises

The trade war between the United States and China has not given either side much to cheer about. As of January, Washington has levied 10 percent tariffs on U.S.$250 billion in Chinese goods, and China has reciprocated with similar tariffs on U.S.$110 billion in U.S. goods. In the United States, the uncertainty over the future trade relationship has caused significant volatility in the stock market, created hardship for American exporters (particularly farmers and high-end manufacturers), and contributed to a dramatic drop in Chinese tourism and investment into the United States. At the same time, for China, the trade war has exacerbated the fallout from an already slowing economy. Shanghai was the world’s worst performing major stock market in 2018, losing more than one-quarter of its value; China’s much-vaunted tech sector is laying off workers; and consumer confidence is plummeting.

The proximate cause of the current trade war is certainly U.S. President Donald Trump. By the time he entered office, Trump had amassed a significant record of tweets, writings, and speeches in which he criticized China for not playing by the rules. In his 2015 book, Great Again: How to Fix Our Crippled America, he noted, “There are people who wish I wouldn’t refer to China as our enemy. But that’s exactly what they are. They have destroyed entire industries by utilizing low-wage workers, cost us tens of thousands of jobs, spied on our businesses, stolen our technology, and have manipulated and devalued their currency which makes importing our goods more expensive—and sometimes impossible.” And as a presidential candidate, he promised to fix China’s “longtime abuse of the broken international system and unfair practices.” He and his trade team began their tenure determined to reduce the bilateral trade deficit, push China to advance structural economic reform to create a more level playing field for U.S. firms, and tackle the thorny issues of intellectual property rights (IPR) protection and cyber espionage. When traditional diplomacy and trade negotiations fell short, the President launched the first round of tariffs in July 2018, precipitating a tit-for-tat series of tariffs over the next several months. (The Trump Administration had also previously imposed separate tariffs on steel and aluminum as well as on Chinese washing machines and solar panels.)

Yet the trade war signifies far more than President Trump’s desire to rebalance the bilateral trade deficit. It represents the culmination of decades of pent-up frustration within the United States over China’s failure to make good on the promise of its 2001 accession to the World Trade Organization (WTO): to open its markets, develop transparency and the rule of law within its trade regime, and protect intellectual property (IP). Notwithstanding the skyrocketing level of bilateral trade and the successes of some individual U.S. companies, many U.S. administrations have come to understand the U.S.-China trade relationship as a succession of broken promises. The trade war also reflects Chinese President Xi Jinping’s failure to follow through on his early promise of economic reform; during his first six years in office, his initiatives instead signaled a shift away from greater openness and from free and fair competition. And finally, the trade war represents a move toward at least a partial decoupling of the two economies as part of a much larger geostrategic competition, primarily between the United States and China but also more broadly between two models of development.

Promises Made, Promises Broken

The U.S.-China trade story is not a one-sided tale of woe. Over the past 40 years, trade between the two countries has grown rapidly. China is the United States’ third largest export market, and U.S. goods exports to China jumped 106 percent during 2007-2017, while exports to the rest of the world increased only 35 percent. Exports from the United States to China support more than 1.8 million jobs in the United States. And for some states, China is the land of opportunity: For example, almost 25 percent of Washington state exports go to China. According to the U.S.-China Business Council, U.S. consumer prices at an aggregate level are 1-1.5 percent lower because of less expensive Chinese goods. And American brands such as Apple, Coca-Cola, and Nike have become household names throughout China.

At the same time, the U.S.-China trade relationship has never been an easy one. Even when American companies thrived, their success would often have been even greater had the playing field been even. Over time, the failure of Chinese leaders to level this playing field has produced a sense of profound disappointment and frustration. Most of the concerns highlighted by the Trump Administration, such as market and nonmarket barriers to entry, IP theft, subsidies, and coerced technology transfer have been sources of contention for decades. Negotiations for China to join the World Trade Organization (originally the General Agreement on Tariffs and Trade) began in 1986 and took 15 years to conclude. Throughout the negotiation period, the United States complained frequently and loudly that China used tariff and nontariff barriers to keep its markets closed to U.S. products. As early as 1991, the United States indicated that it was prepared to levy U.S.$3.9 billion in trade sanctions against China unless Beijing addressed Washington’s concerns around market access and transparency in its trade regime. Intellectual property also emerged as an early source of conflict. In 1994, the United States designated China a Special 301 priority foreign country (the worst designation a country can receive from the U.S. trade representative) due to its failure to enforce intellectual property rights law, particularly involving pirated compact and laser disks, and subsequently published a list of Chinese products subject to 100 percent import tariffs, such as small electronics and silk garments. The two sides reached accommodation with a pledge from China to improve its IPR enforcement regime and remove barriers to IPR-related products. Yet within a year, the United States was back at the table, with additional complaints about IP violations.

China’s accession to the WTO in 2001 and the U.S.-China bilateral agreement in support of that accession marked a high point in the trade relationship. China undertook a number of important changes in its trade regime, such as cutting average tariffs for various U.S. industrial, information technology, and agricultural products. China also promised to open its services sector, including telecommunications, insurance, banking, securities, and professional services to U.S. firms, and to eliminate government rules requiring technology transfer and local content. In addition, Chinese President Jiang Zemin and Premier Zhu Rongji appeared deeply committed to market-based reform—moving aggressively to reduce the role of state-owned enterprises (SOEs) in important sectors of the economy. Yet the glow of China’s successful accession faded quickly. In December 2002, almost immediately after China’s entry into the WTO, the United States asserted that China had not fully complied with its commitments on agriculture, services, IPR protection, and transparency of trade laws and regulations.

By most accounts, progress in realizing China’s economic opening over the past few decades has been halting and often disappointing. Organizations such as the U.S.-China Business Council and the U.S.-China Chamber of Commerce publish annual surveys of their members, seeking their views on specific areas of Chinese business practice. These reports have noted important progress in some areas, such as the time it takes to get a business permit. Yet by many other metrics, such as reducing tariff and nontariff barriers, eliminating coerced technology transfer, and reducing and eliminating subsidies to SOEs and local content requirements, China has failed to make the expected advances, creating a permanently unfair playing field for U.S. and other foreign companies. And the financial cost to American companies can be significant. According to a U.S. government-sponsored report, in 2017, theft of intellectual property by Chinese actors alone cost the U.S. economy as much as U.S.$600 billion.

Still, within the framework of an “engagement” policy, the United States has approached its trade relationship with China believing that as China developed economically, it would adopt more attributes of a market economy: rule of law, transparency, free competition among private enterprise, and prices that are determined by supply and demand. Moreover, there was an understanding that Beijing would strengthen its enforcement of economic and trade laws around issues such as IPR. When problems arose, the United States primarily worked through the World Trade Organization’s dispute mechanism, and sought support from other countries facing similar challenges with Chinese trade practices. Washington and Beijing also initiated a system of high-level dialogues to try to make progress on larger issues of trade and investment. In the mid-2000s, the United States and China established the Strategic Economic Dialogue to discuss major economic issues at the highest official level; the first meeting was held in 2006. This dialogue has continued in one form or another through each of the subsequent administrations, rebranded as the U.S.-China Strategic and Economic Dialogue during the Obama Administration and the Comprehensive Economic Dialogue under the Trump Administration. The dialogues resulted in a few notable achievements: a bilateral tourism promotion agreement, a bilateral air services deal that more than doubled nonstop routes between the two countries in 2014, and a 2015 agreement by China not to intervene in exchange markets except under “disorderly market conditions,” such as periods of sharp investor pullback. Over time, however, the dialogues became known less for concrete accomplishments and more as opportunities for senior leaders to understand better the views and policies of the other side and to impress upon their counterparts their concerns.

The Game Changers

The traditional dynamics of the U.S.-China trade relationship changed dramatically with the selection of Xi Jinping as General Secretary of the Communist Party in October 2012 (and then President in March 2013), and the election of U.S. President Donald Trump in November 2016. Each has played a critical role: While Trump initiated the tariff war, Xi created the business environment in China that provided support in the United States for Trump’s change in approach.

Despite his rhetoric in support of economic reform and globalization, during his first six years in power, President Xi rejected efforts by actors both in and outside China to advance the process of economic reform and opening up. Instead, he systematically sought to strengthen the role of the Communist Party and state in the Chinese economy. Most notably, he enhanced, rather than diminished, the role of SOEs in the Chinese economy. He called for the Communist Party to play a far more active role in decision-making processes not only in SOEs but also in private Chinese companies and even joint ventures. His signature domestic economic policy, “Made in China 2025,” is a 10-year industrial program designed to ensure that Chinese companies control as much as 80 percent of the domestic market in 10 areas of cutting-edge technology manufacturing, including electric vehicles, artificial intelligence, and new materials. And his grand-scale Belt and Road Initiative to connect China to the rest of the world through both hard and digital infrastructure also privileges Chinese companies. New laws on information control—both in terms of Internet content and data localization requirements—further undermine the competitiveness of multinationals. Overall, Xi’s policies have signaled a significant reversal rather than acceleration in China’s economic reform effort. As a result, the policy and business communities in the United States—as well as those of other advanced economies—are no longer confident that it is simply a matter of time until China develops more fully the attributes of a market economy. And given the size and strength of the Chinese economy, many argue that the economic stakes are too high to continue to wait.

In the United States, Trump’s inflammatory rhetoric, chaotic policymaking approach, and get tough strategy also introduced a starkly different tone. While the President initially adopted many of the same approaches to the trade relationship as his predecessors—establishing a Comprehensive Economic Dialogue, engaging in high-level summitry with Xi, and advancing a 100-day action plan to earn some early wins—he quickly lost patience with diplomatic efforts when they failed to yield significant change. He also saw little value in multilateral arrangements and organizations, such as the WTO, and withdrew the United States from the high-end Asia Pacific trade agreement, the Trans-Pacific Partnership (now called the Comprehensive and Progressive Agreement for Trans-Pacific Partnership) at its final stages of negotiation. Instead, Trump sought to pressure China to reform through the implementation of tariffs on Chinese exports, particularly those products tied to Xi’s “Made in China 2025” program.

The significance of the trade war, however, now extends well beyond the economic relationship. Trade has become a proxy for a much larger competition between the United States and China for global leadership. Both in China and the United States, officials and analysts view Xi Jinping’s desire for the “Great Rejuvenation of the Chinese Nation” and Donald Trump’s effort to “Make America Great Again” as incompatible enterprises. Growing numbers of elites in both countries now evidence a zero-sum mentality when considering the U.S.-China relationship, and trade is entwined more directly than ever with issues of national security and political values.

Of course, the U.S.-China trade relationship has never been entirely devoid of broader political and security considerations. The 1989 Tiananmen Square massacre led the United States, along with several other countries, to adopt a range of trade-related sanctions, such as on sales of military technology and equipment, some of which remain in force today. China, for its part, in 2010, imposed sanctions on U.S. companies that sold arms to Taiwan, and in 2014, ordered Chinese SOEs to sever their relations with U.S. consulting firms, on the grounds that these firms were spying on China.

Yet the current period is marked by two significant differences from any previous time in the bilateral relationship. First, Chinese intentions and capabilities have changed. Xi’s desire to rejuvenate the great Chinese nation is not simply about the continued transformation of China into an economic powerhouse. It includes four ambitious goals: realizing sovereignty claims in the South China Sea, Hong Kong, and eventually Taiwan; replacing the United States as the dominant power in the Asia Pacific; shaping the system of global governance on issues such as human rights and Internet sovereignty in ways that conflict with U.S. values and priorities; and serving as an alternative model to market democracies for still developing countries.

And second, in response to Xi’s initiatives, the United States now considers China a strategic competitor. As one of China’s own leading scholars of U.S.-China relations, Wang Jisi, commented in an October 2018 interview: “[F]or over 200 years, the United States has never changed its strategic goals for its relationship with China: free flow of goods and capital, and free flow of information and values. Chinese have always had reservations or imposed boycotts to oppose these two goals. We should criticize and have reason to criticize the United States, but we should realize that China’s own actions have changed Sino-U.S. relations and U.S. perceptions of China.” He also explained: “If we are looking for the cause, it was the change in Chinese policy that led to adjustments in US policy towards China.” U.S. policy has changed because China changed.

Trump Administration officials view the current situation in China as evidence of both a failure in the longstanding policy of engagement and a threat to U.S. economic, security, and political interests. Officials in the Trump White House, several of whom were already predisposed to consider China a significant threat to U.S. interests, have labeled China a strategic competitor on par with, or even greater than, Russia. In his October 2018 speech on China, Vice President Mike Pence stated that “China has chosen economic aggression which has in turn emboldened its growing military,” and he portrayed China as adopting a “whole-of-government” approach to compete with and undermine the United States. The United States is putting in place protective barriers designed to prevent China from accessing advanced U.S. technology: tightening up the regulations governing foreign investment in the United States, strengthening export controls on advanced technology, and exploring ways to limit Chinese students and researchers’ exposure to U.S. labs involved in advanced technology.

The United States is not alone in its growing concerns over Chinese behavior. Many other advanced economies support the U.S. effort to address China’s unfair trade practices, and are adopting similar policies around investment screening. In September 2018 and then again in January 2019, the chief trade negotiators from the United States, the European Union, and Japan issued joint statements criticizing nonmarket practices by other countries that created overcapacity and unfair competition, and pledging to cooperate to combat such practices. As one EU trade official noted, “We are totally willing to work with the United States to tackle China’s unfair trade practices, and we have started this work.”

The White House is also taking the dramatic step of trying to reorient supply chains away from China, particularly those that involve technologies related to national security, and is encouraging U.S. allies to reject purchasing Chinese technology for use in their critical infrastructure. Many observers have cited this move as the beginning of a larger effort to decouple the two economies. Xi Jinping himself acknowledged China’s own effort in this regard, stating, “In the next step of tackling technology, we must cast aside illusions and rely on ourselves.”

The U.S. emphasis on protecting critical technologies has led some Chinese scholars and analysts to argue that the trade war is, in fact, little more than an attempt to contain China and prevent it from surpassing the United States technologically. For example, President Trump’s initial decision to sanction a leading Chinese technology company, ZTE, by forbidding it to buy parts from U.S. companies was widely viewed as an effort to eliminate one of China’s strongest technology competitors. Canada’s detention of Huawei CFO Meng Wanzhou on charges of violating U.S. sanctions on Iran in the summer of 2018, at the behest of the United States, is similarly reported in China as an effort to undermine the success of one of China’s national technology champions. The resolution of the ZTE case, in which President Trump reversed the penalty, by tweeting “President Xi of China, and I, are working together to give massive Chinese phone company, ZTE, a way to get back into business, fast. Too many jobs in China lost. Commerce Department has been instructed to get it done!” suggests that the motivation behind the U.S. penalty was not, in fact, to cripple ZTE.

Conclusion

The U.S.-China trade war has already produced a near-term set of winners and losers. The United States and China are both losers: According to one U.S. economist, just the first six months of the trade war in 2018 cost each country almost U.S.$3 billion in the agricultural, technology, and auto sectors. Firms in some other countries are the winners. Malaysian and Japanese companies, for example, have benefited from import substitution, while Cambodia and Vietnam are becoming the destination of choice for U.S. and other multinationals looking to move some manufacturing out of China. Brazilian soybean growers were among the largest winners: Their exports to China jumped more than 130 percent in 2018 compared to the five-year average.

Over the longer term, it is plausible that the trade war will, in fact, accomplish at least some of its objectives. It may spur China to move forward on structural economic reform. Within China, some reform economists and entrepreneurs have quietly welcomed the U.S. pressure and are attempting to use it, as well as the slowing growth in China, to advance reform initiatives that have stalled under Xi’s more statist approach, such as enhancing the role of the market and advancing the rule of law.

Efforts to reorient technology supply chains may also bear fruit, and some manufacturing capacity may even shift from China to the United States. However, this process of “decoupling” will not be without significant costs. Forcing other countries to choose a particular set of U.S.- or China-sponsored systems will increase inefficiencies and limit prospects for global free trade and investment. Ultimately, the Trump Administration may precipitate the creation of what former U.S. Secretary of Treasury Hank Paulson has termed an “economic iron curtain.”

Even if the genuinely “trade” elements of the trade war are peacefully resolved, the deeper challenge remains. As commentator Kenneth Rapoza put it, “The trade war is not just about manufacturing jobs. It’s the final battle between communism and capitalism.” The Chinese scholar Wang Jisi agrees in part, noting that the clash between the United States and China is a civilizational one. He argues, “We should pay adequate attention to the trend that the two countries are drifting apart over our value systems and try to contain political differences by deepening reform and opening up.” Success in preventing the trade war from hardening into a new Cold War or even kinetic conflict may depend on both sides following his wise words.