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Anticipating Protectionist U.S. Policy: IP Theft and SOEs “Trump” Currency and the Trade Deficit

Jul 04 , 2016

It is not a good time for American supporters of trade and investment with China. For political reasons, protectionist steps by the U.S. may be unavoidable in 2017. In the name of “making China play fair,” trade barriers risk hurting ordinary Americans and offering little in the way of gains. It is important to recognize that some policies are more justified and less dangerous than others.

All Protectionism Has Costs

At its core, protectionism is interference with competition for the sole reason that the competition is foreign. For example, the Chinese government often treats foreign patents as anti-competitive, even while it encourages domestic patents at every opportunity. This is simple bias at the expense of its economic partners.

Protectionism stereotypically involves tariffs, such as recent and pending American decisions to apply new tariffs to certain steel product imports from China. Interfering with competition, foreign or domestic, always has a cost. In this case, domestic cars and buildings are made more expensive if the foreign steel is made more expensive.

While cost is unavoidable, protectionist policies can be designed to discourage or change predatory behavior while limiting damage to the home economy. However, the standard protectionist argument takes no note of this.  Instead, it is merely that “we” should make the products instead of buying from “them,” so we would have the jobs involved.

This entirely ignores the reasons for importing – availability, price, and quality. People and companies purchase imports because they are the best choices available. Taking away those choices can only make the home country buyers worse off. The result of that would be jobs disappearing. This is perhaps most obvious in the case of energy, but it applies to all imports.

A far better justification for tariffs is to encourage purely commercial competition. For instance, agriculture is heavily subsidized in a large number of countries. Ongoing subsidies make competition political in nature, rather than commercial, and destroy its benefits. The most committed governments win instead of the most committed and productive farmers.

Sanctioning specific producers receiving the heaviest subsidies is superior to sanctioning foreign goods across the board. It permits unrestricted imports from those have been less subsidized, followed market principles, and obeyed the law. Buyers of their imports can continue to benefit. Similarly, a trade barrier with a clear review process to remove the barrier provides an incentive for offending importers to change behavior.

Protecting Against China, Unwisely

It is a fair point that the American market has been too open to China. Nearly half the manufacturing job losses in the U.S. in the past generation occurred in the three years immediately after China secured admission to the World Trade Organization (WTO) in 2001. While this was partly coincidence – the dotcom bubble had popped– the jobs did not return. And Chinese manufacturing boomed.

The blow to traditional manufacturing could have been offset over time if China had genuinely opened its own market. Instead, a slew of sectors were reserved for state-owned enterprises (SOEs) even while China-based ventures were showered with incentives to export.

The American people and government cannot go back in time to delay or alter the terms of China’s WTO accession. Withdrawing from the WTO in order to punish China would be the worst kind of sweeping protectionism and thankfully is not being mentioned by major political figures.

But across-the-board tariffs are being mentioned and are also toxic. The calls began more than a decade ago mostly among Democrats and have this year been picked up by the Republican presidential nominee. Blanket tariffs are among the worst protectionist policies – they would punish all Chinese exporters for the actions of only some, and punish American buyers along the way.

The rationale for such an ugly step takes two forms – the U.S. runs a large trade deficit with China and China manipulates its currency. But protectionists cannot link either the trade deficit or the value of the RMB directly to American jobs. Instead they are forced to make assumptions about GDP, run simulations, or the like, while studiously avoiding the actual data.

The combined result is very weak evidence being used to support very strong action. Private Chinese firms receiving no subsidies would be included. With assembled consumer electronics and clothing as the main Chinese exports, poor Americans especially would see their budgets crimped. If the U.S. does turn toward protectionism, this particular turn must be avoided.

Protecting Against China, Wisely

If the trade deficit and the RMB’s value do not matter much, what does? The harm to the U.S. from the bilateral economic relationship stems from theft of intellectual property (IP) and the intense promotion of SOEs at the expense of foreign competitors. A crucial element of both practices is that, unlike with cheap Chinese imports, balancing benefits are sharply limited.

SOEs are not major exporters to the U.S. The massive regulatory support they receive is aimed primarily at keeping foreign goods out of China’s market, denying share to American exports. This is pure cost to the American side. The U.S. belatedly recognized the problem, demanding China document its subsidies at the WTO. The response has been unsatisfactory at best.

Comparatively sound protectionist practices require targeting and it is difficult to target SOEs as they would be largely uncompetitive without subsidies. The U.S. could mimic Beijing by designating strategic sectors analogous (not identical) to China’s. Chinese entities would see strictly limited trade and investment participation in these sectors. The danger is that the “strategic” list could be misused, as has occurred elsewhere.

Perhaps the best area for American action is IP. Global IP theft transfers often expensive technology from the developer to a foreign recipient, who then benefits competitively in its own market and internationally. The damage to developing firms is more fundamental in the case of the U.S. because innovation is the most pervasive American comparative advantage.

The most pervasive thief of American IP is China. Because IP theft strikes directly at the reason why trade is beneficial, it strongly encourages a U.S. backlash against China in particular. It also follows that focused American action that is legitimately aimed at deterring IP theft can encourage free trade more than erode it.

The U.S. has struggled recently to respond to IP theft because it is now primarily a cyber activity, and tracing cyber thieves is challenging. The legal aspect should be treated as secondary. The important commercial actor is not the thief but the IP recipient. And it has been possible to identify recipients in at least some cases.

Step 1: The ITC On U.S. Steel 

The next administration and Congress will do as they like. The International Trade Commission, however, is considering an accusation that China’s Baosteel has benefited from IP stolen from U.S. Steel. This follows the passage of bipartisan legislation, signed by President Obama, that strengthens the legal status of trade secrets. The ITC’s decision can set a valuable precedent.

The ITC should approve sanctions only if receipt of stolen IP is documented. They should be applied only to recipient Chinese firms, not the whole industry. There should be a review mechanism for guilty parties to later show improved behavior. But any sanctions should be powerful, both because they would be deserved and because they are an actually constructive channel for rising American protectionism.

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