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Beijing’s Economic Olive Branch

Apr 16 , 2018

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Chinese President Xi Jinping’s speech at the Boao Forum outlined ambitious moves to further open up China’s economy. Many of the initiatives mentioned were already announced during 2017 or have been in the works for months. Some have even been on the agenda for more than a decade, such as promises to strengthen China’s intellectual property rights protection regime. 

While Xi’s speech did not outline any particularly new or bold initiatives, policy makers in Washington, D.C. should take these market opening moves as the basis for negotiating an agreement. Holding out for a “moonshot” bargain that restructures China’s economy along the lines of American capitalism is delusional and will most likely result in a trade war with no winners.

In his Boao keynote speech, President Xi pledged to open China’s doors “wider and wider” to the world. Specific market opening measures announced include the liberalization of foreign ownership limits in the financial, aerospace, and automotive industries, lower tariffs on imported cars, and improved protection for intellectual property rights. Especially on intellectual property rights protection, one of the central targets of the United States’ Section 301 investigation, the Chinese government has been taking pro-active steps to restructure the State Intellectual Property Office to more effectively crack down on violations. As Xi noted in his televised address, China aims to protect the “legitimate” intellectual property rights of foreign firms. These moves naturally also reflect the fact that China has evolved from copying and counterfeiting goods into a leading holder of patents.

At no point in his remarks did Xi address potential U.S. trade actions, especially the tariffs on $150 billion of Chinese imports to the United States that President Trump has threatened. Rather, Chinese media described Xi’s promises as constituting the next step of Chinese economic reform, stressing that these steps were taken independently of any outside pressure according to China’s “own timetable and road.”

In the United States, on the other hand, Xi’s speech was clearly taken as an initial reaction to U.S. threats. President Trump tweeted that he was “very thankful” for the concessions made, while the Director of his National Economic Council, Larry Kudlow, saw Xi’s pronouncement as a positive first step, indicating that change is coming “sooner rather than later.”

But in no way is the U.S.-China trading relationship out of the woods. Elements of Trump’s economic team are still holding out for a “moonshot” agreement that would address a host of Chinese practices in fostering technology leadership while making the U.S.-China economic relationship fully “reciprocal.” One aim is to undermine China’s efforts to seize economic leadership in advanced technology, first and foremost the "Made in China 2025" blueprint to create an advanced manufacturing economy.

Issued in 2015, this blueprint calls for China to develop its own global competitors in fields from electric cars to aerospace and aviation equipment, solar and wind power, robotics, and information technology. While many countries have similar plans, including the Obama administration’s Advanced Manufacturing Partnership (AMP), officials in the Trump White House contend that China's tactics aim to subsidize local companies by shielding them from competition and pressuring foreign companies to hand over technology.

Besides the large bilateral deficit the United States incurs in its trade with China, one of President Trump’s pre-occupations, much of the present spat is determined by U.S. allegations that China is not playing fair and trying to dominate future leading technologies. The problem is that Chinese industrial policies have worked fairly well so far. A huge push into the production of solar panels, for example, was in part driven by a variety of central and local government supports. This created a “swarming” effect: Chinese entrepreneurs poured money into solar panel manufacturing that undercut global prices. After a painful shake-out of the sector over the past several years, China is now the most competitive producer of these panels, accounting for three quarters of global production. 

It is therefore highly unlikely that China will change major aspects of its industrial policy regime. Moreover, the differences between the Chinese and American political economies are such that full reciprocity in the economic relationship is at best a distant goal. Pressuring China into a grand deal that would force it to restructure key aspects of its economic governance, especially the central role that the Chinese state and state-owned enterprises play, is a dead end. It will result in a trade war that would exact enormous costs on both sides.

The Trump administration’s negotiating leverage vis-à-vis China is also not quite as large as some in the White House seem to believe. For sure, China exports much more to the United States than vice versa, making it more vulnerable to U.S. trade sanctions. But China has three major advantages: what it imports from the United States is concentrated in fewer sectors, allowing it to target politically sensitive sectors in the United States such as agriculture, petro-chemicals, and airplanes. Second, Trump cannot really afford the outbreak of a major trade war politically, with crucial mid-term elections coming up in late 2018. Xi Jinping faces much less immediate political pressure, though over time a grinding trade war could exact a political price for him as well.

Finally, the Chinese corporate footprint in the United States is much smaller than the other way around. As in the case of South Korea, China can easily target U.S. companies operating in the country unofficially. Since many U.S. corporations are quite dependent on China for revenue growth, a combination of targeted Chinese concessions benefitting U.S. corporations and pressure on these same corporations could set in motion a formidable coalition lobbying against an escalation of the trade spat. Initial signs point to this already unfolding.

As a consequence, the Trump administration’s best strategy is to take a win: the current round of pressure from the United States already forced China into making concrete commitments and concessions. Negotiations should further codify these concessions to build a mutually beneficial deal. In particular, strict implementation benchmarks could form part of U.S. demands, such as effective ways to improve the trade balance and measures to stop forced technology transfers by foreign investors in China.

Beyond such specific negotiated outcomes, holding out for a “moonshot” deal that constrains Chinese technology development and creates full reciprocity in U.S.-China economic relations borders on fantasy. The United States can aim to halt abusive Chinese practices and restrict its most harmful industrial policies, but no country will entertain a wholesale restructuring of its economy due to outside pressure. Hopefully, U.S. President Trump’s gratitude for Xi's "kind words on tariffs and automobile barriers ... also, his enlightenment on intellectual property and technology transfers” will remain steadfast in coming weeks and months.

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