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China Needs to Change, But Trade War Isn’t the Answer

Jul 06 , 2018
  • Qin Xiao

    Member, Hong Kong Financial Services Development Council

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After taking office, US President Donald Trump branded China a strategic competitor. The change of direction enjoys bipartisan political as well as support from the business community. Under the new strategy, China-US economic relations have become tense and a furious trade war have started.

Limited trade war may become the normal state of affairs for some time to come. This is because of two basic facts. At the level of interests, trade imbalances, as a structural problem, will not be resolved soon and the prices the US has asked for are too high for the Chinese side to accept. At the level of rules, to make major readjustments to the institutional relationship between the government and the market, China still need a broader social consensus and stronger will to reform. On the other hand, with the level of mutual interdependence, the cost of breakup will be high, and both sides will try to avoid it. As such, it is more likely that the two sides will fight a protracted ‘war’ with talks on the side. The two largest economies and the world economy will suffer significantly, although it remains difficult to quantify the direct and indirect effects.

Tensions in economic relations is part and parcel of US policies to put America first, reverse globalization and abandon the WTO’s multilateral trade regime. Although most economies want to maintain the WTO system and launch negotiations on multilateral trade agreements, America’s arbitrary behavior has killed the process to restart the globalization process. The WTO seems to have a bleak future. The global geopolitical and trade situation will change correspondingly.

Commercial interests and trade rules are two primary dispute areas. The former involves the trade balance and market access. The gap in American and Chinese calculations of China’s trade surplus is as large as $100 billion. Points in dispute include the following: the Chinese deficit in the services trade is not included in American calculations; the Chinese surplus is an aggregate of global supply chain in which the proportion of added value for China is minimal; the surplus also includes exports to the US by American companies in China; the US restricts exports of hi-tech products to China. In other words, US deficit has been the result of industrial structures, production costs, and the global supply chain. Nonetheless, if trade imbalances persist in huge amounts, they certainly have a negative influence on the relevant countries’ economic relations and economic development and are thus unsustainable. It is reasonable and necessary for the two governments to intervene with appropriate measures such as voluntary export restrictions or quotas. To arrive at a feasible plan, the two sides should first determine a reasonable target for rebalancing as a complete balance of merchandise trade is unrealistic. Then they should identify the Chinese exports with regard to which the US has a significant deficit and the ability to substitute for. Measures to expand the varieties of imports from the US or readjust US export controls may also be considered. On this basis, a five-year schedule and roadmap may be produced with a view to find a new balancing point.

On the question of market access, the US has abandoned the WTO’s differentiation between developed and less developed economies and proposed equal reciprocity instead. This is obviously unreasonable. If the US proposition is taken as a rule, it will be impossible for developed economies as represented by the US to sustain existing economic relations with any less developed counterpart. Admittedly, China’s level of development is quite different from it was when it joined the WTO and conditions of market access promised then should indeed be readjusted. Gradually opening wider to the outside world is needed for China’s own economic development and is a set policy. The two sides only need agree on the level and speed of opening.

The question of trade rules manifests in the clashes between China’s government-level model of economic development and free markets in the US and elsewhere. In the view of the US, the Chinese model disrupts the market price system and the fair competition principle with state-owned enterprises implementing national strategies and enjoying fiscal subsidies and various preferential treatments, foreign companies required to transfer technologies in exchange for market access, and non-market institutional arrangements such as administrative review, approval, and monopoly. Besides, the state of IPR protection, judicial independence and impartiality, labor rights protection, and environmental protection all impact foreign capital’s rights and interests in China and need improvement.

China started the transition from a planned economy to a market economy in the late 1980s. It was natural to exercise authority where the rule of law did not exist, to use a visible hand to cultivate the invisible hand, and place economic growth above equity. History has proven that that the model was reasonable to a certain extent but its endogenous problems create traps, such as growth of rent seeking and corrupt interest groups, price distortions and resource misallocation and substitution of authoritarianism for the rule of law. It has therefore always been questioned and criticized in China. As the Chinese economy becomes larger and more international, the externalities of the Chinese mode have challenged the international market. While assessing the Chinese model, I believe it necessary to de-ideologize, and draw upon the lessons of East Asia. China should carry out necessary readjustments and reforms on the basis of the judgment made at the 3rd Plenum of the 18th CPC Central Committee that ‘the market is the decisive factor in resource allocation’ so that its model of economic development will not only suit China’s national conditions but also be accommodated in the international economic order.

Trade conflicts between China and the US involve high stakes and should be properly handled. The two sides should first of all prevent their confrontation from spilling over into non-economic fields such as politics, military, culture, science and technology, as well as personnel exchanges. Then, on disputed issues such as the trade imbalance, market access, and institutional setup, they should try and find a constructive and reasonable balancing point. Additionally, China also needs to advance its own structural reform, readjust relations between the government and the market, and reshape its model of economic development.

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