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Negotiating Out of the Trade War Trap

Apr 11 , 2018


On April 3, The Trump administration detailed plans for steep tariffs it will impose on some $50 billion of imports from China unless Beijing makes big trade and investment concessions soon, a broadside that represents the US’s most powerful challenge in decades to China’s economic practices.

Behind the stepped-up harsh trade actions, there are two arguments to support Trump’s trade war rhetoric. First, it’s a mistake to let China join the WTO. Second, China is the free rider of the WTO system.

The two arguments (actually misconceptions) traps the Trump administration in its own mindset. If we could prove the two arguments are wrong, the logical ground of Trump's trade war naturally collapses.

Before refuting the two misconceptions, I want to clarify something about the US trade deficit with China and its unemployment rate.

The US trade deficit with China includes the value that China makes and the parts made in other countries. If the US puts tariffs on finished products, rather than the added value, it’s obviously incorrect, even absurd. Tons of research done by US scholars and organizations have proved that the main factor behind US unemployment since the 1980s is the technological advancement. American workers’ jobs are being replaced by machines, not Chinese workers. Claiming China should be held responsible for the job decline in the manufacturing sector since 2001 is far-fetched. Such jobs have been declining since 1985. Between 1985 and 2001, the share of the labor force in the US manufacturing sector fell by 33%. Between 2001 and 2017, after China’s accession to the WTO, the share fell by 29%.

Furthermore, the US total trade deficit reflects the shortfall in saving by its households, companies, and government. The combined spending exceeds their income. The US saving rate was 3.4% in March 2018, the lowest since January 2008. Tariffs and quotas can bring trade into balance only if they somehow encourage saving or reduce investment.

The USTR argued in a report that the US had “erred in supporting China’s entry into the WTO on terms that have proven to be ineffective in securing China’s embrace of an open, market-oriented trade regime.” It’s wrong to judge historical events on the basis of the bad outcomes that followed. It was the best option at the time. To strengthen the US-led global trading system and win China’s support for President George W. Bush’s war on terror after the 9/11 attack in 2001, letting China join the WTO in 2001 after 15 years negotiation was the best policy. Most OECD countries supported China’s accession at the time. What's more, according to research done by Philip Levy, former Senior Economist for Trade for President George Bush’s Council of Economic Advisers and as a member of Secretary of State Condoleezza Rice’s Policy Planning Staff, the US benefited a lot from China’s accession to the WTO. In the wake of China’s WTO accession, US GDP per cpita, adjusted for inflation, grew from $44,400 in the fourth quarter of 2001 to $52,800 in the fourth quarter of 2017, an increase of roughly 19%. Over the same period, inflation-adjusted manufacturing sector output in the US rose by more than 15%.

As to the misconception of China as a free rider of the world economic system, the US itself is the true free rider.

The US set up current world institutions, but it lets other countries pay its dues. Before it withdrew from UNESCO, the US owed $542 million in dues from 2011. The US also owes the UN $896 million. More than that, the US refused to pay over 25% of UN peacekeeping costs in 2018.

Adam Posen, President of the Peterson Institute for International Economics, warns that the US has been given a pass on many responsibilities because it leads the system and other countries are willing to ignore a certain amount of hypocrisy. But at some point, if the US goes too far, from occasional free-riding to ostentatiously violating the rules, the US-led system will be imperiled.

Compared with the US, China is not a free rider, but a positive contributor. China is devoted to sharing its economic prosperity with the world. During the 1997 Asian Financial Crisis, China kept its foreign exchange rate stable. It brought huge costs for China itself, but prevented the crisis from escalating. During the 2008 Subprime crisis which began in the US, China ushered in a ¥4 trillion economic plan. China sacrificed its domestic demand to provide stimulus to the world economy. In 2010, China worked shoulder to shoulder with the US to carry out a UN peacekeeping mission appointed by the United Nations Stabilization Mission in Haiti. In 2014, China and the US cooperated closely on fighting Ebola in Africa. China and the US’s bilateral climate cooperation was crucial to the success of UN 2015 Paris Climate Conference. In order to keep free and safe sea trade in the Gulf of Aden, China participated in international anti-piracy operations off the Horn of Africa and the Somali coast in 2008. China has since sent more than 28 naval escort task forces there. China initiated The Belt and Road Initiative (BRI), the Asian Infrastructure Investment Bank (AIIB), and the Silk Road Foundation. The BRI launches trillion dollar Chinese-led investment programs to create a web of infrastructure, including roads, railways, telecommunications, energy pipelines, and ports. This would serve to enhance economic interconnectivity and facilitate development across Eurasia, East Africa, and more than 60 partner countries. The AIIB has now approved 24 loan projects totaling $4.2 billion to finance infrastructure in 12 member countries, including India, Oman, Indonesia and Bangladesh. The Silk Road Foundation has signed 17 programs, investing $7 billion since November 2014. Its investments in Pakistan's Carlot Hydropower, Russia's Yamal LNG, and Dubai’s Ha Xiang clean coal-fired power station are not only supporting local economic development but are conducive to local green and energy-saving emissions reduction. As for China’s contribution to the world, I can give a much longer list. All this proves China is very actively and positively involved in world affairs, and plays a very complementary role in the framework led by the US.

Now China and the US are “too big to fight each other”. The trade volume is much larger than the one between belligerents during the First World War. It is also very different from the situation between the US and the Soviet Union during the Cold War. Then the US and Soviet accounted for more than 50% of world GDP. But bilateral trade and people-to-people communications were limited. Nowadays the value chain formed by globalization has incorporated different companies from different countries. With each having a stake in others, a trade war is very harmful. Negotiation is the only way to get out of the trade war trap.

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