The escalated tensions between the U.S. and China are raising concerns about a potential trade war. In my last editorial, I talked about how our official trade deficit figures with China are grossly inaccurate, and yet those same numbers were cited by officials during bilateral trade talks in July, which resulted in few agreements. Now President Donald Trump has instructed his top trade advisor to launch an investigation into Chinese intellectual property (IP) violations that could result in severe penalties. China says it will defend its interests if the U.S. hurts trade ties. Should the situation come to a head and descend into a trade war, the Peterson Institute predicted that it would ripple through the American economy, lowering private-sector employment by nearly 4 percent by 2019.
All of this bellicose posturing is not only unnecessary, but dangerous for both economies. The fact is that the business relationship between the U.S. and China is vibrant and mutually beneficial, for the most part. American companies are reporting strong second-quarter earnings and revenues from their Chinese operations. Trade with China has created millions of jobs in the U.S. and provided savings for American consumers.
That said, there are real issues of contention in the relationship, and those have to be addressed in a clear, persistent and reasoned fashion. To bring the entire relationship to the brink is not only irresponsible, but self-destructive.
Theft has no boundaries
Ironically, Trump’s calls for an investigation into intellectual property come at a time when President Xi Jinping is in the midst of strengthening laws on patents, copyrights, and trademarks, because China increasingly recognizes that someday it could become a leader in those technologies and become victims of IP theft. In 2015, more than a million patent applications were filed in China, and the government has created three specialized courts to handle IP disputes in Beijing, Shanghai and Guangzhou. Since their creation, these courts alone have heard more than 30,000 cases. In a landmark case in April, New Balance successfully sued Chinese companies for using its logo. In another high profile case, China’s highest court granted Michael Jordan the rights to Chinese characters of his name.
China is more motivated than ever to crack down on piracy, and there’s no better time for the Trump administration to negotiate proactively with the Chinese government on IP issues to secure benefits for U.S. companies without throwing the whole relationship into chaos.
Ignore the headline deficit, focus on the real problems
In my last editorial, I argued that the obsession with our headline trade balance with China is problematic. The bilateral trade deficit with China is overstated because the full value of products assembled in China for export to the U.S. is pinned to China, even though most products contain parts made in other countries. The iPhone is a great example. Also, the distorted deficit figures ignore the trade in services, in which the U.S. runs a significant and growing surplus.
Much of China’s trade prowess over the past decades has been rooted in comparative advantage, including low-cost labor and economies of scale in manufacturing. However, in recent years, trade patterns have been shaped by interventions that tilt the balance by boosting Chinese exports and hampering U.S. imports in ways efficient markets would not. Policymakers should focus their efforts on addressing these substantive non-market interventions.
Chinese manufacturing overcapacity
Policies that fuel the build-up of massive overcapacity in the Chinese manufacturing sector are more concerning. Some of these do not impinge on U.S. interests because the U.S. is not competitive in them, but some do, impacting U.S. exports to China and to third world countries, or even the market shares of U.S. firms at home.
The most prominent example is steel. China does not have a comparative advantage in the production of steel, but government-driven policies have incentivized producers to build up massive production capacity. China’s steel production has grown from 129 million metric tons in 2000 to 808 million metric tons in 2016. China’s trade balance in iron and steel moved from a deficit of $6 billion in 2000 to a surplus of $26 billion in 2016, and these products are offloaded in global markets.
This is problematic and must be addressed. China’s leadership is well aware of this challenge and has been dealing with overcapacity issues as part of the country’s structural reform. Even though Chinese export of steel products is down 25.7 percent from a year ago, progress has been much lower than expectations, and the pace needs to accelerate.
More importantly, steel is not an isolated case. The same overcapacity extends to other sectors in China. In certain industries, Chinese production of goods are below a normal utilization rate of around 80 percent, including products in which U.S. companies have an interest in the Chinese and global market, such as motor vehicles and refrigerators. The U.S. and other trade partners are rightly concerned about spillover impacts from Chinese overcapacity, and should continue to push this issue as a high-priority item in the U.S.-China Comprehensive Economic Dialogue going forward.
Figure 1: Capacity Utilization in China, Selected Industries, 2015
Lifting barriers to U.S. exporters
I am pleased to see substantive results from negotiations and the export of U.S. beef and rice into China, and both sides should build on these successes. China has shown that it can work with the U.S. to lower trade barriers, and this is an opportunity to move forward, not backward.
The U.S. should also lower some of its barriers that prevent U.S. firms from exporting goods to China. The United States strictly controls the export of goods to China that are determined to have military dual-use. However, this export control system has not been updated to reflect modern developments in global trade and technology. Present regulations are so all-encompassing that even items that have only peripheral military application or that are easily obtainable from other sources—like aircraft toilets, SIM cards, and industrial engines—require special export licenses to sell to Chinese buyers. Given the realities of Chinese technological development and the ready access to many goods from other nations, the U.S. administration should review whether these restrictions are meaningful, and whether they end up hurting U.S. businesses. Chinese Vice Premier Wang Yang says China imported $227 billion worth of semi-conductor chips from around the world, but only 4 percent came from the United States because of U.S. export barriers. The Carnegie Endowment for International Peace estimated that if the United States were to liberalize its export barriers against China to the same level that it applies to Brazil or France, the U.S. trade deficit with China would drop dramatically.
In addition, new policies restricting market access on the grounds of national security exacerbate the problem. In the United States, Congress is currently working on reforming the Committee on Foreign Investment in the United States (CFIUS), which reviews inbound investments for security concerns. Lawmakers intend to broaden the scope of security-relevant transactions requiring CFIUS approval, particularly those involving Chinese buyers. Currently, Alibaba’s acquisition of MoneyGram, which allows people to send money to each other in more than 200 countries, is on hold, pending CFIUS review.
China has likewise had a formal security screening process for foreign acquisitions since 2011, and recent Chinese policies suggest greater restrictions on imported foreign goods and services in security-relevant areas. For example, China’s 2017 Cyber Security Law requires information and communications technology (ICT) infrastructure to be “secure and controllable.” In other words, made or located in China.
The lack of transparency of these security processes in both countries is frustrating for companies trying to do business. While security concerns are a legitimate reason to restrict free trade, it is critical that officials find ways to minimize the negative impacts of security-related policies and prevent the loss of substantial benefits that stem from cross-border trade and collaboration.
The United States and China are closer to each other than they think, and they are missing out on an opportunity to reform the bilateral trade relationship by focusing on productive solutions to real problems. The first order of business is to correct the distorted trade numbers so we can assess the real issues behind the trade imbalance. Measured actions must be taken to pressure China into increasing IP enforcement and reducing overcapacity in Chinese manufacturing sectors. Also, the U.S. must remove outdated or illogical barriers that hinder U.S. companies from exporting products to China. Both governments must also increase transparency in national security screening processes. In the final editorial of this series, I will explore in more detail the most productive ways that policymakers in the U.S. and China can move forward together to create win-win scenarios and avoid an unnecessary trade war. Coming soon.
The article first appeared on Eastwest Bank website. To reach further click here.