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The China-U.S. Trade War and Reformist Statism under Xi

Aug 11, 2021

After U.S. President Donald Trump began to levy tariffs and other trade restrictions on China in the first half of 2018, a tit-for-tat trade war rapidly escalated. Even once the “Phase One Trade Agreement’ was reached in January 2020, tensions between the two largest economies on earth persisted. Neither did a new administration in the White House deliver respite. After three years, there is no end in sight for the China-U.S. trade war. 

This was reflected at the recently concluded meetings between U.S. Deputy Secretary of State Wendy Sherman and Chinese Foreign Minister Wang Yi in Tianjin. Although it seemed to go better than when the two sides met last time in Alaska, no outcomes were announced except for combative statements. Overall relations between Beijing and Washington appear to be at an impasse. Both sides blame the other for the problems facing the relationship, indeed questioning each other’s global standing and sincerity. 

U.S.-China relations have thus descended into an ever more adversarial feedback loop with little end in sight. Is there a way out? Prospects certainly look dim, but perhaps better mutual understanding in certain issue areas could help. 

On the economic front, American analysts and diplomats are fond of arguing that the reasons for frictions lay with China’s model of development, especially a lurch towards greater state centrality under Xi Jinping. China hawks are fond of pointing out that Xi was never serious about economic reform. His policies are moving China backwards, introducing greater “command and control” over economic matters harking back to the Maoist era. Some have even suggested that China has been deceiving Washington since the 1980s, merely feigning intentions to liberate the economy and introduce market forces. 

In reality, China has undertaken massive efforts to liberalize and reform the economy since 1979. However, as Xi began to lead the Chinese Communist Party (CCP) in 2012, many of the easy liberalizing reforms had been completed, and China faced the pitfalls of the middle-income trap. Xi thus set out with a bold reform program that sought to give market forces the “decisive” role in allocating economic resources. 

A range of reforms were proposed, ranging from price liberalization and the reigning in of large state-owned monopolies to a slew of social reforms. This major reform push is best conceptualized by the “China 2030” report, a collaboration between the World Bank and the Development Research Center of the Chinese State Council. 

Evidently, far reaching economic reforms seemed high on the agenda as Xi ascended to power. However, many market liberalization moves were either only partially successful or ended in disappointment over subsequent years. A second and newer argument in American policy circles is therefore that Xi tried economic reform, but that each effort created a mini-crisis that prompted rapid retrenchment. According to this line of thought, Xi didn’t resist reform and was not intent on moving backwards in time to the centrally planned economy. Rather, Chinese policy makers attempted liberalization but retreated each time it got out of hand. This created a decade of failed reforms. 

Officially, Beijing has denied this, but there are plentiful examples of attempted liberalization followed by rapid retrenchment and assertion of state control. For example, in 2015 the People’s Bank of China attempted to create a more market-driven exchange rate for the yuan, leading to a devaluation of nearly three percentage points against the U.S. dollar in two days. This then created a sharp decline in the stock market and rapidly increasing capital outflows. To quell market panic the Chinese government imposed harsh capital controls, cracked down on margin-financing in equities, and spent nearly US$320 billion of its foreign currency reserves to support the yuan's value. 

Clearly, liberalization was followed by retrenchment and the assertion of greater state control. This narrative is certainly more convincing than the one asserting that Beijing was never sincere about economic reform. But it still misconstrues part of the dynamic. 

The need for continuous reform and adaptation has become deeply ingrained in the CCP’s thinking ever since Deng Xiaoping. And not just rhetorically. Reform efforts are continuing in various crucial areas, ranging from the residency permit system and social services to market pricing and, perhaps most prominently, finance. In fact, the last couple of years have seen a substantial opening of China’s financial sector with more market-driven dynamics, such as growing bond defaults and a repricing of risk. 

In this context, the recent clampdown on China’s internet giants, including finance and education tech companies, is often interpreted in the West as another effort by the CCP to assert its “control and command” economic ideology over what has become an increasingly free wheeling and powerful economic sector. This interpretation is not incorrect, but again leaves out the major rationale shaping Beijing’s economic reform philosophy. 

Although Beijing never fully bought into the laissez-faire economics so adamantly preached by Washington in the 1990s, key aspects of Chinese reform were deeply influenced by market liberalism. Much of what Chinese reformers did in the early years was to get the state and bureaucrats out of the way to give markets greater sway, while allowing private enterprise to grow. 

By the time Xi came to power, disillusionment with laissez-faire economics had become more pronounced due to the Global Financial Crisis of 2008. Nonetheless, many of Beijing’s economic policy-makers, including Xi’s economic lieutenant Liu He, a well-known proponent of marketization, had been educated in the West and thus continued to be deeply influenced by market liberalism. Difficult reforms of the financial system, however, showed that pure liberalization seldom worked. In fact, many of the failed reforms, such as yuan exchange rate and outward investment liberalization, failed not due to insufficient liberalization, but because liberalization was implemented without sufficient institutional safeguards and controls. 

Economic policy-makers in Beijing thus grew increasingly disenchanted with the mantra of simple market liberalization. They became convinced that for markets to work in the interests of society, the state had to step in. Though emphasis on state centrality in economic policy had never quite retreated, a new statism was born. Quite unlike that of the Maoist era, its single-minded focus is to reform the state and its role in the economy to undertake successful marketization and technology development. 

Nowhere is this clearer than in financial reform, an area Beijing is still struggling with due to very high debt, institutional dysfunction, and the continuation of speculative manias. Here the state has more forcefully inserted itself, ranging from regulatory blasts to more subtle influence over Big Tech and beyond. Nonetheless, reform continues. Perhaps the key aspect of financial opening, the capital account, is being relaxed in a controlled manner through market access programs such as the Bond Connect, Stock Connect, and Wealth Management Connect scheme with Hong Kong. 

This turn to increased state intervention and a statist philosophy of economic management is not only confined to China. In an ironic twist, both the Trump and Biden administrations see Washington playing a much more forceful role in the American economy, including in trade, technology development, industrial policy, and aggregate demand management. The new economic statism is well and alive, not only in Beijing, but in most Western capitals. Neo-liberal laissez-faire ideology, in contrast, is finding fewer and fewer adherents, especially among politicians. 

By recognizing this global shift towards a new statist economic philosophy, perhaps Washington and Beijing could stake out some common ground. Many of the policies Washington is proposing to counter Beijing, such as new industrial policy programs, are exactly what American policy-makers have chided Beijing for. An open, pragmatic, and less ideologically tainted understanding of the two economies could perhaps yield a foundation for more effective dialogue and even cooperation. Alas, with so many issue areas dividing the United States and China, the ever more adversarial tone characterizing the relationship is likely to continue. Hope is low for an open dialogue on how to manage economic competition and finally resolve the trade war.

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