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Trade War Reflects Both Sides’ Foot-dragging on Structural Reforms

May 16 , 2019
  • Zhang Yun

    Associate Professor, National Niigata University in Japan

Amid the abundance of analyses of and comments on the China-US trade war, we’ve heard endless strategic debates over whether the US has begun to engage in “all-round” containment of China. A cool-headed historical and comparative perspective will help us uncover the essence of the matter.

China and the US before the financial crisis

Ten years back, when China was developing rapidly, the main drivers of growth were sectors such as export-oriented manufacturing and real estate. As the “factory of the world,” it paid a tremendous environmental and social price for fast development. After the Chinese government proposed the idea of a “harmonious society” in 2004, Beijing explicitly advocated transforming China’s development model, with the emphasis of its development philosophy shifting from quantity to quality. The new development model aimed to avoid the “middle income trap.” This latter problem was particularly thorny, as only 13 of the 100 or so countries labeled as middle-income in 1960 had become high-income nations half a century later.

In this same decade, the US was also witnessing high growth, while “victories” in the wars in Iraq and Afghanistan not only consolidated US conviction in its own imperial identity, but also made all countries believe firmly they were living in a US-led unipolar world. Based on this belief, countries bought large quantities of US bonds and financial products which were deemed safe assets, rendering America’s government and financial institutions brimming with money — which further prompted the spread of dubious financial products such as subprime mortgages. Low fundraising costs led to expanding consumption, which in turn cul-minated in unprecedented US reliance on the financial industry, overconsumption, and low savings.

’08 crisis disrupts China’s planned structural reforms

The global financial crisis that broke out soon after the bankruptcy of Lehman Brothers Holdings in early 2008 put tremendous pressure on China, which was already determined to transform its growth model. In order to ease the shock from global economic stagnation, China started a $4 trillion stimulus package in early November 2008 that focused on large-scale public infrastructure construction, stimulating the dramatic expansion of productive capacity in such industries as iron and steel, building materials, and coal. Now the US government is criticizing China for state capitalism, overcapacity, and trade deficits — and, from a political and strategic vantage point, takes the Belt and Road Initiative as a symbol of China’s competition with the US for international dominance. Yet from the Chinese perspective, in the decade since 2008, China has not only protected its own economy but made enormous contributions to the global economic recovery, while more or less sacrificing its own structural reforms to help the global economy. Therefore, many unintended consequences arose from those emergency responses. Since China never sought trade deficits and overcapacity, it surely is unjustified to accuse China of intentionally of pursuing hegemony.

In October 2008, the Bush administration decided to put in $700 billion to help financial institutions, and issued large sums of bonds; China, for its part, reportedly bought $70 billion worth of US bonds that very month. From the Chinese standpoint, it offered a helping hand when the US was in dire financial trouble—now China finds itself being criticized by the US for doing so, which is certainly unfair.

Today is not the dawn of economic decoupling

Rhetoric about decoupling has reemerged since the beginning of the trade war, but it first gained salience following the economic crisis ten years ago, surrounding the notion of so-called Chinese economic self-reliance. But thanks to deepening globalization of the international production chain, the US economy has made a greater impact upon the Chinese market. Since the US carried out a very timely rescue of its own financial institutions, global confidence in the US system recovered rapidly. It was more cost-effective for China to buy US technologies than developing them on its own, and its export-driven economic model targeted at the US market has seen no fundamental change. Meanwhile, structural reforms in the US economy also saw little substantial headway.

Setback for bilateral investment agreement

The Chinese leadership, led by Xi Jinping, is keenly aware that the country’s reforms have entered what he calls the “deep-water zone,” which calls both for top-down responses, but also for proper handling of international pressure. After all, it is important to proceed with structural reforms together with the US — which is why China has strived hard to work out a bilateral investment agreement with America. The foremost benefit from a bilateral agreement is that China can take advantage of it to promote reforms at home as well as industrial upgrades.

At the end of the 1990s, China took advantage of WTO negotiations to press for domestic reforms, such as reorganizing its array of state-owned enterprises. Now reforms in China again are faced with strong internal resistance. A bilateral investment will provide a push for Chinese reformers to launch market-oriented reforms and help Chinese firms enter the US market. In order to realize China’s national goal, or “Chinese Dream,” it needs to get out of the “middle income trap.” Unlike in the WTO entry negotiations, which was essentially a process of the US making requests and China bargaining, the bilateral investment agreement (BIA) negotiations were quite different.

This time, China also made requests, asking the US to conduct corresponding reforms — thus China has assumed the same role the United States once played, as an external driver for reforms on the homefront. The truth is that the US faces similar resistance against reforms at home, and vested interests exert almost as much power as they do in China. The BIA will give both parties motivation and opportunity for reform.

Second, from a regional perspective, a BIA will further facilitate US participation in Asian economic integration. With a BIA, US firms may be able to take part in Belt and Road projects, China may be able to join the Trans-Pacific Partnership more quickly. Hopefully the previous pattern of China and the US each going its own way in regional economic participation will give way to integration.

Third, from a global perspective, a BIA will be conducive to improving international economic governance. The WTO offers a basic framework for international trade, but there is no higher-coverage mechanism in the field of investment. Should there be a China-US BIA, there would be legally binding rules to make sure investors from any nation will enjoy equal treatments with local peers, which would be a historic shift.

Unfortunately, however, owing to the inadequate leadership of the Obama administration and the subsequent rise of populism during the 2016 presidential election, the BIA has not been accomplished, and the two countries have been trapped in a trade war. That the ballast role of trade in China-US relations has not been updated in a timely way is an important cause of the trade war, the essence of which is stagnation of domestic reforms in both countries. Since decoupling is impossible, the two parties will ultimately have to establish a relationship that is conducive to reforms in both countries.

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