Trump’s Trade Strategy Needs A Coalition To Deny China’s Graduation To A WTO ‘Market Economy’

U.S. President Trump

By Harry G. Broadman 

April 9, 2018

Trump’s tariff threats with Beijing ignore the 1.3-billion-ton ‘Gorilla in the Room’: China hasn’t lived up to it most fundamental commitments made in 2001 when the country sought and was granted accession to the WTO. It’s time for a U.S.-led coalition to challenge China frontally on this. 

President Donald Trump and his U.S. Trade Representative, Robert Lighthizer, are more than correct that the Chinese do not abide by fair, systematic, transparent and market-based rules for global trade. But the tit-for-tat approach the White House is currently taking to create disincentives to try to alter China’s behavior—centered on applying higher and higher and more expansive tariffs to Chinese exports to the U.S.—is not only self-defeating, it is actually aimed at a largely irrelevant facet of the real and far deeper problem at hand.

Beijing has not fully effectuated the changes in its domestic governing economic institutions—what we economists call ‘behind-the-border’ reforms—it agreed with the world trading community 17 years ago it would institute. Simply put, Mr. Trump and his economic team are ignoring the proverbial 1.3-billion-ton ‘Gorilla in the Room’:  China has not lived up to some of the most important commitments made in 2001 when the country’s leadership sought and was granted, accession to the World Trade Organization (WTO).

At the same time, Mr. Trump’s insistence on handling China in a U.S. ‘go-it-alone’ manner is just plain wrong-headed.  Rather than using the ‘power of collective action’ and building a coalition of other major trading powers—many of whom like the U.S. have been exposed to China conducting trade inconsistent with prevailing norms—Mr. Trump’s efforts will have him falling flat on his face.

Yes, although so far Mr. Trump is engaging in his classic blustering, bluffing negotiation style—you’d think we’d all catch on by now—the dustup he has generated is causing serious economic dislocation on the ground in China and the U.S.  More pernicious is the extensive rotting out of the credibility of the U.S. on the world economic stage.

It is regrettable that without making sufficient progress in its WTO-committed reforms—not just passing laws or promulgating regulations but implementing and enforcing them, China cannot credibly be treated as a ‘market economy’ under WTO rules.  But beyond continuing to formally deny China’s aspired graduation to ‘market economy status’—about which the E.U. has been forthright and Ambassador Lighthizer testified in support of last year—a fundamental alteration of the treatment of China within the WTO framework is what’s needed if the WTO is to have any further meaning and survive. It’s finally time to call a spade a spade.

Many of us veteran China watchers have warned about this for years.  And, I am one who believes Beijing has put in place serious and substantial reforms since 1978. Indeed, the country’s method of reforming—based on incremental experimentation both to iron-out components that don’t achieve the intended outcomes and build public support for moving forward—is truly innovative. It’s a process from which the U.S. (among other advanced nations) can surely learn.

But as much progress as Beijing has made, China’s reforms still do not get at the heart of solving the contradictory challenges inherent in the oxymoron ‘socialist market economy’ framework that still guides the country almost 40 years on.

What are some of these? As I’ve written in this space earlier, China’s separation of business and government remains ephemeral; private property rights are still ‘fuzzy’; identification of the beneficial owner(s) and who has ultimate control over decisions within some of the country’s key enterprises is opaque; the large state-owned banks hold little check, if any, over the large backbone state-owned enterprises to whom they lend and often never pay off debts owed; and Communist Party officials occupy some of the most senior positions in the enterprise and financial sectors, including most recently naming the country’s top banking regulator as the Party Chief and Deputy Governor of the Central Bank.

And, these are just a few.

Having worked in China since the early 1990s and advising Beijing on its WTO accession, I truly believe that Chinese society and its governmental leadership should have the full freedom to decide what kind of economy and political system it wants. There’s no right or wrong here.  If China’s choice results in conduct that does not square with the rules of the WTO, whose membership now includes 163 other nations, so be it.  Beijing should then exit the WTO or be shown the door. Membership is not an endowed right for any country.  My guess is China will want to stay.

While there are several reasons why China wants to attain WTO ‘market economy’ status, the most critical one is that its exports would then be subject to far lower anti-dumping duties.  As a non-market economy—with enterprises enjoying explicit or implicit subsidies—China’s domestic prices are not determined by market forces and are fundamentally distorted. The result is the magnitude of anti-dumping duties placed on China’s exports is constructed on the basis of making third-country price comparisons.

If the fundamentals of China’s economy are only bluntly driven by competitive market pressures, shouldn’t that inform the nature of policy instruments trading partners choose to condition Beijing’s conduct in world commerce?  In this context the continuing pursuit of Trump’s tariff tactics—they don’t qualify as a strategy—seems out of whack with reality.

Separate from whether or not China is a WTO-classified non-market economy, Mr. Trump has argued that by dint of its WTO membership, China enjoys significant advantages over the U.S. because it is considered a developing country.  There are 36 countries the WTO classifies as Least Developed; China is not among them. The only Asian countries in the group are: Afghanistan, Bangladesh, Cambodia, Laos, Nepal, and Myanmar.  Almost all the countries so classified are in Africa.

Looking at the magnitude of U.S. and China’s tariff rates is also instructive. While there are several ways of measuring tariffs, perhaps the most meaningful method in a cross-country context is the rate a country charges to its most favored trading partner—referred to as ‘Most Favored Nation’ (MFN) treatment under WTO rules.  As of 2016, the national weighted average MFN tariff rate on all products for the U.S. is 2.7% and for China it is 4.3%. By way of comparison, Switzerland’s rate is 0%, Japan’s is 1.8%, Germany’s is 2.8%, Mexico’s is 4.4%, India’s is 7.5%, Brazil’s is 10.2% and The Bahamas is 18.9%.

Let’s face it, imposing additional tariffs to penalize countries are so 20th Century!

In large part these are the tools Mr. Trump is relying on because he is so fixated with the magnitude of the size of the U.S. trade deficit with China—as he is with all economies—and driving down a large trade deficit through deep depreciation of the dollar is not easily controlled by the Executive Branch, let alone in a world of floating exchange rates.  In any case there would be significant costs to the U.S. economy in other areas—such as inflation—if Trump were even able to go down the dollar depreciation path.

And, persuading China to significantly appreciate the yuan to alter its exchange rate to reduce the U.S. trade deficit to Mr. Trump’s liking is more than wishful thinking.

The crux of the problem is Mr. Trump never saw a trade deficit he didn’t loathe. Unfortunately, he hasn’t surrounded himself with professional economists who know better (or he hasn’t been able to enlist any).  The White House’s tariff policy is only likely to make things much worse than the status quo for U.S. firms, workers, consumers and investors, and it could lead to putting the brakes on U.S. and global economic growth.

Moreover, Trump’s and Lighthizer’s use of tariffs to try to ‘tame’ China is akin to going into a boxing ring wearing a ball-and-chain on both legs.  Actually, we can drop that metaphor:  The fact is that China is following a wholly different playbook than is the U.S. and most other trading partners.  For the U.S. to think and act otherwise is simply fiddling around the edges. The Chinese know this all too well.

Indeed, Beijing is employing 21st Century trade tools.  Probably the most well-known is requiring foreign investors to foster ‘indigenous innovation’—a term China coined for mandating the transfer of technology as the price foreigners must pay to invest in the country.

Regardless of what one thinks about this regime, in the end as much blame can be ascribed to the companies who agreed to abide by this policy and who are now complaining about their loss of competitive edge as a result. To be frank, it is quite odd. Whatever happened to Nancy Reagan’s dictate: ‘just say no’.  In a sense the companies fostered Beijing’s addiction and created the precedent for investors who followed to be subject to the same treatment.

On the U.S. side, regardless of whether China is in or out of the WTO, Mr. Trump’s penchant for negotiating international trade deals and exacting trade rule violations on a bilateral basis makes little sense. This is no surprise given that Trump cut his teeth on doing one-off real estate deals in New York City.  If this was 1818, when international commerce was quite elementary and involved two trading partners, relying on bilateral trade negotiations was eminently reasonable.

In 2018, however, the typical trail an internationally traded product takes between the plant gate and its consumption by the end-user winds across multiple national borders, often going through different stages of transformation with value added along the way. This is a far cry from negotiating most, if not all, real estate transactions—even those conducted in foreign countries.

Thus, unlike 200 years ago, today, international trade flows are frequently multilateral in nature, with the ‘globalized factory’ front and center. This is the raison d’etre of the WTO and its forerunner, the General Agreement on Trade and Tariffs (GATT), which was established in 1947, indeed, with the U.S. as its champion.

But regardless of whether Mr. Trump loves or hates the WTO—and even if he ignores it completely—it’s an irrational negotiation strategy to deal with troubling trade behavior by the world’s second-largest economy on a bilateral basis. The fruit is ripe for the picking for Mr. Trump to assemble a ‘coalition of the willing’ of some of the other largest trading powers of the world, such as the E.U., Japan, Australia, among a number of others, to join the U.S. in its campaign vis a vis China. It’s almost as if the President wants to make his own life difficult.

Should the U.S.—hopefully with its coalition of the willing—deal with China’s trading conduct through the auspices of the WTO?  Perhaps.

Why only perhaps? While it would certainly be preferable to use the WTO, there is an argument that because this is an existential problem with China’s WTO membership, signaling a fundamental change in approach with China may well be more effective.

As the old saying goes:  drastic times call for drastic measures. Indeed, rather than continuing the tit-for-tat tariff routine, the grownup route would be to tell China it is time to renegotiate its membership in the WTO—should Beijing wish to remain a member.

About the Author:

Harry G. Broadman, is former United States Assistant Trade Representative, senior official at the World Bank in China, Russia and Africa, Senior Managing Director at PricewaterhouseCoopers, and on the faculty at Harvard University. Currently, he is CEO and Managing Partner of Proa Global Partners LLC, a global investment transaction advisory firm focused on emerging markets, and a faculty member at Johns Hopkins University.  Contact: www.harrygbroadman.com

The link to this column is: http://www.forbes.com/sites/harrybroadman


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