False narrative fuels Trade War

Amid charges and counter-charges, the US-China conflict has now moved squarely into the danger zone. And in light of the sharp recent escalation of pressures from the American side — the early May hike in tariffs from 10% to 25% on $200 billion of Chinese exports to the US along with a promise of more to come on the remaining $325 billion of exports, together with a full frontal assault in Huawei — even the odds of a cosmetic agreement are slipping by the day.

Washington’s penchant for China bashing has been taken to an entirely new level. Republicans and Democrats agree on very little these days. But blaming China for America’s economic ills resonates across the political spectrum. Once the pro-business constituency of free trade, the Trump takeover of the Republican Party has now embraced tariffs with open arms. For pro-working class Democrats, many of whom have long warned of the perils of globalization and trade liberalization, the transformation into tariff warriors has been relatively easy. After years of abusive trade practices, goes the shared bipartisan rhetoric, it is high time America stood up against China.

Today’s China bashing has gone well beyond the strain of anti-Japan sentiment that was evident some 30 years ago. Back then, the US manufacturing sector was experiencing its first taste of pressures on jobs and real wages that could be traced to a sharply widening trade deficit. A mercantilist Japan, fixated on suppressing the value of the yen and accounting for about 42% of the total US merchandise trade deficit in the first half of the 1980s, was the culprit. This led to the so-called Plaza Accord of 1985, when the so-called G-5 coalition of leading industrial nations put Japan in a straight-jacket of currency appreciation that led to asset bubbles and a string of lost decades of economic stagnation and deflation. Having studied the lessons of Japan very carefully, China’s leadership has resisted comparable advice from the West. And so Washington has embraced different and tougher tactics to address a Chinese threat that it judges to be far more serious than that which arose from Japan back in the late 1980s.

From Japan to China, the United States has been quick to see itself as the victim, choosing to blame others for economic problems that are very much of its own making. Yet this blame game flies in the face of some of the basic and most elementary principles of macroeconomics. Economics students are quickly taught the simple national income accounting identity that investment must always saving. The problem comes in the corollary: When nations are short of saving and want to invest and grow, they must borrow surplus saving from abroad and run current account deficits in order to attract the foreign capital. These balance-of-payments deficits — which the US has experienced in every year since 1982 (with the exception of 1991, when the US ran a small surplus by charging other nations for its military campaign to wage the Gulf War) — are a recipe for trade deficits. But since the trade deficits stem from macro saving-investment imbalances, they tend to be broad based, or multi-lateral, in scope. Indeed, in 2018, the United States had merchandise trade deficits with 102 countries.

Therein lies the pitfalls of China bashing. Yes, China accounted for fully 48% of America’s massive $879 billion merchandise trade deficit in 2018. That makes it a lightning rod in the current US policy debate. Eliminating the Chinese piece of the deficit, goes the argument, is the only way to “make America great again” and thereby alleviate pressures on American workers.

If it were only that easy. For a saving-short US economy, there is no bilateral fix for a multilateral problem. A China-centric solution is like “whack-a-mole.” Eliminating one piece of the trade deficit without fixing the saving problem — a very real possibility in light of a further depression of domestic saving following from the ill-timed Trump tax cuts of late 2017 — simply means that trade will be diverted from China to other foreign producers. Inasmuch as China is one of America’s lowest cost foreign suppliers, that means the trade diversion will invariably go to higher cost foreign producers — the functional equivalent of a tax hike on American consumers.

The likelihood that China bashing will backfire for a saving short US economy raises a far deeper question: Why does Washington pursue such a flagrantly inconsistent strategy? The answer is as much an outgrowth of hegemonic overreach as it is a reflection China’s alleged unfair trading practices. With the dollar pre-eminent as the world’s reserve currency, the United States has developed a sense of entitlement toward open-ended budget deficits that are funded by dollar-denominated debt issuance in its own currency.

Never mind the inefficiencies of a healthcare system that eats up 18% of GDP, or a defense budget that is essentially equal to the combined military outlays of the next seven largest defense budgets around the world, or low tax rates that put the current 16.5% revenue share of US GDP well below the 17.4% average of the past 50 years. Washington would rather pursue fiscal recklessness than come clean with the American public. And it would rather blame the consequences of such a strategy on the trading practices of others than take a long hard look in the mirror.

Indeed, considerable effort has gone into the construction of a false narrative on China in order to justify America’s aggressive trade policies. China has been charged with a number of so-called Section 301 violations of the US Trade Act of 1974 and vilified, accordingly, in the arena of US public opinion. Yet the evidence behind such allegations is flimsy at best and outright misleading at worst. Apparently, it is much easier to find comfort in the false narrative than to accept responsibility for fiscal excesses and saving shortfalls that spawn the macroeconomic imbalances that give rise to multilateral trade deficits.

The tragic irony of a possible trade deal, if it does occur, is that it is likely to focus on a multi-year commitment by China to purchase over $1 trillion of US made goods in an effort to narrow the bilateral trade imbalance between the two nations. This is pure political theater at its worst — underscoring the folly of a bilateral fix for a multilateral problem. It is based on the false premise that this “solution” will address the squeeze on US manufacturing and provide relief to pressures on jobs and real wages of factory workers. Yet nothing could be further from the truth for saving-short America. As noted above, the bilateral fix is a recipe for trade diversion that does next to nothing in providing lasting relief for American workers and consumers.

Most significantly, the fixation on the bilateral trade deficit fails to address the structural issues that threaten lasting tensions between the two nations. Market access is at the top of that list — the opportunity of multinational corporations in both nations to invest freely in each other’s markets. The US claims that China’s joint venture requirements imposed on such investments is a recipe for forced technology transfer. As highlighted in the March 2018 Section 301 report of the US Trade Representative (USTR), this charge has become the poster child of the US-China dispute and the foundational evidence for Trump’s tariffs. This has occurred despite the fact that the USTR admits (on page 19 of the March 2018 report) that there is no direct evidence to support the allegation that technology transfer is forced by joint ventures that represent voluntary agreements between US and Chinese partners. Once again, the false narrative apparently matters more than fact-based analytics.

Notwithstanding the politics of the blame game, there are plenty of realistic options for resolution. Three, in particular, stand out:

Bilateral Investment Treaty. Market access is best addressed through the formalization of cross-border investment rules and standards that are stipulated in a bilateral investment treaty (BIT). The United States currently has 42 BITs on the books and China has 145. Under a BIT, foreign ownership caps can be eliminated, thereby rendering joint ventures unnecessary and taking allegations of forced technology transfer off the table. Prior to the 2016 presidential election in the United Sates, the US and China spent 10 years attempting to negotiate a BIT. Stymied by Trump’s tariffs, those negotiations have been suspended. Restarting BIT negotiations would be the single best strategy to resolve the thorny issue of forced technology transfer.

Trans Pacific Partnership. The political decision to abrogate America’s commitment to TPP in the first days of the Trump presidency was a mistake. This multilateral agreement provided a high-quality framework linking 12 nations accounting for 40% of world GDP through cross-border trade liberalization, labor standards, intellectual property rules, Internet protocols, and environmental norms. With China on the outside looking in, TPP would have provided a powerful mechanism for Chinese conformity to many of the structural norms that are currently being contested. While a rethinking of America’s TPP strategy may not be politically possible for President Trump, it may well be a realistic option after the 2020 presidential election.

Global cyber accord. Like the trade conflict, this is not a bilateral problem. The US and China should take the lead in forging a global cyber accord, complete with pooled metrics of cyber incursions, attack-reduction targets and a robust dispute-resolution mechanism.

The United States and China are on a collision course. The world’s two largest economies have accounted for fully 44% of world GDP growth since 2008. If they opt for a superficial resolution or fail to come to terms on their trade conflict, the global economy could well falter. Resolution is possible but it won’t be easy in the current climate. Saving-short America’s bipartisan political support of China bashing is especially problematic in threatening to turn a trade war into a protracted and destructive economic cold war. Now, more than ever, a fragile world is in desperate need of political will and wisdom — and a leadership courage that is sorely lacking today.

The author is a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China (2014).

The author contributed this article to China Watch exclusively. The views expressed do not necessarily reflect those of China Watch.