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Can the US-China Trade War Be Resolved?

 
 

The United States and China will resume trade negotiations in Shanghai this week, but observers have become increasingly pessimistic about the outcome compared with the positive sentiments just a few months ago. Why have the atmospherics changed?

Conventional wisdom is that both presidents face strong populist pressures against making a deal. For U.S. President Donald Trump, hardliners fear that he might compromise to boost his re-election chances. For Chinese President Xi Jinping, proposals for resolving tensions revive historic emotions about kowtowing to the West. But the uncertainty lies more in the incoherence of the package being negotiated, with key objectives being either illogical or contradictory.

Washington’s demands are driven by three constituents with differing objectives. Trump is obsessed with America’s huge bilateral trade deficits and wants Beijing to buy more. The U.S. business community is concerned about China’s restrictive foreign investment policies. For Washington’s security establishment and politicians, this is all about China as an existential threat to America as the dominant global power.

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Trump’s obsession with trade deficits maybe be misguided in the eyes of economic experts but his tariffs are seen by many stakeholders as a plausible tactic to pressure China to liberalize its investment regime and take in more U.S. goods. But America does not produce enough of the more sophisticated consumer items which China’s middle class seeks. And on security grounds, Washington is unwilling to sell to China the high-tech components it does desire. This leaves only a beggar-thy-neighbor approach for China to increase imports from the United States — buying more agricultural products like soybeans at the expense of Brazil or more Boeing aircraft instead of Europe’s Airbuses. However, this does nothing to moderate America’s trade overall trade imbalance but puts the onus of adjustment on other countries in contravention of WTO guidelines.

This “buy more” strategy makes no sense. America has run an overall trade deficit every year for over 40 years — long before China even became a major trading partner. The United States is unique among nations in being able to run deficits in perpetuity because of the dominant role that the dollar plays in the global economy. America’s deficits provide the world with all the dollars it wants with the magnitude exacerbated in recent years by its surging budget deficits. This explains why, despite all the tariffs levied on China, America’s bilateral trade deficit widened to $30 billion in May, the highest in five months.

Much attention has been given to the complaints of the U.S. business community that China “unfairly” force foreign firms to transfer technology in exchange for access to its vast market. Beijing argues that no coercion is involved since foreign firms can simply walk away. However, the powerful role that its state plays in driving its economy gives Chinese firms exceptional bargaining advantages. The problem is not that Beijing’s actions are illegal but rather that they appear unfair. The challenge is how to alter China’s behavior, adjust regulations, and create institutions to deal with these issues. The discussions thus far have fallen short regarding verifiable and feasible solutions. This has trapped both two sides into dwelling on possible retaliatory measures that for China are seen as infringing on its sovereignty.

If Beijing responds effectively to the requests of the U.S. business community, this would further integrate the two economies but go against the interests of those in the security establishment that favor decoupling the two systems. The new Foreign Investment Law that Beijing passed last spring would strengthen China’s capacity to export and innovate — but ironically over time the consequences work against both Trump’s objective to curb trade deficits and those who see China as an existential threat to America’s technological dominance.

Asking Beijing to cast aside its financial support to promote a more innovative economy is a nonstarter. All countries provide assistance to spur new activities, especially those with strategic implications. China’s support differs from OECD norms in both scale (the pervasive role that its state plays) and form (state-owned enterprises benefiting from more favorable lending terms than private firms — but this can be rationalized by the argument that state firms are better credit risks).

China no longer relies on direct subsidies, which might violate WTO guidelines. OECD economies are more likely to provide assistance in the form of tax incentives that target both consumers and firms but this approach makes less sense for China since its fiscal system is not as sophisticated. And the United States is unique in that technological innovation has benefited greatly from defense-related research and development that ultimately benefited private commercial activities. The biggest conundrum yet to be solved in this trade war is the proper form for state support for economic activities, since there are legitimate reasons for differing country approaches.

Currently the two sides are testing each other’s intentions to reach a trade deal centered around two goodwill gestures that resonate with their respective leaders. For Trump the test is Beijing’s willingness to purchase more agriculture products to support his political base. And for Xi it is about Washington’s willingness to relax restrictions on Huawei’s access to U.S. high-tech components to placate Beijing’s nationalist anxieties.

All this maneuvering is seen largely as matter of tactics in shaping an acceptable deal but ultimately the problem is really about the coherence of the package and the relative bargaining strength of the three constituents. But with Trump as the ultimate decision-maker, some kind of compromise is possible since he is less obsessed with the Huawei security threat argument. This suggests that if he is satisfied enough with Beijing’s offer to buy more to support his political base and wants to cater to the interests of the U.S. business community, then the security establishment would have to accept more modest restraints on China’s high-tech ambitions. The complexity of the choices and shifting sentiments suggest that if some kind of an agreement is struck over the coming months, it might be more of a “moderated truce” than a real solution. Resolving U.S.-China economic tensions would then have to be postponed to after the presidential elections.

Yukon Huang is a senior fellow at the Carnegie Endowment for International Peace and author of “Cracking the China Conundrum: Why Conventional Economic Wisdom Is Wrong.”

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