Pacific Money | Economy

How China and the US Threaten the World Trading System

The world’s two biggest economies are also the biggest threats to the global trading system.

By Yukon Huang and Jeremy Smith for
How China and the US Threaten the World Trading System
Credit: Pixabay

Over decades, trade transformed China into a major economic power with extensive commercial links throughout the world. By 2012, China had become the largest trading partner of 124 countries, well exceeding the comparable figure of 76 for the United States. But as trade remade China, in the process China also remade world trade. It began with China’s emergence as the center of global supply chains, then again with its massive infrastructure program that drove global demand for commodities like iron ore, copper and coal, and most recently by Beijing seeking new export markets outside and within Asia in response to the U.S. trade war

China’s rise was made possible by its integration into a rules-based international system. Competitive pressures and sensitivities, however, strained relations with many of its key trading partners, especially when Beijing used its economic leverage for strategic interventions throughout Asia and selectively in Europe, Africa and Latin America. Yet China is not alone in using its economic clout for political purposes; the United States, too, has levied sanctions on countries like Iran and Venezuela and used punitive trade measures against China and other nations. Though their interventions differ in nature, the global trading system is ironically now being undermined by the coercive actions of its principal creator­ and its major beneficiary.

Figure 1: China’s trade balance with selected regions and economies. Data from IMF Direction of Trade and authors’ calculations.

As China became more integrated into the global economic system, its use of coercive actions to serve its strategic interests also increased. Gaining membership to the World Trade Organization (WTO) in 2001 facilitated its emergence as the center of a global production network, receiving parts and components mainly from the Northeast Asian economies of Japan, South Korea and Taiwan – totaling 40 percent of overall Chinese imports at that time – and processing for re-export to the United States and Europe (see Figure 1). As China became the assembly plant for the world, it boosted East Asia’s economic prominence. But China was also seen as aggravating global macro imbalances and sowing the seeds for heightened tensions with the West.

The global financial crisis of 2008 caused China to launch a massive infrastructure investment program. This resource- and energy-intensive effort fueled a surge in trade and investment with major commodity producers, mostly in Africa, Latin America and the Middle East. China’s seemingly insatiable need for raw materials and petrochemicals caused its deficit with these commodity exporters to nearly triple from 2009 to 2012 (see Figure 1). China’s deepening presence buoyed up growth in Latin America and Africa, but also generated concerns about exploitation, excessive reliance on Chinese labor and debt traps.

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Meanwhile, following the financial crisis, Europe’s trade deficits with China moderated as China’s surging household incomes increased demand for Europe’s high-end consumer goods (see Figure 1). Europe’s deepening economic ties with China, facilitated by increasing foreign investment, encouraged it to approach relations with China more cautiously compared with the United States. Yet these links also provided China with the leverage to enact targeted sanctions, for example, on Norwegian salmon over prominent dissident Liu Xiaobo’s 2010 receipt of the Nobel Peace Prize, and by freezing aircraft orders from Airbus in 2009 when then-French President Nicolas Sarkozy met the Dalai Lama.

As trade pressures intensified with the West, China began to diversify its export destinations, using its Belt and Road Initiative to strengthen links with Central and Eastern Europe and investing in Mexico as a base to serve the U.S. market in response to trade war tariffs. More significantly, China has stepped up commercial activity with the Association of Southeast Asian Nations (ASEAN), given the region’s geopolitical importance. China’s trade with ASEAN grew at an annual rate of nearly 9 percent from 2010 to 2018 compared to around 5.5 percent for the world as a whole.

ASEAN feels the strong pull of China’s economic gravity, but many members align more closely with the United States on security issues surrounding regional maritime disputes. Vietnam is the most prominent example, as China now sends it many intermediate goods for assembly and re-export, just as Japan used China in the previous era. In many ways, Vietnam, along with the Philippines, epitomize how deepening links with China promote economic development yet simultaneously exacerbate longstanding political tensions involving territorial claims in the South China Sea. This has led to China threatening international oil companies to end their joint ventures with Vietnam for exploration in disputed waters and tightening restrictions on banana imports from the Philippines – ostensibly for health reasons – as tensions flared over contested claims to the Scarborough Shoal.

With its growing external presence, Beijing has increasingly resorted to coercion to express its displeasure on foreign policy issues, often imposing trade restrictions. In May, China levied trade sanctions on Australian beef and barley after Canberra called for an investigation into the origins of the coronavirus pandemic. But Beijing’s leverage in some instances is more limited. The visit of Czechia’s Senate speaker to Taiwan in September was strongly condemned by China, but the failure of its foreign investment to live up to promises has left Beijing with few economic retaliatory options. And China’s recent block of German pork was a largely symbolic move coinciding with pressure on Berlin not to join Washington’s condemnations of China’s human rights record. In most cases, Beijing did not explicitly acknowledge these motives; it instead pointed to product safety concerns or framed tariffs as anti-dumping measures.

China rarely declares its intentions in advance, typically acting alone and using selective measures to target specific entities. Its actions are usually triggered by particular events perceived as threatening core interests connected to its territorial integrity and sovereignty, especially relating to Taiwan and Hong Kong. Such measures are usually short-term in nature and are designed to change behaviors. The effectiveness of China’s actions in influencing foreign public sentiments and policies is a subject of debate. That Beijing persists with largely symbolic, coercive measures reflects China’s inability to use soft power to influence others. A “soft power index” developed by the University of Southern California ranks China near the bottom of 30 surveyed countries; by contrast, the United States is typically among the top five. Lacking this deftness, Beijing resorts to blunt instruments to make its point, while acutely aware that such actions are unlikely to change the protagonist’s fundamental beliefs.

U.S. sanctions, on the other hand, are much broader and enduring in their design and impact, though their results have been mixed. As in the cases of Iran and North Korea, the punitive measures are usually formalized through domestic law or executive orders and are supported by allies. While trade and diplomatic pressures are typically part of such sanctions, the most punishing aspects are financial restrictions – limiting access to U.S. banking services – which can severely cripple a country’s commercial activities.

Doing business with great powers creates a dilemma: The deeper the commercial ties, the greater the benefits and, at the same time, the greater their capacity to leverage economic power for coercive purposes. China has become more assertive in lashing out to defend its interests in ways that subvert the rules-based trade that made China into the economic power that it is. At the same time, the Trump administration has increasingly deviated from past U.S. practices in using selective economic sanctions for strategic purposes against both friends and foes. Moreover, its actions to discredit international agencies like the WTO and the World Health Organization are undermining the world economic order. And nowhere have these tendencies been more on display than chaotic decoupling measures taken by the White House in the ongoing U.S.-China trade war. Together the actions of these two major powers now threaten the viability of the international financial system that has served the world well for the past 70 years.

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

Jeremy Smith is an economist at IHS Markit and a former junior fellow at the Carnegie Endowment for International Peace.