FORGING AN ALTERNATIVE ECONOMIC STRATEGY FOR DEALING WITH CHINA DAVID DOLLAR EXECUTIVE SUMMARY countries, and even the UK). At the moment, the U.S. risks being left out in the Asia-Pacific region as America’s economic relations with China have RCEP and TPP proceed without it. deteriorated under the Trump administration. U.S. exports and imports are both down, primarily (4) Negotiate with China over its role in the because of the tariffs that the U.S. has imposed. international economic institutions. For example, if Investment in both directions is also down. The U.S. China were to join the Paris Club, the United States policy was aimed at increasing exports to China could support a greater Chinese standing in the and changing various Chinese trade practices, but IMF. Similarly, the U.S. could trade a greater weight so far it has failed. The “managed trade” approach for China in the World Bank if it were to join the of specific export targets has not worked and Development Assistance Committee and make its should be scrapped in favor of a focus on structural BRI loans more transparent and concessional, with issues in the Chinese economy: non-tariff barriers; competitive procurement for projects. The general restrictions on foreign investment in some sectors; point is that if the United States wants changes in poor protection of intellectual property rights; forced Chinese behavior, it must be willing to anchor those technology transfer; extensive role in the economy of changes in a role in the international institutions state-owned enterprises; and subsidies to develop commensurate with ours. specific technologies. The impact of these policies is to limit the exports coming from American firms (5) Rationalize our policy in the national security and workers, exports both to China and to third sphere. Slowing China’s growth or killing Huawei countries. Bringing China up to advanced country are not realistic national security objectives. China norms would open new trading opportunities and is likely to catch up with the U.S. in terms of overall raise American incomes. GDP within 15 to 20 years. Consequently, the U.S. is going to have to live with a large China that has a The key components of an alternative economic very different system from our own. Clearly, America strategy for dealing with China are: needs to protect technologies with national security implications through export and investment (1) Negotiate down the U.S. tariffs on Chinese controls. But if the parts of the economy affected products in exchange for a “phase 2” agreement are defined too widely, then important dynamism focused on the structural issues above; realistically, is cut off. Most of the economy should be open China will be willing to change some but not all of to trade, investment, joint research, and student its policies; exchanges. The U.S. has enormous strengths. If (2) Stop the talk about exchange rate and trade there is a level playing field, American firms and imbalances, which are distractions from the main workers can be expected to do very well and to issues; benefit from trade and investment with China. (3) Coordinate our China economic policies with THE PROBLEM allies. This will involve dialogue with the EU as well as with Japan and South Korea to agree as much as The main problem that the United States has with possible on priorities for specific Chinese reforms. China is a set of trade and investment practices Ideally, the U.S. will rejoin TPP and push hard to that are outside the norms of advanced economies. include new members (South Korea, more ASEAN China likes to think of itself as a developing country, 1 FORGING AN ALTERNATIVE ECONOMIC STRATEGY FOR DEALING WITH CHINA based on its per capita GDP, but it is the second issue off the table and demonstrates that it is largest economy in the world and the largest possible, through dialogue and incentives, to bring trading nation, and the U.S. would like to see it China up to global norms. move quickly to advanced country standards. The specific policies in question are: extensive non- Within the category of IPR protection and forced tariff barriers, such as arbitrary and changeable tech transfer, a special concern is theft of standards; restrictions on foreign investment technologies that have military applications. Any in some sectors; poor protection of intellectual IPR theft from American firms makes us poorer, property rights; forced technology transfer through but theft of military technologies also undermines various coercive means; extensive role in the our security. Hence, special policies are needed to economy of state-owned enterprises that have protect national security. favorable access to land and credit; and subsidies A final problem in the economic relationship is to develop specific technologies. These policies that Trump administration policy has completely limit the exports coming from American firms and lacked realism, and the examples are endless. workers, including exports both to China and to third The administration imposed a 25% tariff on countries. Bringing China up to advanced country most imports from China, a tax paid by American norms would open new trading opportunities and consumers and firms, in order to get China to raise American incomes. negotiate. This succeeded in bringing China to the Aside from these practices that directly affect table, but the U.S. side over-estimated its leverage. the United States, China is also out of step on U.S. trade is simply not that important to China global norms for lending to poor countries, which anymore (it conducts more trade with ASEAN will have important indirect effects on the U.S. than with the U.S.). So, China was not willing to economy and foreign policy. China’s Belt and Road make significant structural reforms. It did agree Initiative has been lending about $50 billion per to purchase more from the U.S., but the specific year to developing countries, primarily to construct targets in the phase 1 deal also proved to be transport and power infrastructure. The initiative unrealistic. As of mid-2020, China was only buying has the potential to be beneficial, as developing about half of what would be required to meet the countries need this infrastructure. However, the targets. This is partly because of the COVID-19 Chinese loans lack transparency, so it is hard to know pandemic, but the experience shows the failure which projects are financed and on what terms and of managed trade with China. The U.S. policy also whether the overall amount for a particular country showed a lack of understanding of how global value is leading to unsustainable debt. What is clear from chains work. Faced with the U.S. tariffs, some final available information is that the loans are mostly assembly shifted to countries like Indonesia and commercial. As a result of the COVID-19 pandemic Vietnam. But China’s exports of machinery and and recession, many countries, especially in Africa, components to those countries increased, so its are falling into debt distress. China did join the G20 overall exports did not decrease. The U.S., in turn, in calling for a debt moratorium for the poorest imported more from Southeast Asia. As a result, countries this year, but it is not a member of the American consumers paid more but trade patterns Paris Club of official creditors, so providing further did not change in any fundamental way. The China debt relief is going to be complicated and perhaps tariffs also did not account for the fact that U.S. insufficient. firms use imported parts and components to make their production more competitive. Even before the In the mid-2000s China was also out of step in virus hit, Trump’s China tariffs had cost the U.S. that it had an undervalued exchange rate and a a net loss of 175,000 manufacturing jobs. A final large overall trade surplus, the broadest measure example of the lack of realism came in the summer of which is the current account. But this problem of 2019 when President Trump designated China was corrected during the Obama administration; as a “currency manipulator,” an accusation that China’s currency has appreciated 35% since 2007, was simply not true. As the Trump administration on a trade-weighted basis, and its current account comes to an end, the U.S. is left with a confused surplus has fallen from above 10% of GDP to less and unrealistic economic policy towards China. than 1%. This macroeconomic success takes one 2 FORGING AN ALTERNATIVE ECONOMIC STRATEGY FOR DEALING WITH CHINA SOBJECTIVES otherwise allow trade, investment, joint research, exchange of students and researchers — all of the China should move as quickly as possible to foundations of an open innovation regime. developed-country norms for trade and investment. Specific features of this evolution could include The U.S. should undo the mistakes of the Trump stronger penalties for IPR violations; redress administration with as little damage as possible mechanisms for firms that feel subject to forced to the U.S. economy. One of the challenges of technology transfer; discipline of state enterprises; dealing economically with China over the next few and changes in laws and policies to make R&D years will be that the current policy is confused subsidies WTO compatible. This should be codified and unrealistic. Many changes need to be made: in various ways. Initially, this could be a bilateral eliminating the tariffs, which have hurt American agreement, similar to what was envisaged for firms and consumers; moving away from managed phase 2 of a U.S.-China agreement. But changes trade; encouraging China to play a larger role in in policies will have more force if they are included global economic institutions, not a smaller one; in larger agreements, ideally with Asian and/or protecting genuine national security concerns while European partners, and eventually in reformed removing the crude protectionism implemented in WTO rules.