John Mearsheimer (2004) more than a decade ago predicted that the US would seek to impede China’s rise. This is indeed what IR Realism predicts (and prescribes): the hegemonic power will seek to prevent the ascent of the rising power. This is what we may now be witnessing. China’s economic rise has been nothing but remarkable. China has already overtaken the US economy on a PPP basis, even if the US economy remains larger if measured at market exchange rates. China is also spreading its wings economically and financially. China is already the largest trading partner for more countries than the US. It has also become a major investor in many countries through the state-led/ -sponsored Belt Road Initiative. China’s defense capabilities are increasing and its naval presence is expanding. While Chinese per capita income remains well below US income, much stronger real GDP growth will continue to help narrow the gap. While China lacks diplomatic allies and feels increasingly vulnerable on account of its dependence on overseas trade, this does not diminish US concerns. The US and China confront a classic security dilemma. As Thucydides put it: it was the rise of Athens and the fear this inspired in Sparta that led to the outbreak of the Peloponnesian War. China remains on course to rival the US economically, financially and politically.
 |
| Source: IMF |
Are longer-term security concerns really what are driving US trade and economic policy towards China? On the face of it, the US seeks to redress a number of economic grievances related to the bilateral trade deficit, the violation of intellectual property rights, forced technology transfer, SOE subsidies and Chinese industrial policy (China 2025) as well as limited foreign access to the Chinese market in terms of trade and investment. The US administration has resorted to a combination of higher tariffs, tighter investment restrictions and export controls as well as other measures targeting Chinese technology companies. The US administration has on more than one occasion invoked national security to justify these measures, yet it is far from clear that this is the real reason behind its policies. (In the case of steel imports from Canada or auto imports from the US at the very least, the national security justification is more than doubtful.)
 |
| Source: IMF |
What are the ultimate motives and strategic goals behind US policy towards China? Three broad positions can be gleaned from public statements and policy actions. They differ less in terms of means and more so in terms of ends as well as in terms of the implications for the stability of the liberal international economy system.
First, the US may view China as a serious long-term strategic competitor and seeks to stop or slow down its economic ascent. The goal is to prevent China from acquiring advanced technologies and from dominating the technologies of the future (e.g. AI, robotics, advanced computing). This is to be achieved through a combination of supply chain disruption, limits on Chinese access to advanced US technology and policies aimed at weakening China’s ability to successfully develop such technologies indigenously by forcing it to abandon its industrial policy, protecting intellectual property rights and stopping forced technology transfer (for an interesting discussion, how far along the way to technologically dominance China is, see Lee 2018). A major assumption underpinning US concerns is that competition in these new technologies will lead to winter-take-all outcome or will at least favor China in a broader strategic sense at the expense of the United States. After all, from a security point of view, a technological edge may also translate into superior defence capabilities. If these are the concerns behind the US policy actions towards China, the international multilateral economic regime is under serious threat. Trade barriers may be raised permanently without regard for multilateral rules and cross-border FDI restrictions may lead to the emergence of a technical "iron curtain". Trade barriers will make the world and individual economics poorer and barriers to cross-border investment will slow technological diffusion and hinder global economic development. Vice President Pence and presidential advisors like Peter Navarro (and no doubt some defence officials ) seem to be viewing the world in these terms. What matters are not absolute economic gains, but a country's relative economic and security position vis-a-vis other countries. If this view prevails in Washington, it is difficult to see how a long-lasting economic conflict between the US and China and a significant weakening of the multilateral, rules-based international economic system can be avoided, for China will be very unlikely to make the types of concessions that might placate the US.
Second, the US sees China as taking advantage of loopholes in the international economic governance regime and as not offering sufficient reciprocity. In this view, China’s state-capitalist economic system allows Beijing to benefit disproportionately (and/ or unfairly) by violating the spirit if not necessarily the letter of the international trade and financial regime. Moreover, while China has ready access to advanced economies in terms of investment and technology acquisition, significant parts of its economy remains closed to foreign investment, if not de jure then de facto. In this vision, the US seeks to create a level-playing field that would translate into fairer competition and a fairer distribution of gains. If reforms can address such issues as forced technology transfer, SOE subsidies as well as market access in terms of investment and goods, the international economic system will become more liberal, allowing for more market-based competition and freer trade and cross-border investment and generating greater global welfare gains.
Last but not least, seeing China (and other countries) as taking advantage of the US, Washington seeks to weaken international economic governance in order to gain maximum leverage vis-a-vis other countries, thereby allowing it strike "deals" that are more favorable to the US. In other words, the US is prepared to abandon multilateralism and to disregard international principles and norms in order to extract greater benefits for itself - and at the costs of the countries, including China. Bilateral trade imbalances are a particular bone of contention. The complaint charge is economically questionable, for if trade deficits matter at all, it is multilateral value-added deficits that matter, not bilateral deficits measured in dollar terms. Complaints about forced technology transfer and intellectual property rights are more serious concerns from an economic perspective, as are potentially SOE subsidies and industrial policy. The violation of intellectual property may limit the incentive to invest in innovation. Subsidies and industrial policy may allow one country to extract quasi-monopoly rents under certain circumstances. But the complaint about trade deficits smacks of domestic politicking and electioneering. By imposing tariffs on imports, governments offer (concentrated) benefits to certain US sectors (e.g. steel) while imposing (diffuse) welfare losses on the US economy as a whole, especially if the economy targeted with tariffs retaliates. Granted, getting China to buy more goods may help US exports and economic growth i the short term. But in addition to it being a violation of the multilateral, rule-based trade regime, it is at least debatable whether this translates into longer-term economic gains. Economic theory does show that a large economy can exploit its power and take advantage of the smaller country by shifting the terms-of-trade in its favour - as long as the smaller economy does not retaliate. But Beijing does not seem will to yield - and this is quite aside from the question whether China qualifies as a small economy in terms of trade theory. Last but not least, pushing China to open its domestic market to increased trade in goods and services as well as foreign investment by threatening to restrict Chinese access to US markets is good economics (welfare-enhancing) and good politics (winning support from corporate America).
If one could be certain about what the ultimate strategic goals driving US policies are, one could predict with some degree of confidence how the Sino-US economic and trade conflict will evolve. For instance, if the US is concerned about long-term economic, technological and ultimately military competition, then the policy tools it is currently deploying are not just tactical in nature, but strategic. In no particular order: tariffs destroy supply chains; tighter export controls prevent China from acquiring US technology; preventing individual Chinese tech companies from doing business in the US weakens their economic and technological position; preventing US companies from doing business with Chinese companies may force them to invest in indigenous innovation etc.
If the US is only concerned about creating a more liberal international economic regime and greater reciprocity within it, then most of the policy tools it is currently employing are meant to get China to make the concessions necessary to address US grievances. Once the grievances have been successfully addressed, policies could be reversed. In this scenario, US policy actions are simply tools to create a more liberal and more reciprocal international economic regime. This would benefits the US, but it would also benefit from global economy as a whole.
Last but not least, if US policies are politically opportunistic, they may be used as long as they manage to garner key domestic political support and support the short-term US economic outlook. In this case, they will also likely cease to be employed once the economic and political costs of these policies increase (e.g. US recession). On the other hand, should these policies prove successful in terms of garnering domestic political support, the US may be tempted to exploit its relative greater strength (more limited dependence on foreign trade) in order to to reach bilateral agreements skewed in its favour (NAFTA, US-Japan agreement, KORUS). This would seriously the present trade regime.
Policy actions taken thus far are more or less compatible with all three interpretations. Different individuals in the administration may have different agendas, but actions taken so far are roughly consistent with all three agendas outline. In other words, the actions taken thus far tell us little about the Washington's ultimate strategic goals.
If the US views China as a long-term competitor, it will be difficult, actually impossible to find a compromise solution. The concessions Beijing would have to make are too great and that is assuming that there is a level of concession that would pacify the US, short of total Chinese economic capitulation. If China’s long-term economic rise continues, as is likely, we may be facing a new cold economic war. The international economic system would then probably fragment and the emergence of competing economic blocs would become likely.
If what the US seeks is a international economic level-playing-field, then the conflict is amenable to a solution. China will need to make some concessions and accept changes to the international economic regime, including greater openness to foreign investment, greater protection of IPR, reduced financial support for SOEs etc. In fact, this is something Chinese liberals and reformers would like to see. A more technologically advanced China may even have an interest in seeing stronger protections and safeguards in some areas (e.g. IPR). Abandoning support for SOEs and industrial policy might be more difficult , but not impossible to achieve. In the end, continued US economic hostility may not be a price worth paying and room for compromise probably exists, as China gradually moves away from the state capitalist model. The international economic regime would become more liberal and characterized by greater reciprocity. This is unlikely to happen overnight, but over the medium term.
If the US only seeks short-term wins aimed at extracting economic benefits for itself, the multilateral, rule-based trade regime will be in trouble - at least until the other larger countries retaliate sufficiently in order to deny the US economic gains. This is what China (and the EU) is trying to do. After all, China faces limited incentives to agree to US demands, as it may encourage Washington to demand more and greater concessions in the future. Any agreement will then be more of a truce than permanent settlement. China (like Japan) would require an ironclad guarantee that contentious issues will not be re-opened once they have been settled. On the flipside, if the US encounters sufficient opposition, it may begin to realise that a trade war among roughly equal economies wars is not only welfare-destroying, but also cannot be won if the other parties are prepared to retaliate.
How will China continue to respond to US action in the trade war? China has benefitted hugely from its integration into the international economic system over the past four decades. Inward investment, technology transfer and access to overseas markets have allowed for export-driven industrialization. The relative openness of the advanced economies to Chinese inward investment helps facilitate continued economic upgrading. More importantly, China depends more heavily on foreign trade, foreign commodities and foreign technology than many other advanced economies. This should give Beijing incentive enough to make at least some concessions in order to preserve a system that has been serving it well. Only if the US is seeking to preserve the liberal international economic regime will it make sense for China to make sufficient concessions. This would then help transform China into a “responsible stakeholder” (Zoellick 2005; Ikenberry 2008) something some policy-makers and analysts predicted long ago. In China, there are constituencies that at least support further liberalisation (aka concessions). They see China’s success as largely due to China’s successful integration into the world economy and progressive liberalization rather than state-directed development policies. They would point out that Chinese SOE are far less profitable than private-sector companies and that state industrial policies are far more likely to fail than to succeed. In the short term at least, it is unlikely that their views will prevail given greater centralization and slowing down of economic reforms under President Xi.
While the short- and medium-term risks should not be underestimated, the world economic system may yet emerge as more liberal, more multilateral and more rules-based. But this is far from certain. After all, a lot of countries support reform of the liberal international trade regime as well as the creation of a level playing field as far as reciprocal market access is concerned. The other major economic powers, including Japan and the EU (and its major member-states), are in general agreement on the need for reform. Rightly or wrongly, they are also increasingly concerned about China’s foreign economic policies. Politically, the right strategy would be to start a broad-based dialogue among reform-minded countries and then take the agreed up position to Beijing. Greater multilateralism would increase the pressure on China, but it would also reassure China that it is not at the mercy of a unilateralist, unpredictable United States. So if and when more multilateral-minded political forces come to power in Washington, the global economic system may yet emerge as more liberal and more rules-based and gain greater legitimacy in the eyes of the major powers if the international economic regime can be reformed. If, on the other hand, it is long-term fear of China that is driving US foreign economic policy towards China, then the multilateral economic system is bound to weaken further and to become more unstable. The same will be true - at least in the short to medium-term - if the US sticks to its unilateral approach aimed at extracting concessions solely meant to benefit the US rather than make the regime more liberal based on the principles of reciprocity and multilateralism. Only time will tell.