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China’s Industrial Policies and Trade Rules – If You Can’t Beat ‘Em, Join ‘Em?

Three recent reports help illuminate the complexity of the problems currently facing the global trade system, and the elusiveness of tidy solutions.

One report — from the German government — suggests a potentially significant departure in how the West deals with China’s challenge. The second report — from the U.S. government — provides a timely reminder of the extent to which China’s WTO compliance has come up short. And finally, a sobering report from the United Nations Conference on Trade and Development (UNCTAD), demonstrates just how counterproductive trade wars can be.

If You Can’t Beat ‘Em, Join ‘Em?

Germany’s National Industry Strategy 2030 signals a growing consensus in Germany that in order to respond to China’s challenge, government needs to be more proactive in fostering and supporting critical strategic industries. The strategy calls for, among other things, state investment in important technology firms to prevent them from being acquired by foreign entities.

This of course comes on top of Germany’s existing Industry 4.0 program, and the attempted (but disallowed) rail merger between Siemens and the French giant Alstom – a deal that was explicitly presented as necessary to permit Europe to compete against China’s state-backed national champions.

Discussions are now underway as to whether EU antitrust policies need to be relaxed in order to allow greater latitude to meet the challenge posed by Chinese mega-firms. The implications are clear: as concerns over China mount, regulatory frameworks are being rethought, and state-directed industrial policies are gaining ground.

Pro-market democracies have been – implicitly or explicitly – making the argument for more than seven decades that free markets, free trade, and minimal government involvement in the marketplace is the path to development and prosperity. Is Germany now taking a tentative step toward reversing this thinking? Ironically, the conventional wisdom at the time of China’s entry into the WTO was that China would inevitably become more like the West. But could some countries in the West actually end up becoming more like China?

If Western countries adopt more state-directed economic policies, greater levels of direct and indirect subsidization, and compliant regulatory environments that facilitate the rise of massive domestic companies, will they continue to forcefully criticize China for doing precisely the same?

And if China is no longer under persistent Western pressure to curb these policies; will it interpret that as a “green light” to intensify its efforts in support of national champions and China Inc? Or is it already a foregone conclusion that China will double down on these policies to address its vulnerabilities as exposed by the trade war?

Coalition Building Through Moral Suasion and Accountability

Meanwhile, across the Atlantic in Washington D.C., the Office of the United States Trade Representative (USTR) has just completed its annually mandated report to Congress assessing China’s compliance with its World Trade Organization (WTO) obligations. Few trade issues have been as well-cataloged over the years as the variety of ways that China’s WTO compliance has fallen short.

The report outlines what USTR refers to as a “consistent pattern” of unfulfilled obligations in areas ranging from technology transfer to agriculture, and makes a compelling case that reality has diverged sharply from the optimistic hopes and aspirations held by the West at the time of China’s WTO accession.

And while there has been widespread global consternation over the unilateral U.S. application of punitive tariffs in response to China’s trade practices, there is also an underlying recognition among major trading nations that many of the United States’ grievances are in fact legitimate and that China needs to be – in one way or the other – held to account.

Walking the Talk and Paying the Price

A just-released UN Conference on Trade and Development (UNCTAD) report spells out in no uncertain terms the costs to U.S. consumers and firms of prosecuting the current trade war.

The UNCTAD study estimates that of the $250 billion in Chinese exports subject to U.S. tariffs, roughly 82 percent of those sales will be captured by firms in other countries, about 12 percent will be retained by Chinese firms, and only about 6 percent captured by U.S. firms.

On the other side of the coin, out of the $110 billion in U.S. exports hit by China’s tariffs, about 85 percent of those sales will be captured by firms in other countries; U.S. firms will retain less than 10 percent, while Chinese firms will capture only about 5 percent.

Roughly 82-85 percent of Chinese exports to the United States and U.S. exports to China deterred by tariffs in the current trade war will instead be captured by firms in other countries.

Any possible pay-offs will be felt not in the United States or China, but rather primarily in Europe, Mexico, Japan, and Canada. This news should not cause too much rejoicing in those jurisdictions however, because they will also be absorbing a fair amount of trade war collateral damage, as a result of investment, business, and market uncertainty, and damaging trade-induced distortions.

The Path Less Taken

How then to move forward?

Is it a winning strategy for the West to try to best China at its own game – or is that by definition a losing proposition?

Is the smarter strategy to intensify pressure through tariffs in an attempt to compel or cajole China into playing the game by traditional rules – or is that just a self-destructive dead-end?

Is the answer more talk, either bilaterally between the United States and China or in a multilateral setting — or is that just a “fool’s errand” given the fact that more than a decade of reports and consultations have failed to substantially move the needle?

Ultimately, it could be the case that the entire terms of engagement between China and the West on trade, investment, and economic integration need to be re-conceptualized. One thing is clear though. The existing assumptions, rules, and approaches have thus far proved incapable of producing a practical modus vivendi that will allow trade and investment between China and the West to continue on mutually acceptable and mutually beneficial terms.

The original version of this article was published as “China’s Trade Practices Spawn Tough Questions But No Easy Solutions” in The Diplomat and can be found on the Hinrich Foundation website.