The Taiwan Banker

The Taiwan Banker

Elusive armistice

Elusive

2019.01 The Taiwan Banker NO.109 / By Matt

Elusive armisticeEconomic competition between the U.S. and China will intensify even if the two countries resolve the current trade conflict
China and the United States agreed to not impose any new tariffs for 90 days at December's G20 summit, giving the world hope that the world's two largest economies can bring their troublesome trade spat to an end. If the two countries fail to negotiate a satisfactory trade deal, Washington could increase tariffs from 10% to 25% on US$200 billion in Chinese imports. Washington is using tariffs to push back against Chinese mercantilism and pry open the Middle Kingdom's markets. 17 years after China's accession to the World Trade Organization (WTO), its market barriers remain formidable: weak protection of intellectual property, forced technology transfers and aggressive state-led industrial policy. Beijing's so-called "socialist market economy with Chinese characteristics" looks more like state capitalism, to which its neighbors Japan and Korea are no strangers. Both countries shelter key segments of their economy from foreign competition. They also have relied heavily on state-led industrial policy to build national champions. But neither has challenged the U.S. directly as China has with its contentious Made in China 2025 industrial blueprint. That plan, which outline's Beijing's bid to dominate cutting-edge industries like aerospace, robotics and artificial intelligence - in which the U.S. leads - alarmed U.S. policymakers, providing impetus for tariffs and a slew of other restrictions aimed at China. Through the initiative, the Chinese state aims to subsidize the rise of national champions who will take on and ultimately surpass the leading companies of advanced economies like the U.S., Germany, Japan and Korea. Made in China 2025 has set the goal of boosting the domestic content of “core materials” to 40% by 2020 and to 70% by 2025. After realizing the policy had upset the applecart, Beijing in June ordered censors to remove any mention of it from state media. Yet Chinese President Xi Jinping continues to encourage self-reliance. "Unilateralism and trade protectionism are rising, forcing us to adopt a self-reliant approach," he said in September. Made in China 2025 directly violates WTO prohibitions on technology substitution. That China, one of the world's largest benefactors of free trade, would launch such a policy, severely limit foreign participation, and respond to criticism by renewing calls for self-reliance brings into question the wisdom of letting China join the WTO. “It seems clear that the United States erred in supporting China’s entry into the WTO on terms that have proven to be ineffective in securing China’s embrace of an open, market-orientated trade regime," the U.S. Trade Representative said in a January 2018 report. Leading the Trump administration's charge against China's unfair trade practices is USTR Robert Lighthizer, an attorney and steely negotiator. Lighthizer reportedly took his job at the USTR to recalibrate Washington's China trade policy. Lighthizer is the third person to head China negotiations in the Trump administration, following Commerce Secretary Wilbur Ross and Treasury Secretary Steve Mnuchin. The latter two men come from financial backgrounds, rather than legal ones, and are not known for their toughness. If anything, they seemed eager to cut a deal with Beijing that would quickly end the trade war, easing jittery markets. Neither man sought to tackle the thorniest parts of the trade tiff. Observers close to the White House say that both Ross and Mnuchin failed to impress Trump. While the president publicly talks up his hopes for a rapid resolution of the conflict, privately he sets a high barrier for removal of the tariffs. Convinced - and not wrongly - that China has "ripped the U.S. off," (the trade imbalance, stolen intellectual property, forced technology transfers), Trump aims to inflict pain on the Chinese economy until Beijing agrees to change its ways. In Lighthizer, Trump has found someone who can channel his anger with China's trade abuses into a [somewhat] coherent policy. The Wall Street Journal reported in December that Trump took Lighthizer's advice to impose tariffs on China instead of accepting deals that Mnuchin brokered: Trump rejected three separate deals brought to his him by the Treasury Secretary. Lighthizer warned the president that the Chinese were being insincere in negotiations, The Journal said. To be sure, Trump could sour on Lighthizer as he has on others who have served in his administration. Despite Trump's presidency being just two years old, there is already a long list of ex-officials. The mercurial Trump falls out with people easily. For now, however, Lighthizer is in the driver's seat on China trade policy. Thanks to his experience as a high-stakes negotiator, he will command more respect from Trump than his predecessors and be better able to extract concessions from China. Beijing won't easily circumvent Lighthizer or wear him down. “He believes strongly that the endgame is China,” Robert Lighthizer's brother Jim Lighthizer told Bloomberg in a September interview. “He believes that it is going to be a long, long haul with China.”Elusive armistice Lighthizer is correct that it may take years to compel a change in Beijing's industrial policies. One reason is that China is desperate to escape the middle-income trap that has ensnared countries like South Africa and Brazil. Beijing sees advanced manufacturing prowess as key to speedily ascending the global value chain. From the perspective of Chinese policymakers, without Made in China 2025, the nation's competitiveness will lag. Even if the Chinese leadership adjusts the policy - Beijing said in December it would revise the plan to allow more participation from foreign companies - they aren't likely to jettison the leading role of domestic companies. Indeed, old habits die hard. The U.S. is asking China to allow markets to play a decisive role in its economy - not the state. Beijing isn't ready to hand over that much power to markets. Indeed, for its first thirty years of existence the People's Republic of China was a command economy with minimal space for the private sector. Market reforms began in 1978, carving out a large role for the private sector, but even today the Chinese government sets national economic policy in a top-down manner. Beijing ensures that state-owned firms beholden to the Chinese Communist Party play an outsized role in the Chinese economy despite their unfavorable productivity vis a vis the private sector. Powerful vested interests have stalled major SOE reform since China joined the WTO in 2001. Not all of Washington's requests of China are far-fetched. China can address the trade imbalance with the U.S. by purchasing more U.S. goods. Reportedly, Chinese President Xi Jinping told U.S. President Donald Trump at the G20 that China was willing to "reduce the trade imbalance" by purchasing more agriculture, energy and other products from the U.S. Further, in recent years China has steadily improved intellectual property protection to safeguard rising Chinese brands. China has realized that IP theft will stymie the very indigenous innovation it aims to spark. Meanwhile, foreign firms benefit. They are winning more IP-related cases in Chinese courts than ever before. It is conceivable the U.S. and China could find more common ground on IP issues. A t the same time, it make economic sense for China to end the trade war. Bloomberg Economics reckons that a 25% levy on all Chinese imports to the U.S. could reduce China's annual GDP growth in 2019 to 5% from 6.6% this year. Unfortunately, underlying competition between China and the U.S. will make a lasting trade armistice elusive. Since the global financial crisis of 2008-09, China has believed that the U.S. is a declining power. In Beijing's eyes, the crisis revealed the flaws in America's brand of free-market capitalism. The unwillingness of former US President Barack Obama to push back against Chinese mercantilism further emboldened hardline elements in the Chinese Communist Party. Obama was more concerned about getting China's cooperation on climate change than making it abide by its WTO commitments. Meanwhile, U.S. companies are flummoxed by Beijing's failure to enact market reforms. China can't count of them to lobby Washington on its behalf anymore. To be sure, the majority are still profitable in China, but they face rising labor costs, local competition and security risks. Technology firms are particularly vulnerable as the U.S. restricts Chinese investment in sensitive American technology. The Trump administration in October forbade U.S. firms from doing business with Chinese state-funded semiconductor maker Fujian Jinhua Integrated Circuit Company, which has been accused of conspiring to pilfer trade secrets from American chipmaker Micron. In December tech-related tensions between the U.S. and China flared again as Canada, acting on the U.S.'s request, arrested Meng Wanzhou, CFO of Chinese telecoms giant Huawei, for the alleged violation of Iran sanctions. Washington is requesting the extradition of Meng. Given Huawei's spotty corporate governance record, the allegations are not implausible. Yet the optics of the arrest will feed jingoistic sentiment in China. In a December edition of his newsletter, long-time China watcher Bill Bishop said that the case could be used "as another rallying point in the increasing efforts to reduce reliance on the US." Meng's detention "certainly fits within the broader campaign by the US to block Huawei from 5G networks outside of China," he said. The race for a foothold in 5G is just one part of a larger competition between the world's two largest economies for domination of next-generation technologies. Tariffs may stop escalating in 2019, but the high-tech tussle between the two countries is just beginning.