What Should America Do About China?

Until the mid-2000s, China actively encouraged foreign direct investment through a vast array of incentives, many of them mercantilist and unfair in nature. While the consequences of China’s mercantilist policies might not have always been good for the U.S. economy, and especially for many production workers in traded sectors, U.S. multinational corporations benefited from access to a low-cost production platform.

And Americans in their role as consumers benefited from lower-cost goods. While China occasionally engaged in policies that brought complaints from U.S. industry, by and large the United States was satisfied with the relationship.

In 2006, that began to change. China made the strategic decision to shift to a “China Inc.” development model, based on successful Japanese and Korean examples, that focused on helping Chinese firms grow by moving up the value chain and gaining global market share, often at the expense of foreign firms.

As such, conflict now exists not just between American and Chinese workers, but between American companies and Chinese companies, just as it did between Japanese companies and American companies in the 1980s and early 1990s. This fundamentally changes the dynamics and the politics of U.S. trade policy toward China.

If the United States is to effectively address this challenge, it is critical that policymakers and experts have an accurate view of Chinese economic policy and China-U.S. trade.

Unfortunately the two prevailing views are misguided. The “free trade” view holds that efforts to press China to end its mercantilism will only backfire and limit what is largely a mutually beneficial trading relationship.

The “protectionist” view, in contrast, holds that trade with China is fundamentally bad for U.S. economic interests. There is no way, the view goes, that U.S. workers can compete with Chinese workers who are paid less than 10% of American wages. Better we impose protective tariffs, “Buy American” provisions, and other protectionist measures and build our own autarkic economy.

Both views miss the mark. Free traders are right that it is in the economic interests of the United States for China to be an integral part of the global trading system. But they are wrong in thinking that these benefits can accrue if China’s policies undermine that trading system and China continues its strategy of absolute advantage implemented through mercantilist policies.

Protectionists are right in that it is important to ramp up the pressure on China to get it to start playing by the rules. But the notion that the United States can’t be competitive against China, even if the latter plays by the rules, is wrong. So is the notion that global integration with China can’t be in America’s and the world’s interests.

The United States doesn’t need to close its borders to be a vibrant competitor. It must, however, require that other nations, especially large ones like China, play by the rules.

Yet there is no evidence that China intends to voluntarily abandon its innovation mercantilism. Despite ongoing efforts by successive U.S. administrations to engage the Chinese in dialogue, there is little evidence that this process is doing anything more than helping to manage particular issues that come up.

In cold-war terms, that amounts to “containing,” not “rolling back,” Chinese mercantilism. It’s time to realize that China does what it does not because its policymakers don’t understand the merits of the American system and the Washington consensus. They fully understand the arguments embedded in the Washington consensus. They just reject them in favor of the Beijing consensus.

As a result, it is time that the United States — along with the market-based global trading community at large — takes stronger action to press China to join the community of trading nations and curtail its mercantilist policies. The United States can and should take a number of specific steps unilaterally, but it should also press its like-minded trading partners to take steps on a bilateral and multilateral basis, including through the World Trade Organization (WTO).

The status quo is not tenable

The single most important steps are to recognize the severity of the problem and then commit to real, sustained and vigorous action to address it. Until Chinese innovation mercantilism is seen as the serious threat to U.S. economic prosperity that it is, U.S. responses will not be as strong as they should be, and easily trumped by other concerns, especially foreign policy ones.

The Office of the U.S. Trade Representative too often engages in fighting the last wars — the tariff war and the war to sign trade agreements. It’s not set up, either institutionally or philosophically, to fight the current war — the war against rampant innovation mercantilism fueled by a wide array of non-tariff barriers.

Perhaps the most significant challenge facing the United States in pressing China to reform is that too many U.S. officials believe they have few arrows in their quiver to force China to change. They can harangue Chinese leaders at G20 summits or attempt to persuade them at “Strategic and Economic Dialogue” meetings, and take the occasional WTO action.

But by and large the view is that the United States is largely impotent to get China to change unless China sees change in its own interest. The best we can do, the thinking goes, is hope that China will change on its own before the damage to the United States is too great. This fundamentally passive stance must be revised because the status quo is not tenable.

U.S. policymakers need to do two things. The first is to identify areas where stronger legal tools are needed and press for their implementation, either domestically or in global agreements like the WTO.

Fundamentally, the WTO system is designed around “trade” agreements relating mostly to imports and exports and issues like tariffs. Thus, it addresses issues like export restraints and export quotas. But more systemic distortions, such as government-run production cartels or the use of regulation and standards to discriminate against foreign firms, are not really addressed.

The second thing is to band together with other like-minded nations to use the power of exclusion and pressure. The United States should promote a renewed vision for globalization grounded in the idea that markets should drive global trade and investment, that countries should not seek to accrue sustained trade surpluses, that currency prices should not manipulated for competitive advantage, and that fair competition forces countries to ratchet up their game by putting in place constructive innovation policies that leave all countries better off.

This new alliance of free-trading nations needs to get progressively tougher on China until it significantly scales back its mercantilist policies. In addition, it should create a new free-trade zone, involving only those countries genuinely committed to adhering to the principles and reality of open, free and fair trade.