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posted on 17 January 2017

Invading China, One Trade Dispute At A Time

from STRATFOR

-- this post authored by Matthew Bey

The divide between domestic politics and geopolitics can be a hard one to bridge. Partisan politics and pageantry can get in the way of a country's underlying geopolitical imperatives, driving policies that undermine or contradict them outright. The tension between national and international politics is on full display as the United States prepares to inaugurate Donald Trump as its 45th president.

Throughout Trump's campaign and subsequent transition, voters, commentators and observers in the United States and beyond have scrambled to square his proposed policies with the geopolitical constraints they will encounter. Many of Trump's campaign pledges centered on retooling the United States' trade partnerships, for instance by renegotiating NAFTA or scrapping the Trans-Pacific Partnership pact. The United States' trade ties with China have been the object of Trump's most vehement criticisms; the president-elect has even proposed a 45 percent tariff on all Chinese goods to correct the apparent disparity in the bilateral relationship.

Chinese President Xi Jinping delivers a speech to Swiss Parliament on Jan. 15. The United States' trade ties with China have been the object of U.S. President-elect Donald Trump's most vehement criticisms. (ARND WIEGMANN/AFP/Getty Images)

Although Trump is unlikely to follow through with such a drastic measure, he is nonetheless poised to take a much harder line on trade with China. The next four years will almost certainly bring more investigations into China's export and domestic policies and more aggressive interpretations of World Trade Organization (WTO) regulations and U.S. law over Beijing's practices. But China and the United States are on diverging paths. While the United States is turning its focus inward, Beijing is trying to exert its influence as a global leader. In fact, on Jan. 17, President Xi Jinping became the first Chinese leader to address the World Economic Forum in Davos, Switzerland. To achieve its desired results with China, the Trump administration will have to pry into and challenge Beijing's own economic policies.

Taking a More Aggressive Approach

In a 2010 testimony before a congressional commission, Robert Lighthizer, Trump's pick for U.S. trade representative, outlined broad criticisms of the U.S. trade relationship with China. Lighthizer disparaged China's export practices as well as the United States' response, calling for a "significantly more aggressive approach" to Beijing. As trade representative, Lighthizer will have the opportunity to redress the deficiencies he identified in Washington's policies. Under his guidance, the United States will more actively enforce existing trade rules and regulations to crack down on China's dumping activities, impose countervailing tariffs on the country's exports and investigate its efforts to circumvent country of origin provisions. (Washington launched a probe in November to investigate whether Beijing was skirting duties and anti-dumping regulations by sending steel to Vietnam for minimal processing before exporting it to the United States.) The Trump administration may empower U.S. institutions to more easily conduct investigations into Beijing's trade practices, increasing their oversight and budgetary allowances. In addition, it will likely continue to refuse China market economy status under WTO rules, thereby facilitating anti-dumping cases against the country. But these measures would merely represent a continuation of President Barack Obama's policies.

Beyond the tools that the United States is already using to counter Beijing, many of the alternative mechanisms that Lighthizer has proposed are legally untested and may prove ineffective. Lighthizer has argued that China's political system and economic policies are at odds with those of the WTO and that the United States must adapt its interpretation of WTO rules accordingly. To that end, the Trump administration could make the case that Beijing's attempts to manage the yuan's value are a type of export subsidy, something the WTO prohibits, or a countervailing duty subject to U.S. law. Trump may name China a currency manipulator - as he has threatened to do on his first day in office - to support such a claim. Doing so, however, would entail changing the U.S. Treasury's criteria for currency manipulation since China's interventions over the past two years have been focused on strengthening the yuan and not weakening it, as Trump has alleged. And even if the currency manipulation charge stuck, Beijing would probably continue with its interventions anyway; after all, the yuan could drop by 20 percent if left to its own devices, threatening China's domestic stability.

Other efforts to turn existing WTO policy against China would likely be similarly limited. The organization lacks clear mechanisms to govern some of Beijing's trade practices, including the support of national champions or the application of special taxes on specific firms, such as Apple Inc. Though Washington could try to challenge Beijing's use of a value-added tax export rebate, which Trump has alleged is tantamount to an export subsidy, it would likely meet stiff resistance from other members of the organization. The practice, currently permitted under WTO rules, is commonplace among U.S. allies. And should Trump try to increase tariffs on China unilaterally without going through the WTO dispute mechanism, he would risk retaliation from Beijing or, for that matter, other trade partners affected by such a decision. (Furthermore, WTO rules restrict the use of some of the most powerful unilateral trade enforcement mechanisms, such as Section 301 of the Trade Act of 1974, that Trump could invoke to justify a tariff hike.)

Retreading Familiar Territory

Each of these more aggressive approaches to the U.S.-China trade relationship would require Washington to insert itself into Beijing's domestic policies, familiar territory for the United States. Before China joined the WTO in 2001, Japan was the bugbear of U.S. trade policy. After World War II, the United States saw Japan as an indispensable ally in the Cold War, a capitalist country that could counter the spread of communism in the Asia-Pacific region. To support Japan's economic growth and secure its military partnership, the United States allowed the country preferential access to U.S. consumer markets. Tokyo did not reciprocate, however, and maintained its protectionist policies.

By the 1980s, Japan's economy had become as advanced as that of the United States. Japanese products, moreover, had grown more competitive in the U.S. market for high-end manufactured goods such as automobiles and electronics, sectors the United States had once dominated. In fact, toward the end of the Cold War, polls suggested that the American public saw Japan's economic might as a greater threat than the Soviet Union's military power. The United States adapted its trade policy toward Japan accordingly, challenging Japan's protectionist policies, currency management and economic model - just as Trump proposes to do with China. As deputy trade representative, Lighthizer oversaw several key bilateral negotiations to resolve trade disputes between Washington and Tokyo, most notably in the steel sector.

Today, the United States has much the same problems with China that it did with Japan three decades ago, but with some important differences. For one thing, the United States' most fervent trade disagreements with Japan took place before the creation of the WTO and its relatively strong bilateral trade dispute mechanism. Tokyo's favored means of dispute resolution - voluntary caps on its exports to the United States - have since been banned. For another, the United States' relationship with Japan is dramatically different from its relationship with China. Unlike Tokyo, which owed its economic vitality and physical security to Washington, Beijing has no such ties binding it to the United States. Consequently, the Trump administration will have a harder time imposing its will on Beijing.

Beijing's Struggle

More important, China is the midst of its most difficult economic transition since the Chinese Economic Miracle began in the 1970s. For decades, investment in critical infrastructure such as ports, electrical grids and roads has fueled the country's economic growth, enabling China to take advantage of its relatively cheap labor pool and export a wide array of goods. But that model has run its course: China's economic growth has fallen below 7 percent according to official reports, and its exports declined for the second year in a row in 2016. Investment in domestic infrastructure is no longer generating the growth that it once did, leaving the country's leaders to navigate a bumpy and treacherous road toward a stable economic growth based on consumption.

It is difficult to overstate the magnitude of China's structural shifts and the challenges that they bring. Years of sustained investment have left many of China's heavy industries - chief among them its steel industry - suffering from chronic overcapacity, while incentive structures keep even unprofitable companies in operation. Herein lies the problem for the Trump administration. Despite Washington's continued calls to stop dumping steel on U.S. markets, and Beijing's desire to do so, the Chinese government lacks the power to shut down its excess steel capacity. Local officials throughout China pressure companies to stay in business, concerned more with maintaining tax and employment levels in their jurisdictions than with heeding Beijing's directives. Though President Xi Jinping has tried to clear the way for much-needed reforms to China's state-owned enterprises through a concerted anti-corruption campaign, his efforts have yet to achieve much success. What's more, his attempts to consolidate power have left little room for alternative solutions to the country's economic problems.

No matter what steps the Trump administration takes to challenge China's economic and political system, Beijing's focus will remain on its own fragile rebalancing. So far, the Chinese government has undertaken economic reform at its own pace, regardless of foreign pressure. In future trade negotiations with the United States, China will try to stay within the confines of the WTO framework and preserve the status quo. Under the circumstances, Trump may have to resort to or threaten to use more rigorous interpretations of U.S. law and WTO regulations to see a noticeable change in Chinese policy, notwithstanding the risks of retaliation.

Over the next four years, trade will become the focus of the United States' relationship with China - a relationship that will likely come under renewed strain as the next administration re-evaluates various aspects of Washington's policy toward Beijing. In the meantime, the countless countries and companies that hang in the balance will hold their breath and wait for clarity on the future of one of the world's most important trade relationships.

"Invading China, One Trade Dispute at a Time" is republished with permission of Stratfor.

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