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Will Trump risk trade war with China or seek reciprocity?

US president-elect is right to be angry about Beijing's trade policy, but for the wrong reasons

| China

Donald Trump has yet to be sworn in as president, but in a series of troubling remarks and tweets, he appears to be setting the stage for a turbulent and confrontational U.S.-China relationship. Worse, he is focused on all the wrong issues: threatening to undo U.S. commitments to China on Taiwan that are the foundation of U.S.-China relations, and on outmoded economic problems from the 1990s.

President-elect Trump's suggestion that the U.S. "One China" policy may be a bargaining chip for trade negotiations was either ignorant or reckless, and accomplished the rare feat of at once enraging both Beijing and Taipei, which resents being viewed as a bargaining chip. Trump's comments stirred a populist Chinese nationalism, putting Beijing on edge and creating a sour tone to begin his tenure amid an already volatile relationship.

The pressing, real economic issues facing U.S.-China relations are whether to grant China market status in the World Trade Organization and how to counter China's predatory industrial and investment policies. These issues require close U.S., European Union and Japanese cooperation. But Trump's anachronistic views on U.S.-China economic relations -- charging currency manipulation and unfair trade practices -- suggest he is in something of a time warp. Yet he may carry out his threat to impose 45% tariffs. One of his chief trade advisers, Peter Navarro, has argued it was a mistake to allow China into the WTO -- precisely the lever that Beijing's trading partners have used effectively over the past 15 years to counter many of China's trade transgressions.

Indeed, the U.S., EU, Japan and even fellow BRICS India and Brazil have all already hit China with anti-dumping tariffs on some of the industries like steel and aluminum where Chinese overcapacity, fueled by support for "zombie" money-losing state owned enterprises, is roiling world markets -- precisely as the rules of the WTO allow. And in regard to "currency manipulation," from 2006 to 2015 the yuan rose 37% against the dollar as China moved toward financial liberalization, enough so that last year the International Monetary Fund included the yuan in the basket of currencies known as Special Drawing Rights.

Contrary to Trump's views, Beijing's financial intervention of late has been desperately trying to pump up the value of a declining yuan. The further irony is that a combination of the U.S. Federal Reserve raising interest rates and speculation based on Trump's promised stimulus package have spurred a stronger dollar, making U.S. exports less competitive regardless of China's monetary policies.

Real China concerns

Nonetheless, despite wrongheaded views of its causes, Trump is right to chide China as an economic actor: There are serious issues, with China's trade and investment polices adversely impacting the U.S. and Beijing's other major economic partners. In a word, it is a lack of reciprocity flowing from China's predatory, neomercantilist industrial policies that raises questions about whether it is moving backward from its trajectory toward a market-driven economy.

As Xi Jinping took power, the Third Plenum of the 18th Party Congress in 2013 said that its new economic reforms would make markets the "decisive factor" in China's economy. But several stimulus packages starting after 2008 financial crisis have reinforced China's 100,000 or so state-owned enterprises, but at great cost: China's debt has ballooned from 160% of gross domestic product in 2005 to over $250% in 2016, or $27 trillion, amid growing bubbles in the property market and corporate and banking sector debt crises.

Thus, Xi has doubled down on support for SOEs while reform efforts have been largely put on hold. Xi Jinping's agenda subordinates all to consolidating his power at the 19th Party Congress this fall. Even in the financial realm, where Beijing has sought to internationalize the yuan, reforms are faltering.

There has been a large-scale outflow of yuan from China; some estimates place it as high as $530 billion in the first 10 months of 2016. Use of the yuan in China's trade has dropped from 26% to 16% since 2014 and yuan deposits in Hong Kong are also shrinking. To prop up the yuan, China has gone through roughly $1 trillion of its $4 trillion in foreign currency reserves over the past two years. Beijing is considering capital controls, including limited outward investments over $50 million to stanch the bleeding.

This resurgence of economic statism contradicts China's desire to be granted market economy status by the WTO. Under the terms of Beijing's 2001 accession to the organization, its designation as a nonmarket economy expired after 15 years on Dec. 11. The underlying assumption was that by 2015 China would evolve into a market-driven economy. But the language of the WTO accord is silent on what happens after 15 years. Under WTO rules, nonmarket economies must demonstrate that their economies operate on market principles to gain market status. Neither the U.S., nor the EU nor Japan has granted China market status and as a result Beijing has taken the WTO to court, arguing that after Dec 11 it should have been automatically granted market status. Whether or not it attains that status affects the ability of China's trading partners to impose more severe anti-dumping tariffs.

The issue is most likely to be resolved through difficult sector-by-sector negotiations, with many firms in China's buoyant private sector gaining that status, but SOE-dominated industries only phased in as China's many subsidies -- interest-free loans, property and other types of support are phased out.

The question of Chinese cross-border investment is similarly difficult, as China pursues "national champion" industrial policies. U.S. and EU chambers of commerce complain that it is increasingly difficult to do business, with China using arbitrary regulatory measures -- its new nongovernmental organization and national security laws -- to restrict foreign direct investments in information-technology, services and other sectors considered strategic.

Yet Chinese firms are ramping up investments in the U.S., $46.5 billion in 2016, scouring Silicon Valley for tech firms. China is pursuing a 10-year "Made in China 2025" plan to compete in advanced manufacturing (e.g., mobile phone chips, robots, "smart" manufacturing), including multibillion dollar funds to acquire each technology. This has spurred a backlash, heightening screening of proposed Chinese FDI: Last fall, Germany blocked a Chinese firm's acquisition of chipmaker Aixtron, while in December, U.S. President Barack Obama blocked the acquisition of an Aixtron U.S. subsidiary.

Beijing is negotiating bilateral investment treaties with the U.S. and EU, and has reduced its "negative list," but not enough to conclude an agreement with Obama or the EU. Robust BITs would deepen China's economic ties with the U.S., EU and Japan, as well as signaling Beijing's intent to transform its economic model with market reforms.

With regard to China's market status and investment policies, the key is reciprocity. Trade and investment, especially with the world's second-largest economy, must not be a one-way street. There is a risk that China will seek to divide the U.S., EU and Japan on these issues. Any perceived advantage in separate deals with China would be temporary at best. It would only mean China would eat them last.

Thus, it is critical that OECD economies pursue parallel policies aimed at achieving reciprocity with China. One can only hope that Trump's view of China fast-forwards from the 1990s to 2017. As Benjamin Franklin, one of America's founding fathers advised, we must hang together, otherwise we will hang separately.

Robert A. Manning is a senior fellow of the Brent Scowcroft Center for International Security at the Atlantic Council and its Strategic Foresight Initiative. He served as a senior counselor to the undersecretary of state for global affairs from 2001 to 2004, as a member of the U.S. Department of State policy planning staff from 2004 to 2008 and on the National Intelligence Council Strategic Futures Group from 2008 to 2012. tweet: @RManning4

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