TRADE WORLD WAR
CHINA VS THE WORLD
 
The evidence is clear, China declared economic war on the rest of the world even as the Clinton, Bush, and Obama administrations all sought engagement and dialogue with China’s leaders. For decades, U. S. policy-makers believed and hoped that this would lead the Chinese government to retreat from its mercantilist path. However, it is now abundantly clear to objective analysts that this approach has failed. Rather than reform, China has doubled-down on its so-called “innovation-mercantilist strategies.” And, despite the claims of some apologists for Chinese behavior, the end-game is clear: Chinese-owned companies across a range of advanced industries are gaining significant global market share at the expense of American, European, Japanese, and Korean competitors.

In a landmark report, the Information and Innovation Foundation (or ITIF) argues that a far more proactive, broad-based response, in tight-partnership with our allies, is needed to ensure that Chinese “innovation mercantilism” is contained and rolled back. Our goal must be to restore the genuine market-based and rules-based global trading system envisioned when the WTO was established.

To understand how we got here, and why so few policy-makers have understood it, consider the recent history of China.

In 2015, Chinese President Xi Jinping unabashedly trumpeted his goal of making China the “master of its own technologies.” By this he meant that Chinese firms, operating in China, would produce virtually all technology goods and services for Chinese consumers. China’s arrival at such a point resulted from the evolution of Chinese economic policy over the past two decades. Up until the mid-2000s, Chinese economic-development strategy sought principally to attract foreign direct investment (or FDI) and induce foreign multinational corporations to shift production to China. That production was mostly in more traditional manufacturing. Even then, China used an array of unfair tactics to achieve that goal, including systemic currency manipulation, massive subsidies to firms, limits on imports, and requirements for forced local production by firms wishing to sell products in China.

That strategy changed in 2006, as China shifted to a so-called “China Inc.” development model of indigenous innovation. This focused on enabling Chinese firms, particularly those in advanced, innovation-based industries, at the expense of foreign firms.

China’s “National Medium-Term and Long-Term Program for Science and Technology Development (2006-2020),” is referred to as the “MLP.” The MLP essentially announced that modern Chinese economic strategy sought absolute advantage across virtually all advanced industries. It fundamentally rejected the notion of comparative advantage?which holds that nations should specialize in the production of products or services at which they are the most efficient and trade for the rest. Instead, China’s goal today is to dominate in production of both advanced-technology products such as airplanes, semiconductors, computers, and pharmaceuticals, as well as commodity manufacturing. Ultimately, Chinese policymakers wish to be self-sufficient in supplying Chinese markets for advanced-technology goods and services with their own production while still benefitting from unfettered access to global markets for their technology exports and foreign investment, the latter designed to acquire and integrate into Chinese firms’ know- how, often based on foreign technology.

Put simply, China is increasingly pursuing a strategy of shutting out foreign competitors in these sectors in the interest of supporting domestic industries.

To this end, China has deployed a vast panoply of “innovation-mercantilist practices” that seek to unfairly advantage Chinese producers at the expense of foreign competitors. These practices have included

- forced IP and technology transfer as well as forced local production as a condition of market access;

- theft of foreign IP;

- curtailment and even outright denial of access to Chinese markets in certain sectors;

- manipulation of technology standards;

- special benefits for state-owned enterprises (or SOEs);

- capricious legal cases designed to force foreign companies to license technology at a discount;

- refusing to allow access to key resources (such as, rare earth elements) unless companies locate in China; and

- even government-subsidized acquisitions of foreign technology firms.

We can already see the implications. Sixty percent of the global U.S. trade deficit in 2015 was with China. U.S. manufactured imports from China were six times larger than U.S. exports to China that year. Moreover, in 2015, in the 10 largest high-technology sectors in U.S.-China trade, Chinese exports were $1.12 trillion?50 percent larger than America’s $752 billion of exports.

Furthermore, overall Chinese trade in these same 10 high-tech sectors was in surplus by $354 billion, while the U.S. was in deficit by $357 billion. Worse, from 2009 to 2015, the Chinese surplus in these sectors soared by 128 percent, while the U.S. deficit grew by 166 percent. This shift coincided with a cratering of the U.S. share of global exports of manufactured products.

Indeed, the U.S. share of global exports of manufactured products plunged from 18 percent in 2000 to 12 percent in 2015, while China’s share quadrupled from 6 to 24 percent over that time period. To put this in absolute terms, U.S. exports of manufactures of $650 billion in 2000 were almost three times larger than Chinese exports of $220 billion that year while, by 2014, Chinese exports of $2,2 trillion were almost double U.S. exports of $1.2 trillion.

OECD research into trade finds that “China’s trade surplus with the United States shrinks by a quarter when calculated according to which countries provide the parts and services that go into its exports and imports.” But even if that is the case, a gross imbalance in U.S.-China goods trade over the past decade-and-a-half remains.

Extrapolating this trend through 2050, we could very well envision a world where U.S.-China trade is in balance, but where the structure of both the trade and national economies has radically shifted, with China’s exports and economy shifting to “higher-value-added advanced industries,” while America’s exports and economy become more “commodity- and natural-resource based,” with increases in food, fiber, and mineral exports (along with waste paper, our fastest growing export to China, by volume). Indeed, the fastest-growing U.S. exports to China from 2005 to 2015 were vegetables, tobacco, cereals, food residue and waste, beverages, explosives, and mineral fuels. At this rate, America can go back to being an economy made up of “hewers of wood and drawers of water.”

In order to effectively respond to Chinese mercantilism, U.S. policymakers are, beginning to acknowledge that “China, Inc.” is not like capitalist western democracies including Japan. Contrary to what most economists have assumed, there are six factors that together make China fundamentally different.

1. China’s growth strategy is predicated on mercantilism; that means seeking to grow by cranking up exports and limiting imports. To be clear, this is not unique to China; many Asian nations have relied on this strategy. But when combined with the other factors, China becomes unique.

2. Chinese strategy is not just about mercantilism, it’s about so-called “autarky,” another word for becoming self-sufficient. The Chinse government has proven that it seeks autarky in many traditional industries, such as steel and shipbuilding, and now wants it in emerging industries such as aerospace, computers, and semiconductors, placing itself counter to the fundamental tenet of comparative advantage that underlies liberalized trade in the globaleconomy.

3. It’s not simply that China’s focus is to transform its industrial structure to higher-value- added industries; it’s also that this goal is to be achieved principally by Chinese firms. In contrast to some nations that sought to do this and relied at least in part on foreign firms, such as Singapore and Ireland, China has made clear through its indigenous innovation strategy that foreign firms in China serve as a “means”?transferring technology to Chinese firms?and are not an “end” inthemselves.

4. Unlike market-oriented democracies, China lacks separation between the state and the market. Not only are SOEs a major component of China’s economy, but many private firms are not fully autonomous, subject to influence by the Chinese state.

5. While China is not the only nation lacking “the rule of law,” the lack thereof makes enforcing actions against China in venues such as the WTO difficult, to say the least. For example, while the Chinese government is correct when it states that it does not have official rules mandating technology transfer in exchange for market access by foreign firms, the fact that these requirements are systematically enforced in informal ways makes them just as effective, but almost impossible to prosecute. And,

6. China’s size. As the second-largest economy by gross domestic product and largest in terms of population, China is unique. Its size plays out in two ways. First, because its market is so large, no multinational firm can easily walk away from the Chinese market. As such, Chinese officials know that they have foreign firms over a barrel: either comply with their discriminatory policies or lose market access. Second, the country’s large size means that China’s policies have an outsized effect on many nations. If a smaller nation such as Thailand did everything China does, it would be an irritant, but only that. When China uses these types of polices, it represents a fundamental threat to the very fabric of the global trading system.

Given this trend, we offer the following forecasts for your consideration.

First, in the coming year, the administration, supported by Congress, will acknowledge important realities about the Chinese economic threat, including:

1. China is so large and its innovation-mercantilist practices so egregious and all-encompassing that it should be the principal focus of U.S. trade enforcement policy.

2. As it stands, China’s strategy is a fundamentally mercantilist one, which seeks self-sufficiency in serving domestic markets through local production. That means developing China’s own high-tech, innovation-based industries even as it excludes foreign competition in such sectors.

3. When China pursues innovation-mercantilist policies directly, it threatens the health and viability of American (and other foreign) enterprises. This needs to be contested in the most vigorous manner possible by U.S. government agencies with enforcement power, whether under U.S. law or pursuant to international agreements.

4. China will not abide by the fundamental free-market tenets on which the WTO is based unless the U. S., EU and Japan adopt a policy of “constructive, alliance-backed confrontation” with China for violation of principles including fair treatment, reciprocity, and transparency.

5. Chinese economic policy has tremendous implications for U.S. national security beyond U.S. economic competitiveness through the vitality of the U.S. industrial base, the security of components which pass through defense industrial supply chains, and the ability of U.S. economic strength to finance a robust national security and defense apparatus.

6. If China is to be a member of the international community, it must provide access to its markets on fair terms, so that U.S. enterprises and industries (along with those of other foreign countries) have every opportunity to be competitive global players in the sectors in which they compete. And,

7. A win-win economic and trade relationship with China is only possible if it is grounded in the framework of rules-based, market-determined, enterprise-led trade activity. The U. S. can only achieve this with the assistance of like-minded allies.

Second, given this new reality, the United States will adopt a new strategic direction for trade by 2020 based on the following strategies:

- Work with our allies to create and maintain a comprehensive “bill of particulars” on Chinese innovation-mercantilist policies and practices, and decide which elements will be brought to the WTO for action and where new rules are needed.

- Develop new and improved rules that fully address Chinese innovation mercantilism, and agree to pursue implementation of them with like-minded countries. And

- Make sure any agreements with China include these new rules.

Third, by 2021, the administration and Congress will make organizational reforms within the U.S. federal government to enable an effective and coordinated response to Chinese economic aggression.

These actions will most likely include:

- Establishment of an “Industrial Intelligence Unit” within the National Intelligence Council.

- Creation of a sub-directorate within the National Security Council responsible for raising to the highest levels of the U.S. government the need to develop and coordinate an inter-agency response to combatting foreign innovation mercantilism.

- Creation of an “Office of Competitiveness” within the United States Trade Representative’s Office, whose job it is to identify, in collaboration with an interagency trade task force, foreign government policies and practices that do not necessarily violate the WTO, but that hurt U.S. commerce. Staff and resource this new office with economists with industrial-sector experts, lawyers, and other professionals who understand the implications of China’s mercantilist practices.

- Staff and resource the United States Trade Representative’s Office and other federal agencies which play an important role in confronting Chinese innovation mercantilism to reflect the scale and importance of their duties. And,

- Expand America’s network of intellectual property and digital trade attaches around the world.

And,

Fourth, by 2020, the U. S. will establish stronger processes to contest Chinese Innovation Mercantilism.

Organizational reforms, will need to be accompanied by new approaches and processes to respond to China’s innovation-mercantilist policies. To do that, the administration and Congress will do the following:

1. Establish Stronger Processes to challenge Chinese Innovation Mercantilism

2. Rethink Key Policies Toward Contesting Chinese Innovation Mercantilism, and

3. Take Additional Administrative and Legislative Actions including:

- Denying use of the U.S. banking system to companies benefitting from stolen IP.

- More closely coordinating domestic IP actions with foreign policy actions.

- Providing enhanced small-claims mechanisms for small- and medium-sized enterprises to bring IP actions against those stealing their IP.

- Providing technical assistance and support for companies retaliated against in China for bringing trade complaints.

- Continuing to not recognize China as a “market economy” and amending U.S. trade law to reflect that “non-market-economy status” includes “state planning” and “control over intellectual property and technology.” And,

- Adjusting, curtailing, or cutting off scientific and other cooperation in the absence of progress on Chinese mercantilism.

References

1. Robert D. Atkinson, Nigel Cory, And Stephen J. Ezell. Information Technology & Innova- tion Foundation, March 2017. Stopping China’s Mercantilism: A Doctrine of Constructive, Alliance-backed Confrontation.

2. The State Council of the People’s Republic of China. The National Medium- and Long- Term Program for Science and Technology Development (2006-2020). 2006.

https://www.itu.int/en/ITU-D/Cybersecurity/Documents/National_Strategies_Repository/China_2006.pdf

3. Cong Cao, Richard P. Suttmeir, and Denis Fred Simon. Physics Today, December 2006. China’s 15-Year Science and Technology Plan.

http://china-us.uoregon.edu/pdf/final%20print%20version.pdf

4. Sylvia Schwaag Serger and Magnus Breidne. Asia Policy, July 2007. China’s Fifteen-Year Plan for Science and Technology: An Assessment.

http://www.nbr.org/publications/asia_policy/Preview/AP4_China15yr_preview.pdf

5. John Veroneau and Shara Aranoff. Politico. April 6, 2016. How to Stop Our Partners’ Un- fair Trade Practices.

http://www.politico.com/agenda/story/2016/04/how-to-stop-our-partners-unfair-trade-practices-000084