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Another messy falling out in China–US relations

Author: Yao Yang, PKU

In 2004, US Nobel Prize-winning economist Paul Samuelson published his last academic paper to tell the world that China’s technological progress may not be good news for US workers. His contention was if China improves its labour productivity on goods that China is already exporting to the United States, then the United States will benefit. But if China begins to improve its labour productivity on goods that the United States is producing and is then ultimately able to replace US companies in producing those goods, then the United States will lose because that will suppress US wages.

Samuelson appeared more connected to reality than his contemporaries, most of whom were stern supporters of free trade. Ten years after the global financial crisis, more US economists have begun to align with Samuelson, and the Trump administration has taken his idea into action.

When the Trump administration announced punitive tariffs on steel and aluminium last month, US allies rushed to Washington to ask for exemptions. Martin Feldstein — the veteran President of the National Bureau of Economic Research — put it bluntly: in the end, every US ally would be exempted, and the only target remaining would be China. He was quite right.

In pursuit of China, of course, steel and aluminium are not the end of the story — China’s steel and aluminium exports to the United States are very small. More serious moves are now in the name of Section 301 investigations. These investigations specifically target intellectual property violations, about which the United States has long complained to China. The Trump administration has announced it will raise tariffs on China’s export worth of US$50 billion, most of which are in the high-tech areas. Although President Trump continues to call China a friend of the United States, the mood in Washington toward China has changed.

After 20 years of animosity, the United States restarted its contact with China in the early 1970s. President Richard Nixon’s historic visit to China in 1972 opened a new chapter for US–China relations. The two countries walked together because they faced the same arch-enemy — the Soviet Union. On the US side, a ‘rapprochement’ policy was formed to guide its relations with China, which ultimately led to the establishment of diplomacy between the two countries in 1979. The 1980s were then a honeymoon for the two countries. The United States gave most favoured nation (MFN) status to China and it tolerated China’s mercantilist policies (such as dual exchange rates). There was also military cooperation between the two countries.

The honeymoon ended abruptly after the 1989 Tiananmen Square protests. The United States and its allies imposed an arms embargo on China. The George Bush Sr administration and later the Clinton administration did not, however, isolate China. Instead, a new ‘engagement’ policy was fashioned. The belief behind this policy was that, by engaging China, ‘China will become more like us’.

Economic integration was the cornerstone of the policy. In 1995, then US president Bill Clinton delinked China’s MFN status from its human rights record. In 2001, then US president George Bush Jr signed the agreement to take China into the World Trade Organization. This was a critical step in unleashing China’s export potential, which was supported by millions of low-wage but relatively well-educated workers. In the next seven years, China’s exports increased five-fold.

The winds began to change after the global financial crisis. The Chinese economy performed much better than the rest of the world, mostly thanks to its swift monetary and fiscal responses. Over the past decade, China has quickly narrowed its gap with the United States in terms of GDP. Relying on its newly acquired wealth, China began to take a more active role on the international stage—and that set alarm bells ringing on the American side of the Pacific.

To US elites, China’s sovereign claims in the South China Sea are a move that violates ‘freedom of navigation’, and China’s expansion of development aid through a set of new financial instruments (such as the Asian Infrastructure Investment Bank, the New Development Bank and the Silk Road Fund) shows China’s intention to set up a new financial system that is parallel to the Bretton Woods Institutions. Most of all, US elites are worried that China is exporting its political system alongside its development aid. This fear seems to have been reinforced by the political changes that have happened within China. In a nutshell, US elites now seriously doubt that ‘China will become more like us’.

The mood in Washington has shifted from engaging with China to hedging against it. US elites no longer care about what is happening inside China, be it economic liberalisation or human rights violations. They only care about how China impacts on the United States. The Chinese bargaining chips that used to please the United States, such as small steps of market opening and large purchases of US goods, do not work anymore.

Punitive tariffs are just the warm up for a coming marathon in technological competition. In the years ahead, it is highly likely that the Trump administration will tighten up its control on Chinese companies’ merger and acquisition activities in the United States. It is also possible that the United States will ask the European Union to join in these measures. Judging by the mood in Europe, the European Union is unlikely to object. This will remove one of the most important channels for China to upgrade its technology.

On the China side, it is imperative for policymakers to recognise the change of attitude in Washington and form a new strategy to deal with the United States. A more domestically oriented policy is needed. Announcing retaliative tariffs is a short-term response. The right long-term response is to continue China’s reform and opening policy, which has been critical to China’s 40 years of high growth. This was exactly the message sent by President Xi Jinping in his Boao speech on 10 April.

Reform and opening will not only defeat Trump’s excuse for the trade war, but also create conditions favourable for China’s technological upgrading.

Yang Yao is Dean of the National School of Development, director of the China Center for Economic Research, a Cheung Kong Scholar and a Boya Chair Professor at Peking University.

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