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A reformed China is a stronger China, and such is the US dilemma

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Author: Joshua P Meltzer, Brookings

The United States ratcheted up economic pressure on China throughout 2018, raising tariffs on Chinese imports — US$250 billion so far — to which China retaliated by raising tariffs on US imports. Following the Trump–Xi meeting at the G20 in November, the United States agreed to a 90-day pause on further tariff increases. Both sides will use the time to address US concerns over Chinese trade practices, including those regarding intellectual property theft and market access.

Workers are seen on scaffolding at a construction site in Nantong, Jiangsu province, China, 1 January 2019 (Photo: Reuters/Stringer).

The immediate response to the G20 deal was one of relief, with stock market gains the following day. But given the complexity of the issues bedeviling the bilateral relationship, it is unlikely that much progress can be made in 90 days. There is no short-term prospect of a deal with China that would address all US concerns. Instead, US–China trade ties are likely destined for growing tension and disengagement.

The contours of any deal that China has offered so far are not close to addressing US trade and investment concerns. As articulated in the Special 301 Report in April 2018, these include issues with forced technology transfer, strategic investment by Chinese state-owned enterprises (SOEs) in US technology companies, and government-directed cyber theft of US corporate intellectual property. Addressing these issues would require fundamental reform of the Chinese economy, and there is no indication that this is on the table.

There is also a tension between US demands that China reform economically and US national security concerns. While access to the Chinese market remains commercially important, closer trade and investment increases US vulnerability by giving China opportunities to exploit access to US technology and intellectual property.

Suppose that China agrees to all US demands: reforming its SOEs, opening its markets and expanding the role of the private sector in its economy. The outcome will be increased trade and investment between the two countries, as well as a more economically competitive and capable China. But a more economically capable China would present a sharper strategic challenge for the United States.

For one, economic growth underpins military strength. In 2016, China spent US$228 billion on its military, up from US$50 billion in 2001 — more than the combined defence spending of Japan, South Korea, the Philippines and Vietnam, and second only to the United States. And while this is an increase in military spending of over 350 per cent, it is sustainable because China’s economy has grown by around 950 per cent since 2001.

Second, as China grows, other countries — in Asia in particular — will become more economically dependent on China. China has already replaced the United States as the largest export market for countries such as South Korea, Thailand and Vietnam. China has demonstrated a willingness to exploit this economic dependence to achieve other goals. It restricted tourism to Taiwan following the election of President Tsai Ing-wen who is not in favour of close integration with China, for instance, and it enacted investment restrictions against South Korean businesses in response to the country’s deployment of the US Terminal High Altitude Area Defense (THAAD) missile system.

Finally, China is transitioning from an economy based on manufacturing to one based on services and innovation-led growth. This type of economic growth will continue to create strong incentives for China to use the tools at its possession to obtain the intellectual property of developed countries, legally or otherwise. China’s aim to dominate the heights of technology by 2025 effectively mandates such an approach.

While Chinese intellectual property theft and other practices created costs for the United States in the past, they were tolerated in part because the larger economic relationship generated net economic gains. But this calculation no longer seems to hold, and not only because the economic costs continue to rise. Once national security costs are taken into account, the status quo is no longer sustainable.

The US administration has yet to fix a particular outcome for the US–China economic relationship. But policies are being developed that will have the effect of isolating China economically. One of these is the US–Mexico–Canada Agreement (USMCA), which includes a provision that should another party enter into a free trade agreement (FTA) with a non-market economy, other parties can leave the USMCA and form their own bilateral agreement. It is the first time that the United States has included such a provision in an FTA, and it is widely seen as aimed at deterring other countries from increasing trade with China. Such commitments could be included in future FTAs with Japan, the European Union and the United Kingdom.

The Export Control Reform Act of 2018 (the Reform Act), replacing the Export Administration Act of 1979, also has potentially significant consequences for US trade and investment with China. Under the Reform Act, the Department of Commerce must create new export restrictions on ‘emerging and foundational’ technologies that are important to the defence community but not otherwise captured under the US export control regime. The outcome of this process will be tighter control over and the limiting of exports to and investment in China.

What these measures underscore is the tension between expanding US–China trade and investment, and the emerging US view that growing economic ties with China undermine national security. Instead of the United States and China being on the cusp of a deal, the two countries could instead be in for a prolonged period of economic tension and disengagement.

Arresting this slide and reconstituting sustainable US–China economic ties will require a new understanding between the two countries on acceptable forms of economic behaviour. This consensus will take time to achieve. The question is whether the Trump administration has the strategy and desire to see it through.

Joshua P Meltzer is Senior Fellow in the Global Economy and Development program at the Brookings Institution, Washington DC.

This article is part of an EAF special feature series on 2018 in review and the year ahead.



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