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Future of Trade, Technology, Energy Order

Working Paper

[Working Paper] The United States, China and the Asia-Pacific: The Shifting Economic Agenda

  • 2019-04-18
  • Stephan Haggard, Barry Naughton

ISBN  979-11-88772-69-8 95340

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<p font-size:="" nanum="" style="font-family: " text-align:=""><span style="font-size: 16px;"><strong><span style="color: rgb(218, 165, 32);"><u>Editor&#39;s Note</u></span></strong></span></p>

<p font-size:="" nanum="" style="text-align: justify;" text-align:="">US economic policy toward China has centered on the integration of the country into the US-led global rule-based system since its opening up in 1978. However, this approach has been shaken since the Trump administration abandoned many of the pillars of liberal institutionalism. The clash between such shifts and China&rsquo;s increasingly statist developmental approach under Xi jinping has led to tensions between the US and China. In the lead paper in this collection, Stephan Haggard and Barry Naughton examine policy changes of the two countries and the implications as well as the resulting conflicts which have risen. The authors also offer a careful analysis and map out three possible scenarios of the prospects for US-China relations in the short- and intermedium term.</p>

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<p style="text-align: justify;"><span style="font-size:16px;"><strong><span style="color:#000080;">Quotes from the paper</span>&nbsp;</strong></span></p>

<p style="text-align: justify;"><span style="color:#0000CD;"><strong>Introduction</strong></span></p>

<p style="text-align: justify;">Since the opening to China in the 1970s, US foreign economic policy toward the country was an integral part of the US&rsquo;s broader defense of a liberal, rule-based global economic system. The core to this strategy was the integration of China through the negotiation of binding rules, with China&rsquo;s entry into the WTO as the crowning moment of the approach. Despite disagreements at the margin, this strategy not only united the US&rsquo;s two political parties; it also enjoyed support among US allies.</p>

<p style="text-align: justify;">Since 2016, however, this approach has virtually collapsed under the weight of developments on both sides of the Pacific. In the US, the Trump administration unambiguously rejected basic premises of the liberal institutionalist approach. In China under the leadership of Xi Jinping, there has been a return to a more statist, developmentalist posture toward economic policy, with new industrial policies, greater emphasis on state-owned enterprises, and a strengthened Communist Party role.</p>

<p style="text-align: justify;">This paper begins with a brief consideration of possible growth trends going forward and their implications. We will then examine the US-China conflict in more detail and consider a number of possible scenarios for both the short- and intermediate run.</p>

<p style="text-align: justify;">&nbsp;</p>

<p style="text-align: justify;"><span style="color:#0000CD;"><strong>China&rsquo;s Growth History: Policy and Prospects</strong></span></p>

<p style="text-align: justify;">Since the onset of &ldquo;reform and opening&rdquo; in 1978, China has undergone dramatic economic and political changes, but with a noticeable policy turning point in 2006-2007. China&rsquo;s export ratio (exports/GDP) increased steadily up this point, with an especially rapid increase in 2002-2005 following its entry into the WTO. Since 2006-2007, China&rsquo;s export ratio has declined just as inexorably, although it may now (2019) be stabilizing.</p>

<p style="text-align: justify;">This shift in the role of trade was related to broader changes in China&rsquo;s development trajectory, which were in turn related to the country&rsquo;s secular slowdown. From 1978 through 2010, annual GDP growth averaged 10%. After 2010, the growth rate began to decline, falling below 8% in mid-2014, and now approaching 6% (from above). Even if China does not experience a sharp &ldquo;hard landing&rdquo; associated with the unraveling of excess indebtedness (discussed later), growth will likely continue to slow. This slowdown arises from challenges in raising productivity as China nears the technological frontier&mdash;at least in some areas&mdash;as well as labor market dynamics. Most long-run forecasts predict a significant &ldquo;kink&rdquo; in growth around 2028. At that point, China&rsquo;s labor force will begin to decline much more significantly than today, just as the burden of an aging population begins to kick in.</p>

<p style="text-align: justify;">&nbsp;</p>

<p style="text-align: justify;"><span style="color:#0000CD;"><strong>A Closer Look: The Political Economy of Chinese Growth in the Medium-Run</strong></span></p>

<p style="text-align: justify;">Through 2006, promotion of export-led growth was a key motive of policy-makers; interest groups formed that were created by export-led growth; and these interest groups tended to support policies favorable to the country&rsquo;s post-reform development strategy.</p>

<p style="text-align: justify;">Since 2007, this picture has changed dramatically as growth strategy has shifted. The structure of interest groups seems to have shifted. As China has changed from an important recipient of incoming foreign direct investment (FDI) to an important source of outgoing foreign direct investment (OFDI), new opportunities for lobbying and new interest groups have sprung up, for example among China&rsquo;s state-owned banks and corporations which have themselves gone global. Yet policy shifted dramatically at the end of 2016 from welcoming aggressive corporations expanding abroad to reigning them in sharply (for example Hainan Airlines, Wanda Corporation, and Anbang Insurance). The government now seeks to channel resources into state-controlled initiatives, both in the Belt and Road Initiative (BRI) and in international extensions of government-led technology initiatives. These steps were leading to heightened international conflict even before China&rsquo;s foreign economic environment was disrupted by the Trump shock.</p>

<p style="text-align: justify;">Finally, we should make mention of politics. It has long been held not only as a statistical regularity but as a virtual law that when countries reached a certain threshold&mdash;around $6,000 in 1990 dollars or about $10,000 today&mdash;they were highly likely to democratize; the exceptions were largely oil states. China to date has not only proved an exception to this rule, but seems to be moving in the opposite direction under Xi Jinping. China is becoming more rather than less authoritarian.</p>

<p style="text-align: justify;">&nbsp;</p>

<p style="text-align: justify;"><span style="color:#0000CD;"><strong>U.S. Strategy: Integrating China into a Rules-Based Order</strong></span></p>

<p style="text-align: justify;">The traditional U.S. approach to China involved emphasizing China&rsquo;s role as a &ldquo;responsible stakeholder&rdquo; in a global system of which it had been an enormous beneficiary. The approach was by no means static; as China&rsquo;s comparative advantage shifted, the U.S. sought concessions in areas that reflected changing U.S. comparative advantage, particularly as regards the investment and regulatory climate for American firms. Efforts to encourage China to sign up to international institutions with binding rules or to negotiate transparent bilateral commitments, however, were a key component. These were coupled with dispute settlement mechanisms for enforcement. In addition, foreign actors&mdash;including but not limited to the U.S.―presumed that an evolving legal and administrative system in China itself would provide the basis for foreign parties and their allies to check executive discretion and backsliding, thus keeping the reform process moving forward.</p>

<p style="text-align: justify;">[&hellip;]</p>

<p style="text-align: justify;">To be sure, the U.S. and China were clearly co-dependent. In the U.S., a coalition of powerful American firms had strong vested interests in the relationship because of their investments in China. These investments produced low-cost sourcing networks for a vast range of goods and also provided goods and services for the Chinese domestic market. The U.S. also benefitted from inflows of official Chinese capital to keep government borrowing costs low. Yet China was ultimately portrayed as the more vulnerable partner, needing access to the U.S. market and investment not only for economic reasons, but to deliver robust growth for domestic political reasons.</p>

<p style="text-align: justify;">&nbsp;</p>

<p font-size:="" nanum="" style="font-family: " text-align:=""><span style="color:#0000CD;"><strong>Challenges to the Liberal Approach: The U.S. Home Front</strong></span></p>

<div style="text-align: justify;">A number of developments are clearly challenging this rule-based approach, starting with the radical departure from elite consensus reflected in the election of Donald Trump. There is ongoing debate about whether Trump&rsquo;s approach is personal and idiosyncratic. If so, then trade policy will simply &ldquo;snap back&rdquo; to the post-Trump consensus under a new president, whether Democrat or Republican. Although such a reversion to the historical mean is possible, there is a growing consensus that a genuine partisan realignment has occurred around trade issues, with the Republican base now more skeptical of globalization than its Democratic counterparts. Pressure to &ldquo;do something&rdquo; on trade vis-&agrave;-vis China is likely to persist regardless of who is in the White House or in control of Congress, in part because of rising concerns about Chinese grand strategy.</div>

<div style="text-align: justify;">&nbsp;</div>

<div style="text-align: justify;">&nbsp;</div>

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<p style="text-align: justify;"><span style="color:#0000CD;"><strong>Challenges to the US Approach: China Reimagined</strong></span></p>

<p style="text-align: justify;">First, while China continues to be a relatively open economy for its size&mdash;measured by trade as a share of GDP―there is growing evidence that its hybrid model is by no means trending in a more liberal direction. Although industrial policy never completely went away, the commitment of resources to industrial policy accelerated steadily since the shift noted above that occurred around 2006. In addition to the ongoing focus on exports, new attention was paid to achieving competitiveness in a range of cutting-edge industries. The roll-out of a series of policy tools mobilized to support these programs was emblematic of the new state-led push to foster indigenous innovation and upgrade manufacturing. Moreover, these developments were taking place in sectors that not only had relevance for China&rsquo;s economic position but for its military modernization as well (see Cheung 2019).</p>

<p style="text-align: justify;">[&hellip;]</p>

<p style="text-align: justify;">Second, the liberal presumption that the existing institutions constitute the only meaningful game in town is also being challenged. While the United States and Western Europe re-evaluate the efficacy of a rule-based approach, China is building its own international institutional alternatives. These include its tacit alliance with ASEAN on the Regional Comprehensive Economic Partnership (RCEP), a more-or-less explicit alternative to the TPP. Progress in RCEP has been slow in part because of the greater heterogeneity of the parties, most notably in India&rsquo;s foot-dragging. However, RCEP has potential strategic influence because it is an intra-Asian not trans-Pacific entity. Moreover, its consensus-driven approach to trade policy has a profound political logic: &ldquo;low-lying fruit&rdquo; and &ldquo;early harvests&rdquo; yield gains to the parties while difficult issues are pushed off. Although technically in violation of Article XXIV of the WTO, which calls for FTAs to liberalize &ldquo;substantially all trade,&rdquo; the RCEP may be rewriting rules around a looser, more iterative approach to trade policymaking that yields somewhat less but locks parties into an alternative to TPP-style negotiations.</p>

<p style="text-align: justify;">&nbsp;</p>

<p style="text-align: justify;"><span style="color:#0000CD;"><strong>Future Prospects and Medium-Run Scenarios</strong></span></p>

<p style="text-align: justify;">What can we say about the prospects for U.S.-China relations going forward, looking not only at the short-run but the intermediate term? Three possible scenarios present themselves. The first possibility is that the &ldquo;reverse course&rdquo; visible in the two countries will prove to be an aberration. In this scenario, Trump&rsquo;s legacy is not enduring. In 2020, the U.S. turns back toward the well-worn divisions over trade policy, but with adequate bipartisan support for liberal rules of the road. This would not mean the end of pressure on China, but it would occur within established bilateral dialogues and through use of WTO and other bilateral mechanisms.</p>

<p style="text-align: justify;">[&hellip;]</p>

<p style="text-align: justify;">A second possibility, one we think more likely, is that skepticism about China in the U.S. will continue to rise and that Xi&rsquo;s legacy of a more statist political economy will endure in China. Yet even with the new directions staked out by Trump and Xi, the two countries might manage to negotiate a modus vivendi, however brittle, that would persist across administrations. Both sides would make compromises. Xi would need to make some concessions, most notably with respect to IPR issues, and Trump would not only have to roll back sanctions but promise&mdash;perhaps privately&mdash;to forego their use going forward. This path would not necessarily reflect a fundamental departure in worldviews; rather it would be driven by pragmatic concerns and rising uncertainties on both sides about the sustainability of trade conflict as costs mount.</p>

<p style="text-align: justify;">[&hellip;]</p>

<p style="text-align: justify;">The third possibility is for a period of sustained conflict in the U.S.-China relationship and even the possibility of what is now called &ldquo;decoupling.&rdquo; Unfortunately, there are already elements of this possibility in the National Security Strategy and other documents dealing with U.S. defense posture. The implications of chronic system conflict for the world economy are potentially grave and we can at least imagine the conflict generating a worldwide downturn. Yet we can also imagine this conflict taking very different forms, such as a gradual disengagement of the Chinese and American economies as both seek to diversify and build coalitions of support through their favored policy approaches</p>
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<p style="text-align: justify;"><span style="color:#DAA520;"><strong>Author&rsquo;s Biography</strong></span></p>

<p style="text-align: justify;">&nbsp;</p>

<p style="text-align: justify;"><strong>Stephan Haggard</strong> is Professor at the School of Global Policy and Strategy, University of California, San Diego. Haggard has written extensively on the East Asian developmental state; on comparative transitions to democracy and welfare states worldwide (with Robert Kauffman), and on North Korea. His most recent book is Developmental States (2018), in the Cambridge Elements series. Haggard has a Ph.D. in political science from U.C. Berkeley (1983).</p>

<p style="text-align: justify;"><strong>Barry Naughton</strong> is Professor at the School of Global Policy and Strategy, University of California, San Diego. Barry Naughton has written extensively on the Chinese economy, with an emphasis on market transition, technology and trade, and political economy. His most recent book is the revised and updated edition of his textbook, The Chinese Economy: Adaptation and Growth (2018 from MIT Press). Naughton has a Ph.D. in economics from Yale University (1986).</p>

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