President Donald Trump has postponed until at least April the supposed deadline for concluding the United States’ current trade negotiations with China. A good outcome for both sides would be reached if China agreed to protect property rights better and reduce the state’s role in its economy; the US agreed to strengthen national saving and public investment; and both sides agreed to reverse their recent tariff increases. Unfortunately, this is not the deal that is likely to materialize.
For starters, Trump fixates on the bilateral US merchandise trade deficit. The Chinese could probably deliver on the verifiable -- but worthless -- step of committing to buy more US soybeans, natural gas, and other commodities. But this would have little or no effect on the overall US trade balance, because the US would export less soybeans and natural gas to other countries. Congressional Democrats would rightly point out that the gain was illusory, again highlighting the irrelevance of bilateral trade balances. The more meaningful measure -- the overall US trade deficit -- widened last year, the predictable result of Trump’s budget-busting fiscal policy.
The US and other countries have more legitimate complaints against China regarding technology transfer and intellectual property rights. The effective way to pursue these grievances would have been in cooperation with allies, via multilateral institutions such as the World Trade Organization Partnership. But Trump has gone out of his way to take the opposite approach, making progress difficult.
It is not easy to detect a coherent rationale for US trade policy under Trump. If one exists, it most probably involves pushing China to restructure its economy by providing a greater role for the market, shrinking the state sector, and lessening pervasive government control. Certainly, this has been the overall approach of previous US administrations.
Generally speaking, pro-market reforms would tend to be in China’s interest, too -- as many Chinese economists also recognize. A good example is government subsidies for steel mills and other heavy industry, particularly in the form of cheap loans from state banks. This was one component of China’s fiscal expansion in response to the global recession a decade ago. The subsidies left China with tremendous excess steel capacity -- bad for economic efficiency and foreign competitors.
Although the Communist Party of China endorsed a pro-market shift in late 2013, little or no progress has been made since. On the contrary, it has become clear that President Xi Jinping is not interested in reducing the size or role of the state. Inefficient state-owned enterprises continue to enjoy easier access to bank loans than more dynamic private firms. Nicholas Lardy of the Peterson Institute for International Economics points out that Xi has rolled back market reforms. This may reflect Xi’s failure to appreciate the potential economic advantages of free markets, or his belief that maintaining political control over Chinese society is worth the economic cost.
The US has also long used free-market rhetoric in criticizing the renminbi’s exchange rate. Since 2003, US politicians have complained that the Chinese authorities intervene in the foreign-exchange market to keep the renminbi unfairly undervalued. Although the US objective was to help its companies compete against lower-cost Chinese producers, it pursued this under the guise of pressing for a market-determined exchange rate.
For 10 years, this position made sense. But in 2014, market forces changed direction. Since then, the People’s Bank of China’s has had to spend almost $1 trillion to stem the depreciation of its currency. Had the PBOC let the market work, as US politicians demanded, the renminbi would have fallen even further.
Trump, as candidate and as president, has attacked China for manipulating the exchange rate. A strong renminbi is apparently still a key US demand in the current negotiations. The Chinese authorities, for their part, have no desire to let their currency fall freely. But all now recognize that the goal of stabilizing the renminbi’s exchange rate is no longer consistent with US rhetoric about reducing government influence and letting the market work.
The structural-reform component of the current US-China negotiations recalls similar talks with Japan three decades ago, which were prompted by congressional anger at the large US trade deficit with that country. In June 1990, under the Structural Impediments Initiative, the Japanese government agreed to a detailed set of policy reforms requested by President George H.W. Bush’s administration.
The SII aimed to correct the bilateral trade deficit with more fundamental and effective measures than tariffs. Japan, for example, agreed to tighten enforcement of its competition laws, loosen ties among its keiretsu (industrial groupings), make it easier for large retail chains to open stores, and reduce the bias toward using land for rice farming. The US, meanwhile, agreed to domestic reforms intended to increase its household saving rate, reduce the tax bias toward debt-financed home ownership, and strengthen investment in education and training.
These reforms were designed to reduce the countries’ trade imbalances, especially by narrowing the gap in their national saving rates. But a noteworthy feature of SII was that both the US and Japan requested measures that would make the other’s economy more efficient.
As it happened, the “Japan threat” began to melt away soon after the SII, but not because of US or Japanese trade policy. Instead, Japan’s three-year financial bubble burst in 1990, and its economy has never quite recovered since.
Still, SII was a success, because it led to some modest steps toward mutually beneficial reforms and avoided destructive tariffs and quotas. In theory, it could serve as a useful model for the current China-US negotiations, if they were in similarly competent hands.
Unfortunately, the two countries’ leaders may not have such a firm grasp on economic principles. Xi appears to care only about maintaining political control, while Trump seems to care only about himself.Jeffrey Frankel
Jeffrey Frankel is professor of capital formation and growth at Harvard University. -- Ed.(Project Syndicate)