New alliances, not tariffs, are key to US trade strategy on China

To induce better trade policies in China, multilateralism is the only effective approach. By building alliances and consensus among like-minded nations, the US can rebuild and strengthen the rules of the road for China to observe

Spencer CohenandBadri Narayanan

Published: 5:15am, 15 Jan 2021

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The phase one trade deal, signed on January 15, 2020, was lauded by the Trump administration as a breakthrough in the long-standing impasse in US-China trade relations. It is not. Setting aside the impact of the pandemic on global trade flows and hindrance to the deal’s success, it was flawed from its inception as a bilateral agreement.

The failure follows on the heels of a trade war that has harmed US households, farmers, manufacturers and exporters. President-elect Joe Biden’s administration should not overtly rescind the deal but let it sail into the sunset, along with the ineffective trade policies of the Trump administration, and start anew.

For starters, the deal has not met its trade targets. The signature element was China’s agreement to increase purchases of US goods and services by US$200 billion above 2017 levels during the next two years. This included a US$76.7 billion increase in US exports of goods and services in 2020 compared with 2017 levels, the last year before the trade war.

Goods exports, a more easily measured form of international trade transaction, were expected to reach US$154.4 billion by the end of 2020. Services take longer to measure and report.

As of October, cumulative US goods exports included in the trade deal had reached US$67.8 billion. On a pro-rata basis, factoring in seasonality and trade patterns in recent history, goods exports were down 47 per cent through the first 10 months.

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Unpacking the ‘phase one’ deal for the US-China trade war

Why has the deal not worked? The proximate cause is certainly the coronavirus pandemic, rattling supply chains and depressing Chinese demand for US goods. China’s GDP, after a sharp contraction in the first quarter, is projected to grow 1.9 per cent for 2020, down from a pre-pandemic forecast of nearly 6 per cent.

There is a deeper, structural problem with the deal, though. The working assumption in the negotiations – and a salient theme throughout the Trump administration’s trade dealings – is that trade is a zero-sum, bilateral transaction. Trump’s approach has fixated on bilateral trade deficits but, on the contrary, trade in the 21st century is a multilateral activity.

One can simply examine the flows of Chinese imports into the United States. Many of these goods are assembled in China for final export to US consumers, but they are based on high-value components imported from many other countries, including some close US allies. In 2019, net exports represented 1.5 per cent of Chinese GDP, down from nearly 8 per cent in 2007.

Bilateral trade deficits thus distort how we should think about trade relations. Rather than fixate on outdated measures, trade policy should be about fostering healthy trade that is principled on reciprocal market access, removal of trade-distorting policies, standardised and enforced rules and real protection for trade secrets and intellectual property.

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Trade policy and access to US and other markets can also be used in applying pressure over non-trade-specific issues, ranging from geopolitical disputes to human rights.

To induce better trade policies in China, multilateralism that involves all countries, or at the very least a plurality that includes US allies, is the appropriate and only effective approach. Plurilateralism is not some abstraction divorced from the realities of our fraught relationship with China. It gives us leverage.

By building alliances and consensus among like-minded nations, the US can rebuild and strengthen the rules of the road for China to observe.

These should not be punitive in nature. Rather, doors could be opened for China to join broader trade pacts, such as the Trans-Pacific Partnership. They could be conditioned, for example, on domestic reform that not only legislates robust legal protections for foreign intellectual property but over time proves that enforcement is working.

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Multilateral trade pacts allow us to leverage the heft and commitments of our allies to encourage better policies in China. The US should enlist some of China’s largest trade partners, some of which are close US allies. These include Japan, South Korea and the European Union, which, along with the US, represent nearly half of all Chinese exports.

As a hypothetical analysis, we modelled the potential impact of the US and all other countries except China removing all tariffs on all sectors, without increasing or reducing any tariffs with China, using the Global Trade Analysis Project model.

This gives us a flavour of an extreme notion of tariff elimination to isolate China. Our analysis suggests such a strategy could effectively reduce trade with China merely by expanding trade with other countries. It could lift US GDP by about US$111 billion annually by 2025 while inflicting losses three times as large to China.

In contrast, losses of almost US$335 billion to US GDP could result from all countries raising tariffs against China by 10 per cent in all sectors with equal reciprocation by China. In summary, we can say qualitatively that Americans as a whole could benefit considerably by allying with countries other than China while not introducing any new tariffs against China.

Deals do not make good trade policy. Institutions do, both in setting the rules of trade and enforcement. Ironically, China might gain significantly from a more orderly and committed multilateral system. Chinese policymakers have long struggled to boost domestic consumption as a share of GDP, which has held firm below 40 per cent since 2005.

While household consumption continues to grow, it is annually outstripped by capital investments fuelled by artificially cheap credit and financial repression. This skews credit allocation in favour of state enterprise borrowers over households.

China’s negotiations over entry into the World Trade Organization throughout the late 1990s became cover for domestic reform of the inefficient state enterprise sector, helping the government administer painful but necessary medicine to the sector. The same could be true for a modern, 21st-century trade pact led by the US and its allies.

Dr Spencer Cohen is a senior fellow with Infinite Sum Modelling LLC, Seattle, US, and principal and founder of High Peak Strategy, a Seattle-based research and consulting firm. He is a leading expert on Chinese and US regional economic and trade issues

Dr Badri Narayanan is the founding director of Infinite Sum Modelling, Seattle, and a senior economist with the University of Washington in Seattle. He is also a non-residential senior fellow with ECIPE Brussels and CSEP New Delhi

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