Toward a Mutually Beneficial U.S.-China Economic Relationship

By David A. Parker & Matthew P. Goodman —

President Barack Obama and President Xi Jinping talk before their bilateral meeting at Sunnylands in Rancho Mirage, California on June 8, 2013. Source: White House's flickr photostream, used under a creative commons license.

President Barack Obama and President Xi Jinping talk before their bilateral meeting at Sunnylands in Rancho Mirage, California on June 8, 2013. Source: White House’s flickr photostream, U.S. Government Work.

This December will mark the 15th anniversary of China’s accession to the World Trade Organization (WTO). To listen to some of this year’s election rhetoric, the U.S. decision to allow China into the club of normal trading nations was a mistake of historic proportions. This is hyperbole, which ignores the benefits, real and potential, that a more prosperous China brings. However, it is true that expectations in 2001 for mutual benefit between the United States and China as a result of WTO entry have not been fully met; in fact, the economic relationship has grown increasingly out of balance in recent years. But politicians and policymakers in Washington would do well to focus less on rhetoric and more on outcomes. Washington has a range of tools it can use to seek a mutually beneficial U.S.-China relationship; it is time it started figuring out how to use them responsibly.

Economic ties between the United States and China are massive and complex. More than $700 billion in trade flows between the two countries every year, involving thousands of companies, millions of workers, and inputs from dozens of other countries. Bilateral investment ties are deepening. The flow of direct investment from China to the United States exceeded $18 billion in the first half of this year — three times the amount recorded in the same period last year — with more than $30 billion in additional deals in the pipeline. In the past decade alone, the number of nonstop flight routes between the United States and China has more than tripled. And all of this is dwarfed by the growth in information flows across the Pacific.

This increased interaction has helped to drive global growth for a decade, pull hundreds of millions of Chinese out of poverty, and raise American standards of living. However, not all of the interaction has been beneficial. As recent research has shown,  the so-called China shock of Beijing’s entry into the WTO generated significant disruption in U.S. labor markets, depressing  wages and boosting unemployment in exposed regions and industries. As the Chinese economy has achieved upper-middle- income status, imbalances in the relationship have also grown. In 2015, the United States ran a record-breaking $334 billion trade deficit with China — admittedly less important economically than politically, but a sign of something larger amiss.

The United States is among the most open large economies in the world. Foreign enterprises, including Chinese enterprises, are generally free to compete in a fair and transparent legal environment. By contrast, U.S. companies trying to compete in China face a bewildering array of often-opaque barriers. Among these are equity ownership caps, forced technology transfers, subsidies for domestic companies, restrictions on data flows, and discriminatory competition policy. Some of these policies are clear violations of China’s WTO accession agreement. Many more appear to have been carefully designed to sidestep Beijing’s international obligations, including a sweeping new national security law packed with industrial policy measures.

This is a serious challenge for U.S. economic policymakers. The Obama administration has brought a record number of cases against China through the WTO dispute settlement mechanism; however, as Beijing grows more adroit at skirting rather than openly violating its commitments, effective legal recourse under the WTO is becoming harder to find. Even as U.S., EU,  and Japanese industry associations have all voiced growing frustration, the lure of the world’s fastest-growing market — and  the fear of being shut out — provide powerful incentives for individual companies to comply rather than challenge Beijing’s  policies. And by targeting leading foreign companies with discriminatory enforcement actions, Chinese regulators have intimidated many others into accommodating Beijing’s priorities.

Against these obstacles and facing a clear mercantilist turn under President Xi Jinping, the next U.S. administration is likely to move quickly to consider how it can use existing, or potentially new, legal and policy tools to generate a more mutually beneficial relationship. Any such effort should start with the recognition that Beijing has its own reasons to prefer stability to conflict, including a slowing economy, a credit bubble, and rising popular expectations after almost four decades of breakneck growth. Even as Xi Jinping continues to centralize authority and stokes nationalist sentiment in advance of the 19th Party Congress, there are strong incentives for him to avoid a showdown with the United States.

Given this, what tools might the next U.S. administration consider to work toward a mutually beneficial economic relationship with China?

Trade is the most obvious place to begin. The next administration has a wide range of trade-related statutes to turn to, from Section 301 of the Trade Act of 1974, which targets unfair trading practices, to Section 337 of the Tariff Act of 1930, which covers cases of intellectual property infringement. There are important constraints on how these tools can be used, most notably U.S. commitments under the WTO agreement, and good reason for respecting them. Nonetheless, if creatively used, these and other relevant statutes provide room for investigating, publicizing, and pursuing redress for unfair trading practices.

U.S. policy toward investment is less constrained, given the minimal multilateral rules in this area. The United States maintains an open investment environment and a narrowly focused national security review mechanism run by the Committee on Foreign Investment in the United States (CFIUS). This process is working well and should be left alone; broadening the use of national security as a justification for restricting investment would likely do more harm than good. However, the next president should be open to blocking or deferring inbound Chinese investments on a case-by- case basis in response to discriminatory treatment of U.S. investors in China — and would do well to consider how much scope there is for this under current authorities.

Another tool that warrants further consideration is targeted sanctions, such as those authorized under Executive Order 13694 for the cyber-enabled theft of intellectual property (IP). As others have argued, broad-based U.S. sanctions on China are a lose-lose proposition: it is unlikely that they would receive support from the international community, unlikely that Beijing would comply, and virtually certain that both economies would suffer. However, targeted sanctions aimed at individuals, companies, or agencies directly linked to problematic activities, such as IP theft, may have the potential to change Beijing’s calculus.

Key to ensuring the effectiveness of any of these actions is anticipating Beijing’s likely response. From cancelled airplane orders and blocked investments to delayed repatriation of corporate profits and preferential treatment of non-U.S. firms, Beijing has plenty of economic and noneconomic means through which to make its displeasure known — and a demonstrated willingness to use them. Should Washington decide to act, it must accept the likely costs of doing so or be prepared with measures to deter retaliation and avoid uncontrolled escalation. This means the next administration should conduct a full review of the U.S. economic policy arsenal early in its first term and identify areas where additional authorities from Congress may be necessary.

Unilateral measures by Washington are unlikely to prove sufficient to produce a mutually beneficial U.S.-China relationship. What is needed is a broader economic strategy that uses public as well as private diplomacy, international as well as domestic law, carrots as well as sticks, and direct engagement with Beijing as well as cooperation with third countries. In an ideal world, none of this would be needed. But as the drama surrounding China’s steel overcapacity has shown, when the world’s second-largest economy does not play by the rules, the effects are global. For seven decades, the United States has sought to forge a more open, prosperous, rules-based international economic order. The order has so far managed to accommodate China’s rise, but there is a point at which an imbalance of benefits tips it into disorder.

Mr. Matthew P. Goodman is the William E. Simon Chair in Political Economy and senior adviser for Asian economics at CSIS. Follow him on twitter @MPGoodman33. Mr. David A. Parker is an associate fellow with the Simon Chair. Follow him on twitter @AllardParker. This post first appeared as the feature essay in the Simon Chair’s Global Economics Monthly.

Matthew P. Goodman

Matthew P. Goodman

Matthew P. Goodman holds the William E. Simon Chair in Political Economy at CSIS, with particular emphasis on Northeast Asia.

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