How China has to change if it wants global trade peace

A second, tougher level of trade issues include: forced technology transfers in joint ventures when Western companies try to produce inside China’s tariff walls; counterfeit goods, which cost Western companies billions; industrial espionage; and Chinese joint ventures abroad which see technology absorbed and agreements broken.

China could pass laws to outlaw some of these things. But laws can be ignored. Monitoring and resolution mechanisms would be required, which might prove hard to agree upon. China has frequently used domestic secrecy laws and regulations to refuse judicial and accounting requests from other countries. Since one is usually dealing with state-owned enterprises (SOEs), sovereign immunity is often invoked.

Party connections

A difficult third area is national security. The Huawei 5G problem sits here. China, one of the least open countries in the world, sees this as an unfair trade restriction against them. The basic problem for China is that companies – SOE or not – must co-operate with the Communist Party. Important CEOs need to be members or closely connected. It is less Huawei that is the problem and more the governance system. If Huawei was asked to help the authorities, it would have no option but to do so. More generally, all major Western governments are taking regulatory action on national security issues (particularly for technologies involving joint commercial and military applications).

The fourth most difficult area is China’s failure to do what very large countries are supposed to do.

 

China’s strategy is to catch up to advanced countries via heavy investment and absorption of foreign technology, while developing its own innovations to lock in “standards” for trade partners to follow (infrastructure and telecommunications). 5G is a good example. Nothing wrong with any of this, were it achieved via open competition and corporate governance independent of the state. This is not the case in China. It is prepared to see the return on investments decline to non-economic levels to stay on track for its global goals. Declining returns and global trade tensions are the inevitable result of suppressing consumption, promoting excess investment and using subsidy-supported variable margin pricing strategies to ensure strong export shares.

Large countries are supposed to consume most of their output – this is the only way for world trade to work in the collective interest. For example, the US consumes 83 per cent of its production. China consumes only 53 per cent. The pressure on world trade that this lack of transition to consumption and openness creates is shown in the chart. Since being allowed into the WTO in 2001, China’s share of global goods exports has broken all records (14 per cent of world merchandise trade). The US is miffed – having (appropriately) moved towards consumption and ceded big trade shares to the post-war reconstruction of Europe and Japan in the 1960s, it is now making room for China which refuses to follow suit. Every significant economy is affected (see Japan and the Europeans).

Every year China promises more consumption and openness. What is “said” is also easy to ignore. The trend in Chinese consumption as a share of GDP has fallen from 1960 to this day. The excess capacity of the second largest country in the world, that won’t move to consuming most of its own output, lies at the heart of deflation pressure in and trade tensions with the West.

China is too big to continue with this strategy; it is not a Singapore.

China can’t agree to meaningful openness and the separation of commerce from the state, because that would undermine the state control and strategies. None of this is hidden (see “Made in China 2025”, and party announcements and speeches).

Monitoring mechanisms

China’s problems (massive corporate debt, and trade and investment headwinds) are coming more to the fore. It continues to repeat variants of past policies: fiscal expansion and promoting even more corporate borrowing. These band-aid policies address nothing that matters for the collective interest.

What might work? The US and China joining the Trans Pacific Partnership (TPP) would be the best shot. It has a Chapter 17 on SOEs: arms-length commercial dealings; equal treatment of third parties; banning of monopoly-based anti-competitive practices; refraining from non-commercial assistance for undercutting prices to gain market share (there goes “the China price”); use of sudden changes in market share as an indicator of injury; and putting in place monitoring and resolution mechanisms (that prickly monitoring issue again). Waiving any use of sovereign immunity for commercial arrangements also needs to be in all treaties.

It’s worth noting here that our own government signed a bilateral free trade agreement with China ignoring the SOE and sovereign immunity issues. Astoundingly bad policy for us. It all needs looking at again.

The role of the state in corporate governance and failure of China to consume most of its output are the key global issues needing resolution. They are also the most difficult. My guess is that the US-China trade negotiations won’t deliver much that matters. We will be doing well to deal with some issues in the (above) second level of difficulty.

Contradictions will only deepen over time if all large countries don’t do what they are supposed to do. Any rally on “the deal”, augmented by Chinese official buying, would be a good sell opportunity in markets in my view.

Adrian Blundell-Wignall a former director of the OECD, an adjunct professor at Sydney University and author of Globalisation and Finance at the Crossroads.

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