China to the Rescue of Free Trade

No other country has benefitted more than China from the western-led drive towards free trade and financial integration of the past 30 years. An acceleration of economic growth has allowed GDP per capita in China to go from representing less than 5% of the US to 25% in this period (see graph below), an unprecedented wealth creation for millions of Chinese citizens.

As the US appears to be making significant policy changes in favor of nationalism, protectionism and antagonism, the rest of the world should be careful on relying in China to save free trade and financial integration. They will likely be disappointed.

I have argued before in favor of China as a counter force against the recent populist wave that appears to be propagating inexorably around the world. Economic and financial integration with the rest of the world have been important strategic components of the Chinese development and growth model, to a point in which they may be necessary conditions to preserve political control at home.

China has been able to extract disproportionate economic benefits from the integration agenda and multilateral order sponsored by western powers, without necessarily giving much in exchange. The rest of the world has internalized part of the benefits of the integration of China via low inflation and cheaper manufacturing goods, but more recent evidence shows that the cost of integrating China has been significant, especially in US local labor markets where there is a concentration of industries exposed to foreign competition.

As China has grown in economic power, it has demanded a larger seat at the table in multilateral financial institutions and forced a premature adoption of the renminbi in the SDR basket of the IMF. But at the same time it has pursued an aggressive economic engagement in Africa and South America and a parallel multilateral agenda by sponsoring alternative institutions like the New Development Bank (BRICS development bank), the Asia Infrastructure Investment Bank (AIIB) and the One Belt One Road Initiative, among others.

It was the US initially in 2004 that decided it was strategically in their own interest to engage more directly with China through the development of a bilateral dialogue which then led to the Strategic and Economic Dialogue currently in place. Others like the UK have followed more recently. This engagement has helped to put pressure on China to adopt better standards when it comes to international trade, the modernization of the economy and the integration of financial markets.

Chinese negotiators often have more patience given the longer planning horizon that domestic political conditions allow them to have. This is the way in which they typically extract favorable conditions in different arrangements allowing them not to embrace fully the westerns standards in trade and financial openness (not to mention human rights).

There is plenty of anecdotal evidence of China’s aggressive practices to establish non-trade barriers and avoid competition from firms that want to export to China and in addition to that, there is the Chinese industrial policy that can lead to substantial dumping of products where they have excess capacity. Many countries like the US, Mexico and Canada have been actively promoting cases against China in the WTO. It is also no surprise that more than a third of cases investigated by the US International Trade Commission in response to dumping and foreign subsidies complaints are against China. Some of these investigations have already led to retaliatory actions, like the 522% tariff on Chinese steel levied by the US in 2016.

In part due to those commercial practices Chinese imports from North America (Canada, US and Mexico) have risen only by $160 billion USD since 2000, while their exports have increased by more than $420 billion USD in the same period (see graph below). Concerns about China’s trade and financial policies were articulated most notably by Mexico when China joined WTO in 2001. Now the rest of the world is coming to the realization that perhaps the international trade system was not prepared to incorporate such a large economy in a short period of time. With the benefit of hindsight it can be said that the capacity and flexibility of labor markets to adjust to the China shock were overestimated.

Dealing with China in economic and geo-political matters has never been easy. Many countries have struggled with the calibration between support and containment, more recently the US with its failed strategy of promoting TPP, the pivot to Asia and the enhanced engagement with the Philippines, Vietnam and Australia. It makes strategic sense for Chinese leaders to try to occupy the international ground created by the retracement of the US but the rest of the world should resist the temptation to embrace China unconditionally as the new leader of the international trade order.

It is in the interest of everyone that China succeeds in its reform and development agenda. The most important contribution of China to the rest of the world is to remain a stable and prosperous economy, although it could do more to increase its domestic absorption capacity. But that requires difficult choices by China and a constructive engagement by western powers, demanding China to continue with the liberalization of its economy and financial system. This is a great opportunity for China to step up its standards and play a more relevant role in reshaping the global trade architecture.

Bullying China without a clear sense of purpose is as bad of a policy as it is embracing current Chinese standards for business and trade.

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