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How to Get Past the US-China Trade War

China and the United States, like all other countries, should be able to maintain their own economic model. But international trade rules should prohibit national governments from adopting “beggar-thy-neighbor” policies that provide domestic benefits only by imposing costs on trade partners.

CAMBRIDGE – China’s economic rise poses significant political and strategic challenges to the existing global order. The emergence of a new superpower in Asia has inevitably produced geopolitical tensions that some have warned may eventually result in military conflict. Even absent war, the hardening of China’s political regime, amid credible allegations of myriad human-rights abuses, raises difficult questions for the West.

Then there is the economics. China has become the world’s top trader, and its increasingly sophisticated manufacturing exports dominate global markets. While China’s international economic role is unlikely to be insulated from political conflict, it is also inconceivable that the West will stop trading with China.

But what kind of rules should apply to trade between countries with such different economic and political systems? I recently teamed up with Jeffrey Lehman, Vice Chancellor of New York University’s Shanghai campus, and Yao Yang, Dean of the National School of Development at Peking University, to convene a working group of economists and legal scholars that could devise some answers. Our working group recently issued a joint statement, with support from 34 additional scholars, including five Nobel laureate economists.

China’s admission to the World Trade Organization in 2001, and the establishment of the WTO itself, was predicated on the implicit premise that national economies, including China’s, would converge to a broadly similar model, enabling significant (or “deep”) economic integration. China’s unorthodox economic regime – characterized by opaque government intervention, industrial policies, and a continuing role for state-owned enterprises (SOEs) alongside markets – has been very successful in spurring GDP growth and reducing poverty. But it makes deep economic integration with the West impossible.

An alternative perspective gaining ground in the United States is that the American economy should decouple from the Chinese economy. This would entail high trade barriers to Chinese exports and severe restrictions on bilateral investment flows. Such an approach would further intensify and render permanent US President Donald Trump’s trade war.

We propose a middle ground between convergence and decoupling. The key is that China and the US, like all other countries, should be able to maintain their own economic model. Trade and other policies aimed at safeguarding (or “protecting”) a country’s economic system should be presumed legitimate. What is not acceptable are policies that would impose one country’s rules on another (through trade wars or other pressure) or that provide domestic benefits only by imposing costs on trade partners.

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Targeting the latter category, which economists call “beggar-thy-neighbor” (BTN) policies, is central to our approach. We argue that international trade rules should draw a bold red line around BTN policies and prohibit them. A typical example is trade restrictions that enable a country to exercise monopoly power globally, as China tried to do by restricting exports of rare earth minerals some years back. Another example, which may become increasingly relevant in digital technologies, is closure of domestic markets to foreign investors in order to obtain competitive scale benefits on world markets. A third example is persistently undervalued currencies that help sustain large macroeconomic imbalances (trade surpluses).

Under this approach, many other policies that the US habitually complains about would not be considered objectionable. China’s industrial subsidies and SOEs, for example, would be considered a domestic matter. While they may hurt specific American firms and investors, such practices are not, in general, of a BTN nature: either they benefit the rest of the world in aggregate (as with subsidies), or their economic costs, where they exist, are borne primarily at home (as with state ownership).

By the same token, the US would be free to adopt trade and investment policies that safeguard the integrity of its technological systems and protect communities adversely affected by imports. It could also insulate itself from any negative spillovers from Chinese policies, if it chose to do so, by imposing restrictions at the border. China must recognize that policy autonomy is a two-way street: other countries need it as much as China does.

While our approach is stated in bilateral, US-China terms, it is easy to embed it in a multilateral framework – and even the WTO itself, with some creative legal maneuvering. One such approach is suggested by one of our working group members, Robert Staiger. The stark reality, however, is that progress on the multilateral front is unlikely without a prior agreement between the world’s two largest economies. Thus, we view our statement as an initial step in that direction.

Like all international agreements, our proposed approach depends on the willingness of the parties to abide by the terms. While the concept of BTN may be clear to economists as an analytical matter, we are not so naive as to suppose that the US and China would quickly and easily agree in practice on what is and is not a BTN policy. Disputes about terms and definitions will persist. Even so, our hope is that a framework that sets out clear expectations, respects both countries’ economic sovereignty, guards against the worst trade abuses, and allows the bulk of the gains from trade to be reaped would create the incentives needed to build mutual trust over time.

This approach leaves open the question of how the US and other Western countries should respond to China’s political repression or human rights abuses. That is not because these issues are unimportant, but because clear rules of conduct in economic relations must be established regardless of how even bigger conflicts are to be resolved. Without such a roadmap, it is not just the economic interests of China and the US that will suffer. The rest of the world will pay a high price as well.

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