Blow Up the Global Trading System

Yes, really. U.S. and international efforts to stop Beijing’s economic onslaught haven’t worked. It’s time for President Biden to go big.

In a recent New York Times column, Tom Friedman said that President Joe Biden will have to find a way of “pushing back” China “without blowing up the global trading system.”

While offering no suggestion for how Biden should do that, Friedman inadvertently raised two fundamental questions. Is it possible to push back on China without blowing up the trading system? In any case, is the present faltering system sustainable or does it maybe need to be replaced?

Pushing back on China is certainly justified, but because of its highly centralized, authoritarian system, raising one issue without automatically becoming entwined with all the rest is virtually impossible. Take the dispute between Australia and China over Covid-19. Canberra called for an inquiry into its origins. The request had nothing to do with trade. But Beijing wants no talk of viruses. As Australia’s biggest customer, China knows it can hurt the Aussies, perhaps enough to shut them up. Without a word to anyone and with no economic justification, China arbitrarily slashed its imports of Aussie beef, wine, barley, and coal.

Across the menu, all of the world’s major countries are intricately linked to China. It is virtually impossible, therefore, to seriously imagine any nation “pushing back,” as Friedman asserts, without triggering repercussions on all aspects of the relationship.

At Odds With the Liberal, Rules-Based Global System

More fundamentally, China’s economy is incompatible with the main premises of the global economic system embodied today in the World Trade Organization, the International Monetary Fund, the World Bank, and a long list of other free trade agreements. These pacts assume economies that are primarily market based with the role of the state circumscribed and micro-economic decisions largely left to private interests operating under a rule of law. This system never anticipated an economy like China’s in which state-owned enterprises account for one-third of production; the fusion of the civilian economy with the strategic-military economy is a government necessity; five year economic plans guide investment to targeted sectors; an eternally dominant political party names the CEOs of a third or more of major corporations and has established party cells in every significant company; the value of the currency is managed, corporate and personal data are minutely collected by the government to be used for economic and political control; and international trade is subject to being weaponized at any moment for strategic ends.

To see how this works in practice, take the Internet as an example. Beginning in the late 1990s, China barred international companies like Google, Amazon, Yahoo, and Facebook from its market while erecting the Great Firewall that effectively decoupled China from the Worldwide Web. President Clinton once mockingly said of Beijing’s desire to control the Internet: “I’d like to see them try. It will be like trying to nail Jell-O to a wall.” Well, Beijing has had the last laugh. It has insulated its people from the global internet and keeps globalized corporations controlled.

Even when it allows foreign companies into its market, it keeps them on a short leash. Thus, when Mercedes Benz recently allowed a mention of the Dalai Lama to appear in its advertising outside of China, Beijing threatened to restrict its business in China if it did not remove the offending advertisement. Mercedes immediately complied. Or take Beijing’s reaction to a tweet of the Houston Rockets basketball team manager in support of free speech demonstrators in Hong Kong. Beijing demanded that the manager be fired, and it stopped broadcasting NBA games in China where they are popular and profitable. The coach was not fired but he apologized and promised to stop tweeting about Hong Kong demonstrators. Interestingly, no corporate executive or any national leader suggested complaining about any of these Chinese actions to the WTO. Either they were intimidated or knew without having to ask that the WTO could not do anything about them.

This is very different from what the free world expected when it welcomed China into the free trade body in 2001. From the time of Deng Xiaoping’s adoption of some market methods in 1979 and especially after the collapse of the Soviet Union in 1992, free world leaders believed increased trade with and investment in China would inevitably lead to the marketization of its economy, the demise of its state-owned enterprises, and at least some liberalization of its political system, although the crushing of protestors at Tienanman Square in 1989 certainly dampened headier expectations of democracy. That this anticipation was wildly at odds with reality was made clear on March 1, 2018, by none other than a former champion of China’s admission to the WTO. The Economist’s cover story of that day declared that the free world had “made the wrong bet.” China, it said, was not liberalizing politically or economically.

To Push Back

If one wishes to “push back against China” without causing war, there are two possibilities. One is to complain in the WTO and other diplomatic fora. Over the past 20 years, many protests have been registered but with virtually no effect. Nor is there any reason to believe this will change in the future. Does anyone seriously think Beijing will abandon its “Made in China 2025” policy? No. Indeed, that leaves only one alternative —“blowing up the system” or, more politely, creating a new or alternative system.

That may at first seem lamentable, but aside from the fact that the system never anticipated a player like China, it also never anticipated our globalized world. The trading order established after World War II, operated with currency exchange rates fixed to the dollar and the dollar tied to gold. Capital markets were closed, and international financial flows were minimal. All countries were expected to run roughly balanced trade (current account) over the medium and long term. For those that did not, the International Monetary Fund (IMF) would extend loans to cover chronic trade deficits but only in conjunction with a plan to halt the deficits. John Maynard Keynes even proposed that tariffs be imposed on the exports of countries running chronic trade surpluses to force them to balance trade. Chronic surpluses (such as those of Germany and China today) were then seen as a beggar-thy-neighbor strategy that would prove unsustainable.

The system arose out of the Pax Americana and a deep faith that the U.S. would always be the world’s manufacturing and technology superpower, have the highest productivity, pay the highest wages, and always run a surplus or balanced trade account. Today’s low transportation and communication costs, huge economies of scale, mercantilist trade policies, cross-border investment, and financial investment incentives were simply not envisioned. Nor was the absence in other countries of effective labor unions and environmental and safety facilities. All these factors were simply not recognized at the time.

Indeed, the Bretton Woods system was appropriate for its time. In the 1945-55 period, international trade was significantly in commodities like grain and coffee, capital flows consisted mostly of foreign aid, trade was not strategic, the dollar was as good as gold, labor did not cross borders, economies of scale were not yet a major trade factor, and the main trade barriers were high tariffs left over from the Great Depression.

But, this was very far from what we have today when capital markets are open, financial flows far outweigh trade flows, currencies float in financial markets, much trade is in goods and services characterized by economies of scale and scope, many countries pursue export led growth strategies while using subsidies and tax incentives to attract capital and technology investment, and some countries (Germany, Japan, China, South Korea) accumulate chronic trade surpluses while others (especially the U.S.) act as consumers of last resort by importing more than they export, thereby accumulating chronic trade deficits. These are financed by borrowing from the thrifty, export surplus countries.

This is especially true because of the role of the U.S. dollar as the world’s main commercial and reserve currency. Countries with chronic trade surpluses are consuming less than they produce. They depend for economic growth on purposely undervalued currencies that entice other countries, particularly the United States, to consume more than they produce. This is essentially a beggar thy neighbor policy. The U.S. maintains this arrangement through heavy international borrowing. While the U.S. does have a huge economy and can borrow a lot, this structure eats away its jobs and productivity. As Michael Pettis of the Carnegie Endowment for International Peace explains, today’s globalization structure has put America on a ruinous path.

This significantly arises from a problem the IMF should have addressed long ago—currency management or manipulation. Countries pursuing export led growth strategies attempt to reduce the value of their own currency against that of the dollar. This mercantilist strategy has been enormously successful over the past 70 years for countries like Germany, Japan, South Korea, Taiwan, Singapore, and now China. It has created a system in which these countries constantly accrue large trade surpluses and dollar earnings while non-mercantilists like the United States, the U.K., and Australia accrue chronic deficits. It is exactly what Keynes feared when he advised imposing tariffs or taxes on chronic surplus countries to avoid a beggar-thy-neighbor system.

Most economists have insisted that America’s trade deficits (technically current account deficits) are the result of saving too little. But Pettis explains that the conventional analysis assumes foreign holders of dollars invest in the U.S. solely to finance trade, in which case the amount would exactly match the trade deficit. But it doesn’t because, as Pettis notes, foreign held dollars are invested in the U.S. to assure safety, or because U.S. interest rates are favorable, or to buy technology, or for much else. To the extent this investment is for production of more American goods or services, it is an economic benefit. But a large part of it is invested in non-productive assets and serves to raise the value of the dollar thereby increasing the U.S. trade deficit.

President Biden should not struggle to hold the present inadequate trading system together. Rather, he should call for it to be restructured before it collapses under its own weight.

Reinventing the Globalization System

A first step for President Biden would be to impose a Market Adjustment Charge (MAC) on all non-direct investment (not in new means of production) into the United States. This would do two things. The funds from the charge would go into an Infrastructure Renewal Fund to finance upgrading of U.S. infrastructure. The charge would also tend to weaken the dollar, thereby contributing to an end of the chronic trade deficits.

Step two would be for the International Monetary Fund (IMF) to adopt Keynes’ Bretton Woods proposal that all countries should have balanced trade in the medium to long term. To prevent chronic surpluses and deficits, he called for the IMF (or WTO) to impose tariffs on the exports of chronic surplus countries to force them to balance (a tax equal to the total surplus would also suffice).

As a third supporting step, Biden should urge the establishment of a strong policing mechanism in the IMF and in the U.S. Treasury.

A fourth step would be to create what would effectively be a Free World Free Trade Agreement (FWFTA). This would be done by melding the USMCA (U.S., Mexico, Canada) trade agreement, the EU, and the CPTPP (Comprehensive and Progressive Trans Pacific Partnership, the successor to the failed Trans Pacific Partnership) trade deals and inviting others like India into the FWFTA. This organization would, of course, be open to all other democratic, market-oriented countries.

The fifth step would be to create a free world high technology leadership project (it might be labeled “Made in the Free World 2030″) aimed at ensuring global free world leadership in the development and production of critical high- tech items like robots, semiconductors, Artificial Intelligence, bio-tech, telecommunications, aircraft and rockets, electric vehicles, and so forth. In introducing this measure, Biden should make clear that the United States welcomes participation by the entire free world but will go it alone if necessary. The corporations of those not participating cannot expect equal treatment.

A sixth step would be for Biden to underpin this free world tech leadership program with a reorganization and concentration of U.S. government resources like that of the Kennedy administration in response to Sputnik. The Biden administration should study how China has organized its industrial policy and technology programs as well as how the U.S organized to win WWII. It should create similar structures and programs.

Finally, Biden should invoke the Defense Production Act to direct increased U.S.-based production of critical goods such as medicines, semiconductors, and solar panels, while also submitting legislation to curb corporate political spending and to gain the right of review of corporate overseas investment plans which remain entirely opaque. This should include tax incentives and other subsidies to encourage reshoring of production from abroad to the United States (a la programs that Japan and Australia are already implementing). It should also bar transfer of any technology funded in any way by taxpayer dollars to non-free world countries without a U.S. government license.

That it is time and even past time for this kind of approach was amply demonstrated by the top-level U.S.-China talks that took place just recently in Alaska and by the just completed so called Two Sessions of the Chinese Communist Party. The sessions confirmed that China is seeking economic and technology “self-sufficiency” and the Alaska meeting confirmed that China is unrepentant about its treatment of minority ethnic groups in China and its crackdown on Hong Kong. Further, its swarming at the same time of 200 odd boats in the waters of the Japanese administered Senkaku Islands and similar action near Philippine controlled Whitsun Reef demonstrated that it has no intent of observing the UN Law of the Sea to which it is a signatory or the long-established territorial rights of its neighbors. In short, China does not intend to play by the rules of any supposed “liberal, rules based, global order” described by former Bush administration official Robert Zoellick.

Clearly, excessive free world dependence on China at odds with fundamental free world values. By adopting the above noted suggestions, Biden would dramatically cut U.S. and free world dependence on China thereby reducing its coercive power and appetite for broader confrontation. He would also accelerate U.S. economic growth and job creation while achieving greater national unity.

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Clyde Prestowitz

Clyde Prestowitz is an Asian and globalization expert and a veteran U.S. trade negotiator and presidential adviser. He was a leader of the first U.S. trade mission to China in 1982, the Vice Chairman of President Clinton’s Commission on Trade and Investment in the Asia-Pacific Region. His new book is The World Turned Upside Down: America, China, and the Struggle for Global Leadership .