Illustration by Bob Dahm
F ew nations loom larger on the global economic radar screen than China. In 1993 the World Bank estimated that China had the world's third largest economy but was the fastest growing of them all. The Central Intelligence Agency, which already considers China's economy to be the world's second largest, estimates the Chinese will surpass the United States in total GDP well before 2020, the target date for the Pacific free trade zone promised at the Seattle, Bogor, and Osaka summit meetings of Asia-Pacific Economic Cooperation. One analyst calculates that by 2020 China's economy will be 40 percent larger than ours and that four of the world's five largest economies-China, Japan, India, and Indonesia-will be in Asia.
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Given China's size and population we should of course expect its economy to eventually overtake the United States's in magnitude. China's economic development is also politically desirable-it is most likely to become a force for stability and peace when its people have a substantial stake in economic prosperity. But so far China's progress on political liberties has disappointed; if anything, economic success has reinforced the political establishment's belief in its repressive political philosophy. Meanwhile, China's growth has extracted a price from the United States. As of this year, the United States has a larger trade deficit with China than with any other nation, thanks in part to a nationalist trade policy that grafts Japanese-style mercantilism onto China's current "soft totalitarianism." China continues to block access to its markets; it continues to provide cheap workers, including children and prisoners, whose presence undercuts labor's ability to bargain for higher wages and benefits in the United States. The piracy of intellectual products such as music and software remains a problem, siphoning literally billions of dollars that might otherwise flow back into U.S. firms and-eventually-the U.S. workforce.
Despite such troubling news, and despite 1992 promises about taking a hard line on human rights, the Clinton administration remains surprisingly confused in its China policy. While aggressively promoting the interests of a few U.S.-based multinational companies seeking access to the Chinese consumer market, the Clinton administration has refused to condition market access to the United States on reforms, as was at least attempted (with mixed success) in the case of Japan. The Clinton administration has negotiated two agreements with China to end piracy of intellectual property, but the U.S. Trade Representative's office is far too small and too understaffed with Asia specialists to monitor such agreements. Clinton has consistently failed to retaliate against violations of such agreements for fear that the economics tenurocracy and other ideologists might label him a "protectionist." Finally-and perhaps most memorably-Clinton has decided not to use China's most favored nation trading status as a bargaining chip on political rights and labor standards, arguing that the U.S. will be more influential and the world will be more secure if the United States maintains a friendly diplomatic posture.
In fairness to Clinton, his stance on human rights may be more defensible than his critics concede-it's not entirely clear how much leverage the U.S. has in this realm. Similarly, the national security implications of a more antagonistic relationship are hardly trivial. But when it comes to the balance of trade, at least, the decision not to play hardball with China is troubling. So long as China fuels its growth by engineering massive surpluses with consumer nations, its ascendancy will jeopardize the well-being of the U.S. economy by siphoning away capital for investment and, eventually, dragging down the standard of living for American workers.
The good news is that the next four years will present several opportunities to redefine the U.S.-China relationship, beginning with the expected consideration next year of China's membership in the World Trade Organization (WTO). The bad news is that Clinton's unwavering commitment to highly abstract principles of free trade-as preached by both the American economics establishment and prominent members of the administration-makes a policy switch highly unlikely.
APPEASEMENT OF CHINA
In the textbooks, free trade is supposed to be mutually beneficial to all involved, expanding the global economic pie and spreading prosperity across borders and down the income scale. Nations agree to drop tariffs and other policies that protect domestic industry in the hopes that expanded trade will translate into more business overall. It sounds great but to work in practice, free trade requires tolerable symmetry-a mutual commitment among participating nations to disavow promotion of domestic industry at the expense of trading partners.
Until 1995, trade among the so-called "free market economies" was governed by the General Agreement on Tariffs and Trade (GATT). In January of that year, the GATT nations, with Clinton's eager support, agreed to institutionalize the WTO. While GATT's purpose was in large part strategic-the United States traded access to its lucrative consumer market and technologies to cement anticommunist alliances with nations such as Japan, South Korea, and Taiwan-WTO's primary rationale is the expansion of free trade for its intrinsic economic value.
The problem with the WTO treaty is that it does not outlaw the main protectionist practices of the East Asian capitalist developmental states but it does explicitly outlaw American attempts to protect itself from such protectionism. Tariffs are no longer important in international trade, but so-called nontariff barriers such as national industrial development policies, regulations with differential effects on foreign and domestic firms, unique standards, collusion among a country's firms to keep out foreigners (China's state-owned sector, Japan's keiretsu, South Korea's chaebol), governmental administrative guidance of privately owned enterprises, and the failure to enforce antimonopoly laws are all beyond the scope of the WTO. On the other hand, Section 301 of the American Trade Act, which allows the U.S. government to assist American firms facing access barriers in foreign markets, is explicitly barred. Unless and until the WTO faces up to the catch-22 in its charter, it remains a menace to the livelihoods of all working Americans. WTO is starting to work only because its members know that without compromises it will ultimately drive the U.S. from the organization.
Meanwhile, WTO admission has become China's primary diplomatic goal-because it would mean even more access to lucrative markets in the United States, Europe, and Japan-and the Clinton administration has indicated it will go along without much fuss. But there's one very important catch: China wants to be admitted with the formal status of a developing country. Structurally, China is still a Leninist economy and not ready for admittance as a regular member. As a developing country, China would not have to open its markets to foreign competitors on an equitable basis, and it would be exempt from the provisions of the WTO treaty concerning subsidies, investments in China, and intellectual property rights. In other words, developing nation status would give China license to continue some of its most effective mercantilist economic policies and run up even higher trade surpluses with the United States.
The potential cost is staggering. Already, the U.S. absorbs about 25 percent of all exports from Asia and runs $100 billion annual trade deficits with the area. When China began economic reform in 1978, its foreign trade totaled $20.64 billion. By 1993 it had increased 950 percent to $195.8 billion. The Europeans and Japanese also run trade deficits with China, but the U.S. trade deficit is approximately 2 to 3 times those of the other major trading powers. Some 80 percent of China's exports are manufactured goods. China is the world's largest textile exporter and the largest source of American textile and apparel imports. International agreements are supposed to control the international textile trade, but China gets around them by transshipping through third countries and often by attaching false labels to avoid exceeding the quotas to which it has agreed. "Made in Turkey" labels are common in Chinese leather jackets.
Of course, admission to WTO would hypothetically require a real commitment by China to end such ruses, to make progress on political liberties, to stop the use of prison labor, and to live with a more balanced trade relationship-in other words, a country needs to show development to maintain developing nation status. Yet China hasn't cracked down on prison labor or cut back on extensive subsidies to state industries, as it promised. China cannot politically face the unemployment that ending subsidies would cause and regards foreign demands that it do so as attempts to subvert its political system. Nor has China abandoned its strategy of swapping market access for technology transfers from other nations. In 1995, for instance, China very successfully played off General Motors against Mercedes-Benz over which company would give China the most technology in return for the right to manufacture and sell in China for fixed periods of time. Both ended up giving to China sophisticated technology to design and build new models.
This strategy that merges "the teachings of Chairman Mao with the economic experience of Japan," as Greg Mastel of the Economic Strategy Institute puts it, is the reason Business Week noted last year that "China may already have eclipsed Japan as America's number one trade headache." In a sense, the China trade problem is not a trade problem at all but one of "systems friction," the clash of different forms of capitalism. One of the secrets of China's development strategy, which borrows heavily from the experience of Japan and other successful Asian nations, is to bend the rules and norms of capitalism in order to achieve national wealth and power. In this view, economics is inevitably a zero-sum game, in which some nations win and others lose. China has never aimed at becoming a "market economy" but rather at engaging and exploiting other market economies to become a great power. It undertook economic reform in order to preserve the Communist Party's political control and to achieve through other means what it had failed to achieve through Leninism.
What's interesting about this strategy is that other nations-including the ones who invented the strategy-show relatively little patience with Chinese demands. When China insisted on technology transfer in automobile manufacturing, Japan said "no thank you" and opted out of the race. Japan has increasingly rebuffed China and taken its investments elsewhere, astutely parlaying the neighborhood effects of China's discovery of the market in order to expand its own market share in countries like Indonesia and India. Japan's approach is quite clever: Because China is currently attracting so much foreign investment, countries like Indonesia have liberalized their economies in order to grab a share of the available investment funds and not be left behind. As of mid-1995, Japan had invested $8.7 billion in China, but that was less than it had invested in the city state of Singapore ($9.5 billion) and half of its investment in Indonesia ($17 billion).
T he United States potentially has a very strong hand when it comes to dealing with China. Precisely because the United States purchases so much of what China produces, even a partial loss of access to the American consumer market would be a crushing blow to Chinese economic expansion. Yet because such a threat would violate the precepts of free trade, that option is not under consideration. Instead, Clinton's strategy has been primarily to try to induce or cajole China into reforming itself to look more like the American form of capitalism, through relatively modest changes. Thus, on November 10, 1994, the Washington Post editorialized that in order to get into the WTO, China would have to (1) publish its trade regulations in a transparent form accessible to importers, (2) ensure that all foreign and domestic companies receive the same treatment from the legal system, and (3) stop using artificially low exchange rates to boost exports and impede imports.
Unfortunately, this advice is based on a false premise-an economic determinism almost as rigid as that of the Marxist-Leninists. As explained by Henry Rowen, President Reagan's former national intelligence chief, writing in the Fall 1996 issue of the National Interest, the theory is that policies like the kind described in the Washington Post will cause democracy to break out in China "around the year 2015." Rowen believes that the "United States should . . . make most-favored national status for China permanent and impose no extra obstacles to its admission to the World Trade Organization," in order to facilitate this development. And if China resists? He suggests that the United States discipline China not through economic means but by "our taking actions in security domain."
But this counsel courts real disaster. Any attempt to contain China militarily will surely bankrupt the United States, separate us from our Japanese allies, and militarize the Chinese leadership; if a war ever did ensue, the U.S. would probably lose. Besides, China's developmental strategy depends on peace in East Asia and cooperation from the 55 million overseas Chinese. Those are greater constraints on Chinese behavior than any forward deployed American troops that no one believes would ever be used in a war with China.
The real problem with the Washington Post's position, however, is that even if China agreed to such terms, an imbalance would persist because of cultural differences between Chinese and American business relations. In a speech to businessmen in Tokyo, the vice president and senior economist for J.P. Morgan in Asia, Huan Guocang, advised, "It is extremely important for . . . investors to develop solid working relations with local authorities in the regions where they have committed capital investment, as such working relations can enhance their operations and hedge against potential economic and political risk." This is a polite way to stress the importance of guanxi (connections or networks) in all Chinese trade dealings and helps explain why the overseas Chinese-who have established intricate and successful transnational networks-have been so far ahead of everyone else in trade and investment in China.
This, at last, is the heart of the matter: Simply requiring China to drop its tariffs, abolish prison labor, or stop domestic subsidies is only the first step toward symmetry. Writing in Asian Survey, Maria Hsia Chang explained,
Quite apart from their complementary interdependencies, the economic integration of Hong Kong-Taiwan-Guangdong-Fujian is fueled by the ability of the overseas Chinese to understand, utilize, and exploit guanxi, the predominant mode of getting anything done in mainland China. More often than not, guanxi includes bribery, backroom and insider dealings, and other forms of corruption that have become pandemic in China. Because of their language and cultural affinities, not to mention kinship ties, ethnic Chinese are better able than non-Chinese to develop guanxi-and thus to do business in China.
MANAGING A BETTER RELATIONSHIP
So if simply forcing China to end protectionist policies isn't enough, what is? How does the United States promote China's economic development while preventing predatory trade from provoking international conflict? The answer is managed trade-using public policy to manage outcomes rather than procedures. It assumes that when private companies in different economic systems trade with and invest in each others' economies, a mutually beneficial outcome cannot be assured merely through an agreement on the rules.
A great deal of international trade is already managed-in petroleum, steel, textiles, agricultural products, electronic goods, and many other products-even though global commerce continues to expand to unprecedented levels. Still, the U.S. refuses to recognize that management is needed and it therefore does a poor job compared with other trading nations. Trade management need not seek exact bilateral balances or zero trade deficits. Its criterion should be the health of domestic high-value-added industries-in other words, those that provide technologically advanced jobs for American citizens.
In 1960, at the height of the Cold War, when the United States began to trade with Poland, Romania, and Hungary, it set goals that these Leninist countries had to meet. The United States required that Poland absorb more imports produced in GATT countries-a 7 percent annual increase-or else trade would be cut off. As Greg Mastel says,
The parallels between the challenges the GATT faced thirty-five years ago with Poland and the current challenge of integrating China are compelling. Both cases involve an apparent desire on the part of a non-market economy to move toward becoming a market economy, but with central planning systems still in place and functioning. . . . If China's accession agreement [to WTO] were to include both targets for increased imports from WTO members into China-perhaps tied to growth rates or other relevant economic factors-and also special safeguards, many potential economic problems could be addressed.
Another example is semiconductors. In 1986 the American semiconductor industry was headed for the same graveyard in which the whole American consumer electronics industry is buried. This situation changed with the Japanese-American semiconductor agreement, which demanded and got 20 percent of the Japanese market for imports, and by domestic company reforms, including the creation of a joint research consortium. Today both Japan and the United States enjoy thriving semiconductor industries. The competition between them gives rise to the innovations and price reductions that are occurring, for example, throughout the computer and telecommunications industries.
It is therefore surprising that the Japanese have vowed never again to enter into such an agreement, and American newspapers, such as the Wall Street Journal and the New York Times, editorialize against negotiated market shares among different kinds of capitalist systems. This suggests that the Japanese in 1986 actually wanted to destroy the American semiconductor industry rather than achieve a healthy trading relationship with the United States, and that Americans are still so deluded by economic ideology they are unable to recognize their own success.
There is no question but that America's trading partners would grumble about an invigorated American economic policy. But that would only signal the end of the Cold War trade-off between access to the American market and such things as overseas basing rights for American military forces. The current pretense that the United States can continue to play the same international economic role it did during the Cold War is the real source of instability in the trading system and in U.S. relations with China.
The economic challenge of China will be the most difficult test not just for American foreign economic policy but for American foreign policy in general in the first quarter of the twenty-first century. Unfortunately, Americans still remain confused by the shift in the nature of power from military strength to economic and industrial strength. They tolerate and even applaud bloated, irrational defense budgets while doing nothing to rebuild and defend the industrial foundations of national security. It is not that the Americans are incapable of competing on this front. They actually have a good record of institutional innovation when they recognize that this is where the plane of competition lies. The problem is one of political leadership, mobilization of the country, appropriate staffing of the government, and redirection of the foreign affairs, defense, technological, and intelligence agencies to pay attention to Asia in general and to China in particular. Unfortunately, there is absolutely no sign that this is actually happening.
