Geopolitics

How A U.S.-China Trade Deal Could Backfire On The Whole World

As the two superpowers get closer to an agreement, the global trade regime could suffer. History offers several precedents.

The Empress of China in 1876
Shawn Donnan

WASHINGTON — On a wintry Sunday in February 1784, the Empress of China pulled out of New York Harbor and headed for Guangzhou with a crew of 42 and a cargo of liquor, Mexican silver, and American ginseng. It was off on what's now a well-worn trade route between the world's two largest economies — the first ship under the flag of an independent United States to venture to China in search of fortune. It also raised a question that's consumed U.S. policymakers since: How do you cut a deal with China when the rest of the world wants to make one too?

As John Pomfret, author of The Beautiful Country and the Middle Kingdom, a history of U.S.-China relations that documents the voyage of the Empress of China, writes, America's preoccupation with China goes back to the Boston Tea Party. The protest was at its root against Britain's use of unfair taxes to control the price of tea from China. The Empress of China set out in part to loosen the British grip on the tea trade.

The U.S. long ago replaced Britain as global hegemon and now stands challenged by China. Much as America's Founding Fathers once did, Donald Trump seeks to redefine the relationship with Beijing. Only there is more at stake than bilateral ties. "We have a long tradition in U.S.-China relations of trying to cut a deal with the Chinese that shuts out other people," says Pomfret. The pact taking form between Trump and China's Xi Jinping may do exactly that. It seems increasingly likely to test U.S. alliances as well as the global trading system that American leaders spent decades building. The end of one trade war may well trigger others.

As negotiations continue, it's worth remembering history. Britain's trade hold on China arguably peaked in the 19th century with its victory in the Opium Wars and the painful settlement it imposed. The Chinese haven't forgotten that humiliation: It informs their prosecution of the current trade war with America.

Much as America's Founding Fathers once did, Donald Trump seeks to redefine the relationship with Beijing.

With his tariffs, Trump has sought to force what some in Beijing see as a similar capitulation on 21st century issues such as China's model of economic development, its treatment of intellectual property, and the global reach of its technology. He has also, however, forced a line-by-line discussion over increased purchases of U.S. agricultural and energy exports that reeks of 19th century mercantilism, the philosophy that a nation's wealth is derived from selling as much as it can to the world rather than enjoying the broader benefits of open trade. Trump wants Beijing to buy more to reduce a U.S. trade deficit with China that's grown largerunder his watch.

But the slip toward what purists call "managed trade" is a major departure from U.S. economic policy. It's also causing anxiety in the rest of the world, particularly among U.S. allies such as the European Union and Australia, which are likely to see their own trade with China affected. No one wants a trade war. But many fear the U.S. is putting at risk the global trading regime that has thrived since the end of World War II. "We know that a destructive global trade war between the two big economic powers would be bad for global economic growth and be negative for Australia," says Simon Birmingham, the Australian trade minister, but "the way in which the U.S. has gone about these and some other negotiations is not a way in which Australia would have or, indeed, supports."

As it is, the current trade war has caused collateral damage. The dip in demand from China, which results partly from trade tensions, has hurt the profits of U.S. companies such as Apple Inc. and Caterpillar Inc. Global trade in goods has been slowing, with exports from trade-dependent nations such as South Korea and Japan declining. Germany sits on the cusp of a recession at least in part because of a slowing China; its economy may fall over the edge if Trump imposes threatened auto tariffs. Australia's decision to bow to U.S. pressure and ban Huawei Technologies Co. equipment from its new 5G network leaves it facing retaliation. One Chinese port has forbidden imports of Australian coal, prompting fears Beijing is targeting the country's most lucrative exports.

The fallout may get worse if there's a U.S.-China agreement. In a Feb. 21 note, economists at Barclays estimated other countries could see exports to China drop as much as 20 percent. The EU would see a $55 billion hit to its exports to China, or the equivalent of a 2.2 percent drop in its exports to the world. That's why many critics see Trump's strategy as a beggar-thy-ally approach — with consequences for U.S. power. "The fact that we will have broken so much china, and have battered our allies and angered them and still reached a deal, is a reflection on the continued economic power of the United States," says Stuart Eizenstat, who was in the room when President Jimmy Carter and his Chinese counterpart, Deng Xiaoping, hashed out a deal to normalize relations in 1979 and writes about it in a recent book on Carter's White House. But, he adds, "I think in the end it will subtract from that power. It's a sort of a last fling at unilateralism."

Deng Xiaoping & Jimmy Carter— Photo: Schumacher, Karl H.

Eizenstat says the U.S. and Europe are facing the worst crisis in their relationship since World War II, and things may get more fraught. The EU and Japan are about to embark on their own trade talks with Trump while facing the threat of auto tariffs. And while they're working quietly with Washington on a common agenda to take on China inside the World Trade Organization, those efforts seem increasingly futile.

The irony is that any understanding Trump reaches with China may end up being a blow to the American-led global trading order. Until his presidency, the U.S. led the push for trade pacts that focused on building up institutions such as the WTO to arbitrate disputes and on establishing rules to govern trade — rather than rely on mercantilist, government-directed purchases. Trump and his aides have pursued the bulk of their trade war with China outside the trade organization's rules. That approach appears likely to continue. Enforcement of a deal with China, they say privately, is likely to come via U.S. tariffs rather than a reliance on the WTO to adjudicate disputes, a process that's often painfully prolonged.

Increased Chinese purchase of U.S. products, from aircraft to commodities such as beef, corn, and natural gas, may be just as corrosive. European and Japanese officials grumble about the cost they're likely to bear in loss of potential sales to China. Some of that disquiet might be offset if Trump is able to extract Chinese reforms to address the shared complaints of U.S. and European companies, such as intellectual-property theft. However, the potential agreement could well undermine the principles of nondiscrimination that underpin global trade — specifically the tenet that all trading partners treat each other as most favored nations. "By doing this you are also putting into question the trust that companies and others put into the system," says Luisa Santos, director for international relations at BusinessEurope, the leading voice for European companies.

Douglas Irwin, a Dartmouth economist and author of Clashing Over Commerce, a history of U.S. trade policy since 1776, says Trump is in many ways revisiting a debate that was largely resolved in the 1930s. In a 1934 decision that set the stage for decades of U.S. trade policy, President Franklin D. Roosevelt sided with Cordell Hull, his secretary of state, over George Peek, a White House trade adviser and the first president of the Export-Import Bank. Hull argued the U.S. and the world were best served by trade deals that established rules that allowed the free market to work. Peek argued that trade pacts ought to be purely transactional and the U.S. was best served by a government acting as a broker for U.S. goods rather than negotiating abstract rules. Peek lost the debate in part by losing the moral high ground: He negotiated what amounted to a barter agreement with Nazi Germany. He left FDR's government shortly afterward.

The administration's approach isn't monolithic.

The rules-vs.-transactions debate resurfaced in the 1980s when U.S. administrations took on Japan in a trade war that led to agreements not unlike those now in play with China. These set a series of export limits for Japan, though the issue of how to enforce them was different, given Tokyo's reliance on U.S. military protection. That debate effectively resolved itself with Japan's economic downturn in the 1990s, Irwin says. The trade conflicts with Japan, he says, helped clear the way for the creation in the 1990s of the WTO as a neutral arbiter of trade disputes.

Which brings us back to Trump and China. Irwin argues that a deal that swings the relationship to managed trade would involve a "deterioration of the system." Trump and his aides aren't sentimental about the global trading regime. They say they're unwinding decades of policy that have resulted in little more than America's industrial decay. Any purchases the Chinese may make are simply welcome commitments aimed at reducing a yawning U.S. trade deficit with China.

The administration's approach isn't monolithic. Hard-liners such as White House trade adviser Peter Navarro want a strategic decoupling of the U.S. and Chinese economies. Others, such as Treasury Secretary Steven Mnuchin, seek a less disruptive path. As Trump angles for a deal that makes the stock markets happy, the tension inside his administration is largely between demands for substantive Chinese reforms and the sort of easy deficit-reducing purchases Beijing is willing to make. "The issues on the table are too serious to be resolved with promises of additional purchases," U.S. Trade Representative Robert Lighthizer told Congress on Feb. 27.

Even with a mercantilist agreement, Irwin says, the situation needn't be cast in stone. The very nature of managed trade, he says, means "you usually have to go back to the negotiating table, and things can be repaired."

However, by pursuing bilateral negotiations and ignoring the WTO as a venue to enforce any deal, Trump is encouraging other members to do the same. His invocation of a once-taboo WTO national security loophole to impose tariffs is seen as encouraging others, such as Russia and Saudi Arabia, to do the same. Potentially worse, Trump's blocking of new WTO judges is hobbling the organization's ability to hear cases. Its seven-member appellate body may be down to one panelist by the end of the year.

If Trump uses the current tariffs on $250 billion in imports from China as the primary and long-term tool to enforce any deal, he will hand his successor a difficult legacy to unwind. The U.S. has a history of temporary tariffs that have endured. The prime example is the 25 percent "chicken tax" on imported light trucks introduced in the 1960s over a poultry dispute with Europe that's survived until now. The duties Trump has imposed on China may follow that pattern, Irwin says. For one thing, there's a growing bipartisan consensus on the need to crack down on China that will make lifting any tariffs politically awkward. "With China, there's this ratchet effect," he says. "It's not easily undoable."

While some see cognitive dissonance in Trump's push for state-directed purchases alongside economic reforms intended to reduce the long-term role of the state, others call the approach pragmatic. China for years slow-walked the delivery of promised reforms. Better to get what you can now. "You have to recognize that achieving some short-term goals requires working with China as it is rather than as you wish it to be," says Brad Setser, an expert on international economics who served in the White House and the Department of the Treasury in the Obama administration.

The Empress of China returned to America with a sizable profit in 1785. And the U.S. push to gain an advantage over European rivals on the Chinese mainland has continued ever since. In 1946 drivers on the mainland were forced to switch to the right side of the road after the U.S. lobbied Nationalist Party leader Chiang Kai-shek — who was dependent on U.S. aid — to make the change. Washington, Pomfret says, "got him to do it partially because U.S. auto companies wanted to sell more automobiles in China and wanted to shut the Brits out of the market." Now it may be the rest of the world that gets shut out of a deal between China and the U.S.

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Economy

European Debt? The First Question For Merkel's Successor

Across southern Europe, all eyes are on the German elections, as they hope a change of government might bring about reforms to the EU Stability Pact.

Angela Merkel at a campaign event of CDU party, Stralsund, Sep 2021

Tobias Kaiser, Virginia Kirst, Martina Meister


-Analysis-

BERLIN — Finance Minister Olaf Scholz (SPD) is the front-runner, according to recent polls, to become Germany's next chancellor. Little wonder then that he's attracting attention not just within the country, but from neighbors across Europe who are watching and listening to his every word.

That was certainly the case this past weekend in Brdo, Slovenia, where the minister met with his European counterparts. And of particular interest for those in attendance is where Scholz stands on the issue of debt-rule reform for the eurozone, a subject that is expected to be hotly debated among EU members in the coming months.

France, which holds its own elections early next year, has already made its position clear. "When it comes to the Stability and Growth Pact, we need new rules," said Bruno Le Maire, France's minister of the economy and finance, at the meeting in Slovenia. "We need simpler rules that take the economic reality into account. That is what France will be arguing for in the coming weeks."

The economic reality for eurozone countries is an average national debt of 100% of GDP. Only Luxemburg is currently meeting the two central requirements of the Maastricht Treaty: That national debt must be less than 60% of GDP and the deficit should be no more than 3%. For the moment, these rules have been set aside due to the coronavirus crisis, but next year national leaders must decide how to go forward and whether the rules should be reinstated in 2023.

Europe's north-south divide lives on

The debate looks set to be intense. Fiscally conservative countries, above all Austria and the Netherlands, are against relaxing the rules as they recently made very clear in a joint position paper on the subject. In contrast, southern European countries that are dealing with high levels of national debt believe that now is the moment to relax the rules.

Those governments are calling for countries to be given more freedom over their levels of national debt so that the economy, which is recovering remarkably quickly thanks to coronavirus spending and the European Central Bank's relaxation of its fiscal policy, can continue to grow.

Despite its clear stance on the issue, Paris hasn't yet gone on the offensive.

The rules must be "adapted to fit the new reality," said Spanish Finance Minister Nadia Calviño in Brdo. She says the eurozone needs "new rules that work." Her Belgian counterpart agreed. The national debts in both countries currently stand at over 100% of GDP. The same is true of France, Italy, Portugal, Greece and Cyprus.

Officials there will be keeping a close eye on the German elections — and the subsequent coalition negotiations. Along with France, Germany still sets the tone in the EU, and Berlin's stance on the brewing conflict will depend largely on what the coalition government looks like.

A key question is which party Germany's next finance minister comes from. In their election campaign, the Greens have called for the debt rules to be revised so that in the future they support rather than hinder public investment. The FDP, however, wants to reinstate the Maastricht Treaty rules exactly as they were and ensure they are more strictly enforced than before.

This demand is unlikely to gain traction at the EU level because too many countries would still be breaking the rules for years to come. There is already a consensus that they should be reformed; what is still at stake is how far these reforms should go.

Mario Draghi on stage in Bologna

Prime Minister Mario Draghi at an event in Bologna, Italy — Photo: Brancolini/ROPI/ZUMA

Time for Draghi to step up?

Despite its clear stance on the issue, Paris hasn't yet gone on the offensive. That having been said, starting in January, France will take over the presidency of the EU Council for a period that will coincide with its presidential election campaign. And it's likely that Macron's main rival, right-wing populist Marine Le Pen, will put the reforms front and center, especially since she has long argued against Germany and in favor of more freedom.

Rome is putting its faith in the negotiating skills of Prime Minister Mario Draghi, a former head of the European Central Bank. Draghi is a respected EU finance expert at the debating table and can be of great service to Italy precisely at a moment when Merkel's departure may see Germany represented by a politician with less experience at these kinds of drawn-out summits, where discussions go on long into the night.

The Stability and Growth pact may survive unscathed.

Regardless of how heated the debates turn out to be, the Stability and Growth Pact may well survive the conflict unscathed, as its symbolic value may make revising the agreement itself practically impossible. Instead, the aim will be to rewrite the rules that govern how the Pact should be interpreted: regulations, in other words, about how the deficit and national debt should be calculated.

One possible change would be to allow future borrowing for environmental investments to be discounted. France is not alone in calling for that. European Commissioner for Economy Paolo Gentiloni has also added his voice.

The European Commission is assuming that the debate may drag on for some time. The rules — set aside during the pandemic — are supposed to come into force again at the start of 2023.

The Commission is already preparing for the possibility that they could be reactivated without any reforms. They are investigating how the flexibility that has already been built into the debt laws could be used to ensure that a large swathe of eurozone countries don't automatically find themselves contravening them, representatives explained.

The Commission will present its recommendations for reforms, which will serve as a basis for the countries' negotiations, in December. By that point, the results of the German elections will be known, as well as possibly the coalition negotiations. And we might have a clearer idea of how intense the fight over Europe's debt rules could become — and whether the hopes of the southern countries could become reality.

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