Why the trade war won’t hurt China

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New Delhi | July 16, 2018 4:04 AM

Size does matter, but it is the dynamics and degrees of bargaining power that are at the crux of trade negotiations.

The US-China trade dispute is on and off hotting up.

The US-China trade dispute is on and off hotting up. While many are stressing the rights and wrongs of reining in the Chinese trade policies, there is hardly any debate as to why China adopted such practices in the first place and what that might suggest about development prospects under existing global trade rules.

It is hardly a secret that few developing countries have joined the ranks of high-income countries in the postwar era, and only a handful of these have done so by establishing globally competitive home-grown industries in capital- and technology-intensive manufacturing sectors; not to speak of services. This handful is concentrated in East Asia in countries such as Japan, South Korea and Taiwan.

Also, it is widely acknowledged that the strategic role of the state in these cases was substantial, but some argue that the relevance of these experiences today is limited because the global trading system has changed. Policy instruments like ‘performance requirements’ were banned when the WTO came into force in 1995. Other practices like technology licensing agreements were dissuaded in favour of FDI flows, which allow foreign investors greater control over technology transfers.

Under the new rules, the trading system has become much less permissive of the instruments and areas of government intervention in the economy. Rules that once focused on reducing tariff barriers and confined to goods sector have been expanded to areas such as services, IPR and domestic subsidies. Efforts to extend multilateral rules to issues of investment, government procurement, antitrust measures and trade facilitation were resisted, but now have made inroads through proliferation of RTAs/FTAs. Some flexibility is included in these new policy prescriptions, but flexibility is limited in scale, scope and time. Flexibility that exists is often of little use to countries with weak organisational and financial capacity.

Trade rules are important in providing a reliable framework for exchange, but the multilateral trade regime has become asymmetrical and a glaring example of institutional overreach: the WTO, backed by its strongest developed-country members, has reduced the policy space of developing countries. This is known as ‘kicking away the ladder’, a concept by Ha-Joon Chang of the University of Cambridge, whereby rich countries deny other countries the policy tools that they had used during their own development process.

China started its economic reform and opening up 40 years ago, but it only joined the WTO in 2001. Under the stricter rules of the WTO and the spread of global value chains, China’s policy-makers faced tough reform choices, but they were aware of what they had (and had not) signed up.
Any country’s design of an opening-up strategy is to serve its national development objectives. For China, the idea was clear. At any given stage of development, designing an opening-up strategy is to realise national objectives for that stage of development.

This nuanced view to economic openness speaks to the pragmatic but sequential pace of reform measures in China’s development strategy. As the country pursues its ‘Made in China 2025’ plan to upgrade its industrial base, for instance, only now it is witching to a ‘negative’ list for FDI after over 20 years of using a ‘positive’ list that classified sectors as encouraged, restricted or prohibited for foreign investors.

The number of foreign equity restrictions has been relatively steady since China’s first FDI ‘guidance catalogue’ in 1995, reaching a peak of 186 in 2007. Only by 2015 was there a clear reduction to 95, with the number of restrictions dropping further to 63 in 2017. By industry, the focus of these restrictions has shifted over time from manufacturing to service sectors. The guidance catalogues were possible because China kept complete discretion in the ‘pre-establishment phase’ of foreign investments.

During China’s opening-up, many conditions were set in terms of market access, equity, product, scope and supervision. China can now relax some of these restrictions because its leaders are assured that the Chinese economy is at a stage of development where fewer restrictions are needed. For instance, China’s banking sector has been ‘restricted’ since the first guidance catalogue, with foreign investors later allowed but limited to a 25% equity stake. But when foreign banks’ share of total banking assets fell from 2.4% in 2007 to 1.3% in 2016, restrictions could gradually be relaxed.

In the context of the recent US-China trade frictions and skirmishes, China’s size and strategic patience have brought the US back to the negotiating table. From the view of unorthodox economic policy, the US Trade Representative’s Section 301 report on China provides a rare glimpse of how a country can (still) put back the development ladder that has been kicked away.

Size does matter, but it is the dynamics and degrees of bargaining power that are at the crux of trade negotiations. Developing countries of all shapes and sizes must practise strategic role in reclaiming lost policy space while also identifying sources of new spaces. Important initiatives like China’s Belt and Road Initiative (BRI) usher in an opportunity for other countries to creatively leverage the focus on infrastructure (not rules) to acquire much-needed policy flexibility onto the global trading system.

The author is Professor, Lal Bahadur Shastri Institute of Management, Delhi

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