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Trade war salvos have ominous implications


Trade war salvos have ominous implications

At the Boao Forum in China today, President Xi Jinping gave what was billed as a ‘historic speech’. Some upmarket media predicted it would be the most anticipated speech since Xi came to power, and that bold new reforms would be laid out. In the end, it was nothing of the sort. Regardless, financial markets liked what they thought they heard. Yet, as the temperature of the trade conflict between the US and China rises and falls by the day, markets are going to remain volatile, but basically clueless. We are just going to have to wait to see how the politics play out….Read more….

Xi gave a sort of 2017 Davos speech at what is China’s own Davos at a resort on Hainan Island, about a 90 minute flight due southwest of Hong Kong. It was a measured speech, in which he again played China’s globalisation leader credentials, and railed against those with a Cold War mentality. What he put on the table, though, will probably have earned a yawn from the White House. Not that the content wasn’t interesting but we have heard it all before: broader access for foreign financial companies looking to China’s financial and insurance markets, greater ownership participation in China’s transportation markets (auto, aviation and shipping firms), lower auto tariffs, and an improved business environment for foreign investors, including better protection of intellectual property.

Some or all of these might yet form the basis of a plan to defuse the current dispute, especially since it was also reported today that China was willing to increase its purchases of US LNG, agricultural products , semiconductors and luxury goods to head off Trump’s recently announced, so-called 301 tariffs that were aimed at China’s key manufacturing sectors. For now though, this isn’t part of any deal, and Xi’s speech was devoid of specifics, timings, and the one topic that is most definitely in the US cross-hairs, and that is China’s industrial policy.

If you really want to know what irks the White House about China nowadays, you could take a gander at bits of this 148 page report, published in January Courtesy of the Office of the US Trade Representative, this is the 2017 Report to Congress on China’s World Trade Organisation Compliance. It is a long report in which the US essentially takes China to task for for two key reasons.

Taking China to task for the role of government (!)

First, it alleges that China pressures foreign firms to give up or share their technological know-how and intellectual property as the price for doing business in China. It says, further, that China does not provide adequate IP protection, constrains the activities of foreign firms in ways not reciprocated regarding Chinese firms when they invest abroad, and retains a system of tariffs and quota restrictions that distort trade.

If these comprised the limits of US complaints, we might even think that a trade ‘deal’ could be hatched in the not too distant future. But the second factor is key and that is the USTR report demonstrates deep US unease about the economic role played by China’s government. It says that when China joined the WTO in 2001, it committed to lower the influence of the government in the economy and in industrial policy over time. It’s not correct for the US to assert that this never happened, even it progress was slower than it might have hoped. But a succession of policies put this hope into the bunker starting a long time ago.

China’s focus on state-driven industrial policy and the development of new technologies goes back a long way. In 2006, the National Medium- and Long-Term Plan for the Development of Science and Technology (2006-2020) served as a blueprint for the development of science and technology development. It came with the hope that it would bring about the ‘great renaissance of the Chinese nation’ and turn China into a technological powerhouse by 2020 and a global leader by 2050. The authors lamented China’s shortcomings as an economic power principally because of ‘our weak innovative capacity’ and hatched a new policy that carried the now common term ‘indigenous innovation’.

It seemed innocuous enough, even praiseworthy as a strategy to encourage Chinese enterprises and researchers to develop home-grown technologies. Yet, over time and for foreign firms especially, indigenous innovation came to be associated with various forms of protectionism and favouritism for local companies, unfair trade and commercial practices, and the leveraging of Chinese technical progress on the back of imported technology either from acquisitions abroad or through foreign companies operating in China. According to a US Chamber of Commerce report, indigenous innovation came to be considered by many international technology companies as ‘a blueprint for technology theft on a scale the world has never seen before’.

The 13th Five Year Plan (2016-2020) set out ambitious plans to develop modern manufacturing and new technologies. It aims to deliver significant results in innovation-driven development, flourishing business startups, and total factor productivity. It says that science and technology should become more deeply embedded in the economy, and lays out a number of goals which will help China become a talent-rich country of innovation’.

The launch of the State Council’s industrial policy, Made in China 2025 (MIC25), in 2015 and subsequent announcements took many of these initiatives further. Their focus is on key sectors, including advanced rail, ship, aviation and aerospace equipment, agricultural machinery and technology, low and new-energy vehicles, new materials, robotics, biopharmaceuticals and high-end medical equipment, integrated circuits, and 5G mobile telecommunications.

Most recently, China formalised and launched nationally an ambitious AI strategy, already underway at the local government level. The State Council set out the Next Generation AI Development Plan with the goal of boosting China’s AI status from being in line with competitors by 2022, to world-leading by 2025, and the world’s primary source by 2030. This was followed in quick succession by a report from the National Natural Science Foundation entitled Guidelines on AI Basic Research Urgent Management Projects, the announcement by the National Development Reform Commission of an AI Innovation and Development Megaproject, and a 3-year Action Plan by the Ministry of Industry and Information Technology.

No way, but any way?

There is no way that the US is going to be able to get China to move away from or modify the government’s and Party’s role in industrial policy and in asserting China’s technological prowess. If that is what it indeed intends, then the current trade conflict will either escalate into a full-blown trade war, or is just an hors d’oeuvre for what is to come. It is in effect Cold War 2.0.

Since China has already announced possible tariffs on $50 billion of imports from the US, and total imports are a little more than $130 billion, there is only so much tit-for-tat that China can do. By contrast, the US has announced tariffs on $50 billion of imports from China, threatened a further $100 billion, and could yet raise more given the total import bill of about $500 billion. But China is not out of options.

It has form in targeting firms, and businesses where countries have fallen out with Beijing, including Norway, the Philippines, Japan and most recently, South Korea. It could use behind the border regulatory measures to make life difficult for US firms. It could make overtures to North Korea and throw Taiwan into the mix to put pressure on the US.

But my sense is that this is not a propitious time for China to have a trade war – assuming there were one at all. It is currently trying to establish a new governance regime in which the Party is in control of everything that matters. It is trying to de-risk the still vulnerable financial system, clean up the atmosphere and the land, rebalance the economy, cut heavy industry capacity, and the Party has pledged to improve the quality of life and address inequalities for the citizenry. The last thing China needs now is a major trade conflagration that could damage confidence and growth in the coastal regions especially.

China could bring things to the table that might satisfy the US, at least for the time being. In addition to tariff reductions and import purchases already referred, it could offer to negotiate a code for economic governance, or agree to discuss some specific subsidies and other favours that benefit SOEs. It could engage with the operating and technology transfer regulations which foreign firms complain about. Importantly it could entice the US into areas of health, education, and other modern services that have remained closed and protected. If this all sounds a bit fanciful, it is part of what an opening up agenda would look like, and could still be part of China’s Socialism with Chinese (market) Characteristics.

If, though, these areas are a bridge too far for Xi’s China, then it will be clear that reform and opening up, now 40 years old, is done and dusted. And a trade war will begin in earnest.