July 17, 2018

Three Ways to Deal with China's Unfair Trade Practices

Christine McDaniel

Senior Research Fellow

The Trump administration just upped the ante on a looming trade war with China by announcing a new 10 percent tariff on $200 billion of Chinese imports. At some point these tariffs are going to catch up with us and inflict friendly fire on Americans, and it will be time to turn to Plan B. We have three options.

First, some background. An Office of the U.S. Trade Representative (USTR) “301” report puts the administration on fairly solid ground with many of its trade grievances. The 215-page report paints a picture of 21st century economic espionage. Not only is the Chinese government looking the other way, they are facilitating — if not outright sponsoring — cyber-enabled theft of U.S. intellectual property and sensitive commercial information. It’s a foreign investment and technology transfer regime that stacks the deck against U.S. and other worldwide firms, leaving them with a lack of legal recourse.

Here are three ways to deal with China’s unsavory business practices:

The first option is to punish them with tariffs, investment restrictions, and World Trade Organization (WTO) cases and hope they change. This is already underway, with unilateral tariffs that aim to restrict Chinese firms’ access to the U.S. market, investment restrictions that may target China’s much-needed access to U.S. technology, and complaints registered with the WTO.

In today’s global economy, tariffs do self-inflicted harm. Imagine being in a gunfight in an old wooden ship, with every shot fired at your enemy putting a hole in your own hull. Eventually, you start to sink. American manufacturers rely on intermediate inputs from China, so taxing those shipments puts our own manufacturers at risk of becoming less competitive both here and in export markets.

Restricting Chinese investment in the United States when there are legitimate national security concerns involved is fairly straightforward, although this has proven difficult to get through Congress.

And as for taking our complaints to the WTO, this is a decent bet. We have won most of the cases we have brought, including those against China, which does eventually oblige. But these cases take time and the WTO’s reach is only so far.

The second option is to do nothing. Mind our own business and don’t reach beyond our borders. This option puts the risk wholly on the private sector. The U.S. firms that wish to do business in China can choose to gamble their intellectual property crown jewels for access to a large and growing market. As long as U.S. sanctions and export controls are followed, those comfortable with the risk are free to make a buck or lose a buck.

The third and best option is to change global trade rules. Team up with our allies, who are just as frustrated with China as we are. Form a pact in which signatories commit to open trade and investment regimes, sufficiently strong intellectual property rights and enforcement, and legal recourse mechanisms. Most importantly, signatories commit to not engage in trade or investment with state-owned enterprises or those with close ties to state-owned enterprises. This would effectively leave China the odd man out.

We can’t force a sovereign nation to do anything, but they will always do what they think is in their best interest. Make that an easy choice. Being part of the global economy is in China’s best interest. In fact, their economic survival depends on it.

In order to stay in the club, China should implement reforms the International Monetary FundWorld Bank and Chinese elite have called for: a more open trade and investment regime, phasing out state-owned enterprises, stronger patent rights, and legal recourse mechanisms. These policy shifts — a shift in thinking, really — would help put China on a more sustainable path to economic growth. It would also dial down tendencies that lead to massive resources ploughing into unproductive uses, resulting in over-capacity and excess production flooding into international markets. 

The United States, or at least this administration, has shown that it will not sit idly by and watch a huge state-controlled economy steal the innovations and market share of U.S. firms. But it is unlikely China will undergo a massive shift in thinking because of tariffs alone. We need to play the long game. Stop shooting holes in the hull and take the helm.