If the U.S. Gets Into a Trade War with the EU, It Will Lose an Ally in Pressuring China


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The European Union’s recent announcement that it is preparing to retaliate if the Trump administration imposes tariffs on EU-made autos leaves no doubt that EU-U.S. cooperation on global trade will be compromised for some time if the tariffs go into effect. Besides whatever damage the conflict could do to U.S. jobs, industry, and consumers, this conflict will jeopardize essential allied collaboration to confront Chinese state capitalism, the underlying cause of much of the current trade conflict. When EU President Jean-Claude Juncker visits Washington on July 25, the administration should use the visit to find ways to step back from this precipice.

The primary tool of China’s industrial policy is subsidies to state-owned enterprises (SOEs) for key industries such as robotics, advanced computers, and electric vehicles. SOEs receive preferential access to land, finance, telecom, hydrocarbons, and electricity. They enjoy lower taxes and selective anti-trust enforcement to shield them from private competitors. Trade barriers also block competition: For example, Chinese electric carmakers must use batteries made in China and can’t purchase them from Japanese and Korean sources.

The Trans Pacific Partnership (TPP) free-trade agreement, which the U.S. abandoned in January 2017, contained strong restrictions on SOE subsidies that, ironically, were largely drafted by U.S. negotiators. Despite recent trade conflicts, the European Union, Japan, and the U.S. have been quietly working to develop another agreement containing rules to restrain Chinese subsidies. They include measures that would deprive a member of its voice within the World Trade Organization (WTO) by taking away its access to WTO documents and its rights to attend meetings and to vote; a presumption that non-disclosed subsidies are harming foreign companies, thereby facilitating retaliations, and streamlined procedures for retaliation when subsidies support excess capacity.  Since the payoff for such joint action would be large, forging such an agreement must be a U.S. priority. But the threatened auto tariffs and promise of retaliation will make it much harder for these efforts to succeed.

The growth of SOEs. When China was admitted to the World Trade Organization in 2001, the Western hope was China would move toward a market-driven economy. Instead, particularly after the 2008 financial crisis, China has expanded central planning; 100,000 SOEs have been the principal engine of that expansion. The SOEs produce 33% of China’s GDP and account for 20% of its jobs; the central government controls one-third of the SOEs.

The most challenging subsidy is $330 billion for an initiative known as “MADE IN CHINA 2025.” This program targets key industries of the future and specifies the domestic market share to be achieved — e.g. electric vehicles (70%), electric-vehicle batteries and engines (80%), high-performance computers (60%), semiconductors (35%), industrial robotics (50%), and mobile devices (70%). Such market shares will create a platform for global juggernauts. Moreover, MADE IN CHINA 2025 is only the first of three phases. The goal for 2035 is “enter the front ranks of second tier manufacturing powers,” and the target for 2045 is to “enter the first tier with world leading technology and industrial systems.”

These subsidies build on years of Chinese state support for foundational industries like banks, oil, utilities, telecom, and construction. In recent years, U.S. imports of goods made in China by companies that benefited from $7.3 billion in subsidies included solar panels, chemicals, pipe, steel wire, wheels, wind towers, and kitchen appliances. And they were  just a leading edge.

Dangers to the world trade order. Besides the threat to Western economic interests that this industrial policy poses, it is also a systemic challenge to the global economic system built on the norm of market-based competition. It erodes confidence in the World Trade Organization’s “rules of the road” — which include principles like promoting fair competition through treating foreign firms operating in a country like national firms — of which all trading nations are enormous beneficiaries. It makes neutral resolution of disputes under those WTO rules more difficult.

In addition, China’s policy is a threat to commercial opportunities in countries where U.S. and Chinese companies are competing for business. The subsidies will also put pressure on global supply chains, including production of high tech goods needed for national security.

The need for restrictions and transparency. Five years of U.S. negotiation of the TPP with Japan, Australia, Mexico, Canada, Chile, Peru, Malaysia, Vietnam, and others (that altogether represent 40% of global GDP) produced agreement on a regional free-trade area containing the tightest restrictions on SOEs in any trade agreement. These new rules required disclosure of all SOEs on a public website, including the percentage of government shareholding, the titles of government officials serving on SOE boards or as corporate officers, annual revenues, and details of any policy or program that provides subsidies. The rules also established the right to receive answers to specific questions about SOEs.

Without such transparency, it is extremely difficult to obtain the evidence required to show subsidies have injured outside firms. And China’s subsidy programs are anything but transparent: They are shielded by unpublished government budgets and directives and a law that allows commercial information to be treated as state secrets.

The U.S. withdrew from TPP in January 2017. The other 11 countries completed the deal, which is now named the Comprehensive and Progressive TPP. Each CPTPP member will receive significant market-access advantages over U.S. firms as well as the benefit of constraints on SOEs in Vietnam, Malaysia, and Mexico, where they also play a large economic role.

If the Trump administration’s initial withdrawal from the TPP was intended to reduce the U.S. trade deficit with Asia, then undercutting market access and the ability of U.S. companies to compete with SOEs isn’t likely to help. President Trump has signaled that the U.S. could seek to rejoin CPTPP, if there was a “substantially better” deal than the one brokered by President Obama. But the delicate balance of interests means the 11 members are unlikely to give America a “better” deal than the one previously negotiated.

New efforts to restrain the SOEs. Last week, the EU and Japan signed a free-trade agreement containing SOE rules similar to those in the CPTPP. In December 2017, the trade ministers of the European Union, Japan, and the U.S. issued a joint statement of agreement to work together in the WTO to combat market-distorting subsidies. In January, the EU trade commissioner said, “There are some grave concerns on China, [which is] massively subsidizing state-owned companies — and there we could work with the U.S.”

As a result of this common concern, the U.S. the EU, and Japan have agreed to develop “joint action” on China’s subsidies. Ideas on the table include administrative penalties for failure to disclose subsidies such as loss of access to WTO documents, meetings, and votes; a presumption that undisclosed subsidies are harming foreign companies, thus facilitating retaliation; and targeted remedies against subsidies for the creation or maintenance of capacity inconsistent with commercial considerations. Additional meetings are scheduled for August and September, but it is difficult to imagine a positive outcome if an auto trade war breaks out.

New tariffs on auto trade are likely to harm the U.S. economy as much or more than the targets: The Peterson Institute for International Economics estimates that if the European Union retaliates against auto tariffs as it is expected to do, production in the U.S. auto industry would fall 4% and that 5% of the U.S. workforce in the auto and auto-parts industries would be displaced. The tariffs would also likely sound the death knell of allied cooperation on China’s SOE subsidies, the fundamental cause of current trade conflicts. That would be a devastating price to pay.

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