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ABSTRACT
Three major concerns drove the U.S. into initiating the trade war, and they are (a) the concern that China’s chronically large trade surplus was depressing job creation in the U.S. (b) the concern that China was using illegal and unfair methods to acquire U.S. technology at an effectively discounted price; and (c) the concern that China seeks to weaken U.S. national security and its international standing. On the dispute over China’s exchange rate and trade imbalance, the first conclusion is that it was marked by analytical confusion over the meaning of the term ‘equilibrium exchange rate’. The second conclusion is that China’s trade imbalance reflects the economic conditions in both China and U.S., and that the efficient and fair solution of the problem requires policy changes in both countries. On the industrial policy dispute, the first conclusion is that the issue of forced technology transfer is largely a dispute about China using its market power to benefit itself at the expense of its trade partners. The second conclusion is that China’s use of market power can last only until the other large countries could unite and retaliate as a group. The inevitability of retaliation means that China should replace the joint-venture (JV) mechanism for technological diffusion with other ways to strengthen its technological capability. On the U.S. concern about whether China trade weakens its national security, the first conclusion is that the notion of national security that is commonly adopted in the U.S. trade policy debate is ignorant about the primary determinants of U.S. capability in innovation. By focusing instead mainly on how to hold down China technologically, the long-run outcome will be a technologically weaker U.S. and hence, a more vulnerable U.S. The second conclusion is that the U.S. must identify a clear, short list of critical technologies and critical infrastructure for the recently reformed Committee for Foreign Investment in the United States (CFIUS) to cover, and update this list constantly. Otherwise, the broad and changing nature of notions about national security would allow the bureaucratically driven phenomenon of mission-creep to steadily expand the coverage of the CFIUS process, thereby steadily rendering CFIUS to be operationally capricious. Our principal policy suggestion to China is that, because China’s economy in 2018 is very different from that in 1978 (e.g. many parts of China now look like Singapore and China is Africa’s biggest donor), there should be more reciprocity in China’s trade and investment relations with the advanced economies despite China’s status as a developing economy under WTO rules. Our principal policy suggestion to President Trump is to stop equating strategic competition with economic competition. Strategic competition is normally a zero-sum game. While fair economic competition is usually a zero-sum game in the short run, it generally creates a win-win outcome in the long run.
Acknowledgments
We are most grateful to Irene Lu, Shen Yan, Yu Miaojie, and Huang Yiping for their guidance and patience in the writing of this paper.
Disclosure statement
No potential conflict of interest was reported by the authors.
Notes
1. See Bown and Kolb (Citation2018) and Borzykowski (Citation2018).
2. This is the trade imbalance in the trade of goods. There is controversy over the size of the bilateral trade imbalance, e.g. the official U.S. estimate of the bilateral trade deficit in 1996 is $39.5 bn, and the official Chinese estimate is $10.5 bn. When Feenstra et al. (Citation1999) corrected these estimates by taking account of the value-added in Hong Kong during transshipment, the two figures were revised to $26.1 bn and $20.6 bn, respectively.
3. For simplicity in notation, we will refer to the sum of columns (ii), (iii), and (iv) as the capital-financial account (KFA).
4. By accounting necessity, BOP = the negative of the reserve financial account (RFA).
5. The Economist (Citation2018).
6. The equilibrium CA of a developing country is not always negative, see Liu and Woo (1994) for an imperfect financial market explanation why the economic development of Taiwan had been characterized by current account surpluses.
7. See Goldstein and Lardy (Citation2003) and (Goldstein and Lardy Citation2008).
8. The validity of the point being developed does not rely on the free market exchange rate with open FKA being 7.0. We know that it has to lie above 6.4 and could even exceed 8.3. Our point is even stronger when the reference value is higher than 8.3.
9. This fast, large appreciation of the G-5 currencies against the USD from September 1985 to end of 1986 was quickly considered by all to be excessive and destabilizing to global financial markets. The upshot was that the G-5 and Canada signed the Louvre Accord on 22 February 1987 to halt the slide of USD but sharp Yen appreciation continued.
10. See Pesek (Citation2016).
11. ‘China-centric’ because they ignore the obvious fact that the current account balance is also determined by foreign, notably U.S., economic conditions.
12. The SCE category covers companies that are classified as state-owned enterprises (SOEs); and joint-ventures and joint-stock companies, which are controlled by third parties (e.g. legal persons) who are answerable to the state. To understand the principal-agent problems in SCEs has shaped China’s macroeconomic performance, see Woo (Citation2006) and Woo (CitationForthcoming).
13. The simultaneous expansion of these two sectors meant that the nontradeable sector was contracting. The undervalued RMB explanation for China’s trade imbalance is actually an aggressive industry policy explanation. The subsidy-tariff combination is equivalent to the undervaluation of a currency, see Woo (Citation2004).
14. ROE data are from Cho and Kawase (Citation2018). Also see Tan, Huang, and Woo (Citation2016) for a discussion on China’s zombie firms.
15. STEM = Science, Technology, Engineering, and Mathematics.
16. See Fu, Woo, and Hou (Citation2016).
17. Bradsher and Rappeport (Citation2018).
18. Isidore (Citation2012).
19. Bennett and Bender (Citation2018).
20. The use of an undervalued exchange rate as an industrial policy tool has already been discussed adequately in the previous sections of the paper.
21. Bradsher and Rappeport (Citation2018).
22. Observation by Paul Rosenzweig, former CFIUS staff member, quoted by Bennett and Bender (Citation2018).
23. Bennett and Bender (Citation2018).
24. See McQueen (Citation2018), Rubenfeld (Citation2018), and Klein (Citation2018).