A Big Week In Trade—No other way to describe it.

The past week was a busy one in trade. The NAFTA negotiations faltered and seem to have missed their U.S. domestic deadline. Hearings on the Section 301 action allowed scores of special interests to make their case for either imposing or not imposing scores of particular tariffs. Secretary of Commerce Wilbur Ross publically lamented that the U.S. has locked itself into complying with the fundamental principles of the multilateral trading system that the U.S. has developed over the past 70 years—Most Favored Nation (giving your best tariff offer to all members of the trade agreement; in this case the World Trade Organization) and living up to our obligation to not raise tariffs we have promised (“bound”) not to raise.

In the face of all this Sturm and Drang, two important events occurred that frame a fundamental question facing the community of industrial nations: what is appropriate State support for national industries. Those events are, first, the determination rendered earlier this month by the WTO Appellate Board on the epic-length saga of Boeing versus Airbus. In this ongoing dispute, the U.S. and EU are wrestling over subsidies to the world’s only two commercially relevant large civil aircraft producers. The second event is the introduction of the “Fair Trade with China Enforcement Act,” by Senator Marco Rubio, a member of the Senate Foreign Relations Committee.

The coming together of these two events highlights the dilemma the industrial nations face with the rise of China as a great economic power. Specifically, the striking contrast between how the great economic powers—in this particular case the U.S. and EU—are using the WTO mechanism to define the scope and acceptable limits of self-serving industrial policies in a rules-based, market-oriented trading system, and how to deal with those not so constrained.

The Boeing v. Airbus dispute is a 14-year saga of suit and countersuit under the WTO Agreement on Subsidies and Countervailing Measures (SCM Agreement) to define what constitutes appropriate state intervention into industry. Defining appropriate state intervention in turn defines the nature of competition between industrial competitors in a free-market system.

The U.S., representing Boeing, in 2004 challenged the direct subsidies provided to start up Airbus; followed immediately by the EU, representing Airbus, defining at least 29 forms of regulatory, administrative and contractual (primarily military) programs as forms of subsidy. What followed was a long series of decisions, appeals, more decisions and yet more appeals, including a raft of hearings to judge if steps taken to comply are actually compliant.

This is complicated stuff. In the latest decision, on March 10 of this year, the WTO Appellate Body agreed with the U.S. that EU’s “launch aid” for the A380 and A350 XWB models provided to France, Germany, Spain and the United Kingdom breached WTO rules. Specifically, Airbus got a below-market interest rate to finance the development of the A350 XWB, and that such below-cost financing constituted a subsidy within the definition provided by the SCM.

Among other findings, the decision reversed an earlier compliance panel finding that the remaining EU subsidies undermined U.S. exports of single-aisle aircraft. The U.S. lost its claim that the EU subsidies constituted prohibited import substitution subsidies.

EU reports that it will quickly comply with the Appellate Body ruling, even as it waits anxiously for yet another Appellate Body ruling later this year. In that matter, the EU appealed a 2017 compliance panel ruling that only 28 of 29 subsidy programs granted to Boeing by various U.S. agencies were not longer injurious to Airbus.

And so it goes with rules-based litigation qua negotiation. Developing the appropriate form and scope of state intervention in advanced economies is frustratingly slow, deeply complex, hard-fought, and intermittently disappointing and satisfying as the rules get hammered out.

Enter Made in China 2025, a detailed industrial strategy to catch up with rivals like the U.S., Japan and Germany in advanced manufacturing such as robotics, medicine and medical devices, and large civilian aircraft. The complex evolving analysis of appropriate state intervention, already hard, is now confounded by a massive new player eager and willing to do whatever it takes to become both self-sufficient and a global supplier in the critical technologies of the next half century.

“The root of the challenge,” Harvard Law Professor Mark Wu argues, “lies with China’s distinctive economic structure. Some commentators refer to this structure as Chinese state capitalism. This terminology suggests that the Chinese economy resembles other economies, such as Russia’s or Brazil’s, that are also labeled as state capitalist.” Professor Wu contends however, “that China’s economy is fundamentally different—even unique.” Professor Wu, instead uses “the shorthand reference of “China, Inc.” to describe the Chinese economy.”

The state is heavily engaged, but economic intervention does not always flow through the state. “Alongside the state,” Professor Wu notes, “is the Chinese Communist Party (“Party”), a separate political actor that plays an active role in the management of state-owned enterprises (“SOEs”). The economy embraces market-oriented dynamics, yet it is not strictly a free-market capitalist system. Networked hierarchies and embedded relationships exist among businesses, but not necessarily in the way they operate elsewhere in the world.”

ZTE is a good example of the complicated relationship between State and State-Owned Enterprises competing aggressively across the globe.

Enter Senator Rubio, whose Bill would, among other things, bar the sale of national security-sensitive technology and intellectual property, increase taxes on multinational corporations’ income from China, and impose duties on, and cap Chinese investor shareholding in U.S. companies producing goods targeted by China’s “Made in China 2025.”

Rubio’s hard-line Bill pushes Congress toward a tougher national response to China’s strategic industrial policy. Perhaps it is in part a reaction to the elusive “strategy” flowing from the White House. It is likely that the Bill as proposed does not get it all right. It is not clear that any single piece of legislation can. However, it is crystal clear that a vigorous and thoughtful national debate—indeed, an international debate– is needed on just how to get our existing institutional rules-based system to work constructively with “China Inc.” to ensure balanced and harmonious economic progress for all nations over the next several decades.

Robert A. Rogowsky is Professor and Program Co-chair of the Masters in International Trade & Economic Diplomacy at the Middlebury Institute of International Studies in Monterey, CA and Adjunct Professor of Trade & Diplomacy at Georgetown University’s Masters School of Foreign Service.
These essays are the opinions strictly of the author. They do not necessarily reflect the views of the Institute or any officials of the Institute.

Discombobulation Diplomacy—A Theory of U.S. Trade Policy 2018

When Richard Nixon flew to Beijing in 1972 to open relations with China, he famously sketched out some simple answers to two basic questions: What does China want? What do we (the United States) want? Those same questions loom heavily now. The recent trip by Secretary Mnuchin and six other top U.S. official, which fell flat this past week, is important because the relationship between these two nations is so critical. But the strategy, unlike that of Nixon and Kissinger, seems, well, discombobulated.

The Trump administration has captured a popular and important strand of economic statecraft by taking on China. It is widely accepted across American industry—indeed, industry everywhere but China—that China’s assertive state capitalism must be taken on. The imperative is caught nicely by Rana Fahoor in relaying a conversation she had with a high-ranking officer in the People’s Liberation Army. “I ….asked her about Chinese state-sponsored intellectual property theft and the notion that technologies taken from the West might be used for both economic and national security advantage. She made it quite clear that “capitalism with Chines characteristics” meant that there was not real boundary between corporate interests and national interest. Indeed, she seemed to think it a bit naïve that anyone would assume otherwise. It was the country that mattered, not the company.”

Accepting China’s soft line between corporate interests and national interests– and it is hard to refute under President Xi’s strong leadership– strategic management of the relationship with China is paramount. It is paramount because China will soon be the largest economy in the world. By 2030 it could be substantially larger than the United States. With more efficiency than any democracy, it has the authoritarian structure to strategically exercise its great power for the good of China. China has, for the past, 20 years effectively used its ‘sharp power’ to pursue China’s rise as a Great Power– the first in history to do so based on its economic prowess rather than military might. China’s power grows in lock-step with its economy and as more countries become dependent upon it as a trading partner and as a source of investment and foreign aid. Moreover, President Xi Jinping has made it clear that ‘good for China’ means good for the Communist Party, locking in direct state authority.

Battle lines have been forming for more than two decades, since Deng Xiaoping’s 1992 ‘Southern Tour,’ opening China’s incredible entrepreneurial energy. China since then has grown rapidly along the traditional development path: textiles through low-end manufacturing and assembly of basic consumer goods to high-value technology goods. The Made in China 2025 Agenda lays out China’s plan for 70 percent self-sufficiency in the high-tech industries (robotics, aerospace, telecommunications, etc) that will drive wealth creation in the 21st century. It is the natural goal of any nation working its way up the economic ladder. Made in China 2025 is the blueprint to escape the middle-income trap. Everyone aspires to it. Few succeed. Where China has been competing ruthlessly with Mexico, Brazil, Taiwan and South Africa, it is now setting up a roadmap for taking competition directly to the United States, the EU, Japan, and South Korea. There is nothing in China’s record since 1992 to suggest that it will not be certain in its goals, ruthless in its pursuit of them, and successful in the end.

The good news is that China’s success in technology will be a boon to the entire world. It will bring remarkable welfare enhancing advances in innovation at lower prices and greater accessibility to billions of people around the world beyond what could otherwise be possible.

The bad news comes in two parts. The first is that it will bring remarkable economic power to a one-party system increasingly dominated by a single powerful leader who, for the past 5 years, has consolidated power into a smaller and smaller group led ever more tightly by himself, and who has eliminated any term limits. The future is hard to predict, but thousands of years of human history suggests this may not progress well.

The second part of the bad news is that the 2025 Plan involves heavy government subsidies, supports, administrative guidance, targeting, and protecting; as well as buying up foreign technologies, requiring tech transfers, joint ventures, and sharing trade secrets. It creates an environment in which firm-to-firm competition—the foundation of the Bretton Woods rule-based trading system– is replaced with the mercantilist system of nations competing against nations.

Here is where the dicombobulation appears. A thoughtful “America First” grand strategy would focus first on a highly efficient and competitive North American industrial platform integrating the economies of the United States, Mexico and Canada into an economic stronghold. It would tie a unified North America economy into a Pacific carefully woven geo-economic and geo-political strategy built on major and emerging trading partners across Asia and Latin America, as was created in the Trans-Pacific Partnership. Finally, by pulling in the EU, our major competitor for sales to and consumption from China—and hence the biggest wedge in China’s negotiation with either the U.S. or the EU– the strategy would build a unified coalition of liberal democracies supporting the rules-based trading system as leverage in negotiations with Beijing.

A discombobulated ‘America First’ strategy, in contrast, abandons all that, and insults the leaders while doing it, just for good measure. It reverts to crude protectionist measures built heavily on claims of national security, which threatens the rules-based trading system. It obsesses on trade deficits and resurrects old tactics like voluntary export restrains and ‘managed trade’ tactics to reduce it, such as demanding that China to somehow reduce the deficit by $200 billion. These measures were unsuccessful and abandoned in the 1980s. It is not surprising, as Martin Wolf states, that China finds this “incomprehensible.” (“People closely engaged in the trade talks,” Wolf writes, “are puzzled by what the US is after. Does Donald Trump even want a deal, they wonder, or is his aim just conflict?”) It is not that the Chinese don’t understand the specific demands, it must be that they cannot fathom the dismantling of a grand strategy and replacing it with contentious, ad hoc impulses, that seem like narrow, industry-specific protections measures, which, ironically, the industries do not want. What could go wrong?

Five to ten years from now we shall know. Perhaps it will work. But more likely the U.S. and its current trading allies will be paying a heavy price.

Robert A. Rogowsky is Professor and Program Co-chair of the Masters in International Trade & Economic Diplomacy at the Middlebury Institute of International Studies in Monterey, CA and Adjunct Professor of Trade & Diplomacy at Georgetown University’s Masters School of Foreign Service.
These essays are the opinions strictly of the author. They do not necessarily reflect the views of the Institute or any officials of the Institute.