Question

What are the major challenges in trade (and national security) between China and United States?; What are the differences in political economy between US and China that created the above major challenges?; What should be the short term and long term approach in resolving the issue?

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Answer 1

The major challenges in trade (and national security) between China and USA started occurring after trade and economic relationship between the two countries expanded significantly in the last three decades. The first challenge is with regards to the industrial policies. China has made an incomplete transition to a market economy and USA view Chinese industrial policies with regards to subsidies and tax breaks in a cynical manner. China also gives low cost loans to Chinese firms; it has created foreign trade and investment barriers and has discriminatory intellectual property and technology policies. The second major challenge is with respect to the level of trade deficit. The U.S. merchandise trade deficit with China was $375 billion at the end of 2017 and this was largest U.S. bilateral trade imbalance. This has led US policymakers to view the trade with China as unfair and this situation is also becoming a key challenge. Third challenge relates to cyber theft. This challenge is not only a trade related challenge but also a national security related challenge. There is a clear lack of effective protection of IPR and the IPR enforcement policies in China are highly lax. This leads to increases instances of espionage in China and hence is a big challenge for trade and national security.

Political economy in USA is stronger and more dynamic than in USA. The rational expectations of economic agents and voters are much higher in USA than in China. Voters in USA use past realizations of economic growth to make rational inferences about the competency of the incumbent government. Thus economic policy in USA is a function of control of White House. Still the policies of USA are outward and forward looking. In contrast political economy in China is conservative and inward looking. The government looks at growing Chinese economy by excessively promoting Chinese industries through subsidies and tax breaks. Reforms in China limit privatization as well as global integration. This is in stark contrast to USA’s political economy.

The short term approach to resolve the issue is to rebalance U.S.-China economic relation. This can be done by expansion of exports from both countries and creation of new jobs. In the long run China will have to transform its economy to a sustainable services and consumption based economy. This will enable pushing China up in the value chain in the long run. Co-operation will also be required, in the long run, on a wide range of other non-economic issues as well. This will lead to creation of reciprocity in terms of tariffs, market access, as well as investment by both USA and China.