Spencer Cohen PhD 柯西本

On Monday, I was invited to present at the Association of Washington Business’s Annual Policy Summit on U.S.-China economic relations. Below are my responses to questions submitted in advance on this quite expansive subject for discussion. We didn’t discuss specifically the Phase I Trade Deal, though my view is that the export targets, even sans Covid-19 and Boeing 737 MAX grounding, were unachievable. Tariffs remain in place on many Chinese goods; the deal should be viewed more as a pause (albeit brief) in an otherwise acrimonious trade relationship. In the throes of the election season and the continuing pandemic, trade has lost some of its primacy in U.S.-China relations, overtaken by the virus, assigning of blame, and the intersection of technology and national security made evident in August with the executive orders banning TikTok and WeChat. And just this week, there was the issuing of a new opinion on the “Strengthening the United Front Work of the Private Economy in the New Era” (“关于加强新时代民营经济统战工作的意见“) , calling for improving Party control over private business through United Front work. Will unpack this in a later entry. Welcome any feedback and new perspectives on these topics.

What are some possible solutions to the trade deficit between the U.S. and China, other than high tariffs?

Firstly, we need to break out of the mindset that trade deficits, especially bilateral trade deficits, are inherently bad. This is especially the case in the modern era, where trade is predominately a multilateral activity, involving value-added components from multiple countries that go into a final assemblage of a product before export.

What we should be more focused on is healthy trade. That is, trade that is the outcome of reciprocal market access and absent the heavy influence of state subsidies, state enterprises, currency manipulation, and various other trade-distorting policies, as well as the theft of intellectual property and trade secrets. Today, the U.S. remains a very open economy, for both Chinese and non-Chinese firms alike (setting aside those subject to national security concerns, notably Huawei and earlier ZTE). We learned this week the detailed contours of the TikTok and WeChat bans. These decisions, the legality of which is currently being challenged, come after years of market denial for various U.S. companies, especially those in the social media and internet space.

How do we get to healthy, or at least “healthier,” trade with China? The most productive, and constructive, approach is to enlist the support and involvement of our allies. We need to find ways to work with likeminded trade partners who are similarly committed to broadening market access and protection of intellectual property. One such example, quickly scuttled by the Trump Administration, was the Trans-Pacific Partnership. The TPP was essentially the blueprint for the U.S.-Mexico-Canada Agreement, also known as “NAFTA 2.0.” The same multilateral framework for trade, replete with rules of the road all parties can agree to, can set a standard that China can aspire to join following a roadmap of reforms.

Who has the upper hand in a trade war—the U.S. or China? Which country stands to lose more?

The U.S. in some ways, since as the deficit partner has more goods by value we can subject to elevated tariff rates. However, tariffs are taxes on importers. And for many importers, the goods we purchase from China have no simple and easy substitute they can source elsewhere in the world (i.e., inelastic goods). That means, at least in the near-term, American households and businesses become “price takers,” forced to absorb these costs given no viable, available, and scalable alternatives. For many U.S. manufacturing businesses, small and large, China is a leading or even exclusive source of key intermediate components. Again, these businesses ultimately absorb the cost, unless they are able to pass on these additional taxes onto the customers.

On the Chinese side, despite Party work sessions and discussions extolling the importance of self-reliance (such as recent introduction “dual circulation” into the Party literature), China is not an insular economy, nor able to quickly develop technologies domestically that are highly vulnerable to foreign bans (see, e.g., U.S. export control bans on components to Huawei and past row with ZTE). For U.S. companies operating or contracting with production facilities in China, the trade war may encourage those on the margins to diversify their supply chains outside China. But this is only really feasible for firms who don’t also leverage their production to sell into the China market as well. Moreover, there are limits to how much industrial capacity in China could be replaced with capacity in other regions of the world, such as Southeast Asia or South Asia. Even with rising labor costs, companies still save in China compared with other destinations through last mile logistics, and the continual upgrading of China’s road, rail, and port infrastructure systems. This system cannot be readily accessed or reproduced in other, poorer developing economies, at least not at the same scale.

Will the tariffs create U.S. jobs?

No. The objectives of the trade war at times seem incoherent. But one consistent message from the Trump Administration has been the goal of force-changing the calculus of U.S. companies and encouraging repatriating of production. But in most if not near all cases either: 1) the reshoring of production will be for more automated and far less labor intensive activities, yielding a relatively small employment footprint; or 2) more likely, many of these companies that do consider moving production out of China will look for other locations outside the U.S. It won’t come home.

What is the effect on agriculture and manufacturing?

Farmers, as commodities producers, are highly price sensitive. And while in many cases there may not be a so-called “perfect substitute” for a certain good, there are often imperfect substitutes. Agriculture producers and their commodity commissions have in many cases spent decades investing in market access and expansion in China. Many U.S. goods do not have perfect substitutes for production applications in China, but there are many imperfect substitutes, such as wheat from Australia, Russia, or Canada, that could ultimately displace these goods. And once commodity market share is lost, it is very hard to regain.

For manufacturers, in addition to those with operations in China, there are many firms that depend on China-produced intermediate production inputs. These are much more niche, specific products that are not widely produced across the world. Few alternatives, meaning in the near-term these firms become those so-called “price takers.”

What Congress can (or cannot) do?

Congress can forge ahead with trade deals that exclude China but create a standard China could join. Something akin to the TPP is a start, as discussed above, though this requires the executive branch as well (which has displayed a strong aversion to multilateral deals).

Can China use its U.S. debt holdings as a trade weapon?

No. To do so would be tantamount to economic murder-suicide. Even if China could liquidate its treasury holdings for some other, non-dollar-denominated asset type, to do so as a trade weapon would send shivers through bond markets and rapidly reduce the value of its holdings faster than it can sell them off. Secondly, in doing so, if it would work, could heavily devalue the dollar vis-à-vis the RMB and create severe pain on Chinese exporters—the exact opposite effect (and purpose) of China’s accumulation of dollar reserves in the first place.

China has such a large reserve of dollars because the dollar is a reserve currency. The government chose a deliberate, intentional strategy to intervene in foreign exchange markets to prop up the value of the dollar vis-à-vis the RMB to help strengthen the price competitiveness of its export sector. While we often hear pundits cry foul on these excessive reserves, both in China and elsewhere, this comes part and parcel with the role of the dollar as a reserve currency. It is this role that affords us the “exorbitant privilege” of low interests on private and government borrowing. But it must come inherently from an excess of dollar supply outside the U.S. as a medium of exchange. We cannot be a reserve currency and not run trade deficits.

Can you give an overview of the Belt and Road initiative? What are the risks and how can they be managed?

This a large topic so will try to be brief.

There’s a lot of confusion about the BRI. And that includes both in the U.S. and inside China as well. At a basic level, the BRI is a primarily a lending program for foreign infrastructure projects, including rail, ports, and pipelines. Many projects included under the BRI framework or umbrella were already underway before BRI (or previously, “One Belt-One Road”) was elevated as a signature policy of General Secretary Xi Jinping.

The BRI has received a lot of negative press in recent years. There was the case of the Port of Hambantota in Sri Lanka, which fell into Chinese receivership after defaulting on its debts (though worth mentioning that the original deal predated BRI), or what’s been termed “debt-trap-diplomacy.” There’s the view that the BRI is a military hedging strategy, with energy infrastructure systems designed to evade or circumvent U.S. naval forces in the event of a confrontation. BRI is also used to elicit foreign policy concessions from other nations, such as official recognition of Taiwan as part of China. Still others have pointed to common arrangement whereby most of the overseas work is done by Chinese state enterprises, raising concerns this is an effort to export surplus capacity. China has explored ways to internationalize the RMB through BRI investments and lending.

In reality, like many complex geopolitical issues, the truth lies somewhere in between. China does court governments with less-than-shining human rights records with offers of infrastructure investment in return (implicitly) for downgrading or renouncing of their relationship with Taiwan. But China also provides needed funds and resources to many of the poorest parts of the world—places that have been denied desperately needed foreign aid by what some view as a sclerotic and inflexible foreign aid system centered on the World Bank. Likewise, while China has through its state enterprises acquired long-term exclusive leases to sovereign assets—most notoriously the Port of Hambantota in Sri Lanka—these acquisitions may have been more the result of a corrupt and dysfunctional partner government than the designs and scheming of Chinese planners.

While China’s foreign aid may have less structure or preconditions tied to human rights, it may also be argued that the demand for foreign aid far outstrips the available supply, making China’s contributions—even in the form of loans, not assistance—a welcome development. And while geostrategic planners in the U.S. and elsewhere decry such projects as the China-Pakistan Economic Corridor as nothing more than a hedge against future oil supply disruptions through the Strait of Malacca and other major chokepoints, the logic of such moves should be both expected and viewed as necessary for national economic and security resiliency.

So I don’t see the BRI as a risk to U.S. business and national security. There are negative elements to the BRI, such as the issues discussed above. But we should want and expect China, as the second largest economy in the world, to assume a greater role in global economic development and foreign aid.

The pernicious economic impacts of the pandemic are being felt across the U.S. and each new data point illustrates the worsening situation for most Americans. The longer term impacts of the virus may be more frightening for many Americans, while also potentially creating new, seemingly new opportunities. Two vectors of long-term change in our economy, fundamental in nature, may take root. I characterize the mechanisms by which the virus may induced more fundamental change in our economy as either: 1) an accelerant, whereby the virus works as a force multiplier, rapidly increasing the rate by which slower-developing trends become normalized; or 2) a transformative, force function agent, inducing new types of economic and business models and consumption behavior previously unanticipated.

As an “accelerant,” the virus forces the rapid adoption of purchase of previously slower moving trends in how we consume, work, and engage with one another. Leading examples include the rapid, scaling adoption of e-commerce across households. Geopolitically, the tensions between the U.S. and China, brought to a new nadir during the trade war, will only worsen as blame and aspersions are cast about, sowing further distrust, and opening long-festering wounds only partially resolved by the partial truce known as the Phase I trade deal. The push to reconfigure supply chains, especially of products deemed of national security and/or public health importance, such as both technology products and face masks, will (and has) gain new fuel, and furthering calls for tangible, actual decoupling. Near-shoring and re-shoring will be terms we’re likely to continue to hear, at higher and higher decibels, particularly as we approach the height of election season.

As a force function transformative agent. This one is more interesting, and opens a whole range of possible future outcomes. Households savings may shoot up and remain at an elevated level, as households will continue to be rattled by the exogenous impact of the virus on economic stability and an uncertain future. Working from home may become a truly normalized phenomenon or paradigm shift, as businesses re-evaluate their real estate needs in downtown corridors. Households may also re-calibrate the meaning of leisure, and opt to divert some of the disposable income from outdoor dining to other forms of entertainment and relaxation. Or, simply realize the benefits of dining at home, while still enjoying the convenience of well-cooked food purchased via take out.

These changes, and many more, could result in a near-permanently displaced and dislocated labor force. Individuals who earned their living, albeit often in low wage positions, serving customers in person. Many of these workers lack advanced education, including not much more than a high school diploma, and thus may be ill-equipped for the new economy they may find themselves already during the pandemic and afterwards, on a sustained basis, as well. And for some of these workers, no matter their desire to continue working, they may face near insurmountable barriers to being re-employable. And then what? As a society, we’ll need to collectively choose the values we wish to express through policy. Do we guarantee basic necessities to make individuals economically whole, such as a safe place to live, steady supply of food, and programs to help them transition to other forms of gainful employment, providing them with the resources to enable them to re-enter the labor market and contribute as active members of the economy? Or do we allow the private non-profit sector, or any other service provider, to fill this void? (Or let the void become what it is, and leave the displaced at the mercy of the vagaries of our economy?)

In the past few years, much attention has focused on the so-called Thucydides Trap, the thesis first postulated by Graham Allison that, in heavily unipolar skewed international systems, the dominant hegemonic power is reluctant and often unable or unwilling to acquiescence and accommodate the rise of a revisionist power, creating pressures leading to open conflict. This does imply there is an inexorable outcome of war, but that the risk of conflict is heightened significantly under these circumstances. In Allison’s analysis, of the 16 case studies he reviewed, 12 resulted in conflict, the most recent (and applicable to our current relationship with China) being Germany’s rise, from unification following the end of the Franco-Prussian War in 1871 to the eve of August 1914. China’s path is different from the German Empire, but there are certainly enough similarities to give pause and reflection among policymakers and planners.

In this post, rather than focus on the forces attendant in the rapid rise and displacement effects of an ascendant global power, I’ll focus on some commonalities across non-democratic states preceding their eventual collapse. Global systems are more conducive to accommodation when both the ascendant power and the incumbent hegemon are democratic political systems sharing similar values with respect to rights, freedoms, and the role of the state in society. The British Empire, with a constitutional parliamentarian democracy (albeit one that had not yet allowed for women’s suffrage) was far more able and willing to accommodate the rise of the United States in the late 19^th and early 20^th centuries, as both nations were democratic systems. Can the same be said about the U.S. and China? And is China a stable enough economic and political system to be up to the task of peacefully displacing the U.S. in the Asia Pacific?

Throughout history, at least over the past 300 years, autocratic regimes that fell to revolutions often exhibited a set of attributes. These include, in specific order:An origin mythology and/or rationalizing mythology that serves to legitimate the ruling party or system. Examples include the Bourbon Monarchy’s claims as the Sun Kings under an absolutist rulership, or historical tradition and the rights of rulership in Iran under the Shah or Russia under the Tsars.

Sovereign financial distress created by expensive state projects, such as the funding of a war or foreign war, leading to a crippling of state finances and need to extract new revenues from the elite.

Economic distress caused by financial distress, such as inflationary pressures caused by debasing domestic currency to pay foreign debts.

A fissure among the elite or aristocrats, often times over whether they should allow the monarch or ruling party to extract further revenues.

A vast censorship apparatus that prevents the spread of information and opinions that may light a fire in the populace, giving otherwise apolitical, milquetoast-minded individuals a new set of organizing principles to direct their frustrations.

A ruling elite that have long ago lacked charismatic leadership and cult of personality individuals to offset other growing countervailing pressures on the regime.

Lastly, oftentimes an exogenous event, be it a pandemic, famine, reluctant participation in a war, economic collapse outside the boundaries of the sovereign state in question, or other external, unanticipated event that forces a potentially cataclysmic chain of events.

China under the CCP seems to sit conveniently in each of these categories. The origin myth is the role the CCP played in liberating China from the 100 years of humiliation, first through (and couched in) the ideological confines of communism, and later as the proclaimed steward of China’s continuous economic rise; that China cannot reclaim its self-proclaimed position as the most powerful country in the world, economically and militarily, without the CCP at the helm.

Financial distress leading to economic distress. Though this has not yet materialized, it may in the near future. China’s model of economic growth is sufficiently different from Western-style capitalism comparisons seem less useful. But the extensive, still largely poorly understand, pervasiveness of bad, non-performing debt in the economy and the sustained, persistent shifting of economic power from households, as savers, to the state industrial sector, as borrowers, continues to create gross imbalances and distortions that may become increasingly difficult to unwind. The return on assets—a measure of profitability—of state enterprises continues to be well below that of private sector businesses, and yet these often gargantuan state enterprises claim the lion’s share of state bank lending, crowding out lending to more efficiently run and managed private businesses.

Censorship. China maintains a highly sophisticated state apparatus for controlling the flow of information, as has been well documented and reported outside China.

To be continued in a future post…

The current, and perhaps sustained, global upheaval over the coronavirus is extensive. Disrupted supply chains and supply shocks for U.S. importers of intermediate goods, demand shocks brought on by pubic health quarantines and household and individual reticence to spend time and leisure. The millions of U.S. workers who, either of their own volition or instructed by employers, working from home, hallowing out urban cores and depriving various services-based industries—restaurants, cafes, retail—of normal foot traffic and clientele. The volatility and sudden, jerk devaluations of equity markets inducing a negative wealth effect whereby households and individuals whose retirement savings are invested in the market feel poorer, responding with higher savings and reduced consumption. In an economy where nearly 70% of GDP is through consumption, this makes certain we are in, or will be in, a recession. The only question is when, and how, the economy will recover.

This recession is fundamentally different from past recessions. Typically, economic downturns result, after a period of expansion, from businesses slowing their rate of inventory growth, resulting in a slowing of economic activity and shedding of workers, which in turns dampens consumption. Or, through central bank efforts to stem the rate of inflation through monetary action, primarily through raising interest rates. The much rarer case was the financial crisis of 2008-2009, a recession caused by an asset bubble in the housing market brought on by unregulated, profligate lending and opaque risk assessments, and whose closest brethren was the Great Depression of the 1930s. Credit markets seized up and the entire financial system was the cusp of monumental collapse but for deep, massive fiscal stimulus and monetary intervention in the form of quantitative easing.

The above scenarios are endogenous (albeit the low interest preceding the financial crisis were at least enabled by the large purchases of U.S. treasuries by the People’s Bank of China, in support of its policy of undervaluing he RMB). The COVID-19 virus departs from these scenarios. The economic chaos was created by an exogenous event—the incidence and rapid spread of a virus, whose properties experts are still working to understand. The risks are many, and warnings are easily accessible in Italy and elsewhere. Overburdened healthcare system; depressed productivity from large shifts in work from the office to the home and dramatically curtailed business travel; sick or unavailable workers. The sudden closure of offices, and many aspects of the economy writ large, is unprecedented in modern American history. This will likely pass with time, but the repercussions may be vast and indelible, shaping how Americans interact socially, in the crucible of the economy, and in our daily habits and consumption behaviors.