Some Bigger Picture Trade War Stuff Part I

There is typically so much kvetching and focus on the latest Trump Tweet or White House anonymous sources, that there has been very little attention paid to some of the more fundamental issues at play.  Too often in negotiations, there is very little attention given to the backstory and framework of a negotiation that play an enormous role in dictating the process, objective, or direction of the negotiation.  If you focus simply on the technical issues of substance to be negotiated over, but overlook the framing and historical basis, it is quite easy to misinterpret a negotiation.

Let us consider some of the backstory and framing issues that appear to have played a role in setting the stage where for where we are today.

Is China willing to make material changes to its current economic model of heavy state control, Party managed legal system, discriminatory practices, and a host of related practices.

Before we turn to other questions, let us focus on the most fundamental question of all. I consider this the most fundamental of all questions because let us assume a host of different factors are improved but we held constant 2019 China under the leadership of Great Leader Xi, would China be willing to make material changes based upon negotiations.

I know that this might be semi-controversial, but based upon the weight of evidence, I see almost no evidence that China is willing to make the type of market changes pushed for by the Trump administration.  If we look at the economic and financial market policy of Beijing, not just in narrowly defined trade issues, but across a broader range of issues that are both directly and indirectly related to the issues raised by the Trump administration, it is very difficult to find strong evidence they would be willing to make these reforms. In fact, the weight of evidence seems to indicate significantly greater authority and centralization of Party control.

Even if we look at the specific measures that could be deemed “opening”, their underlying logic becomes quickly apparent.  Beijing has delivered upon a number of financial opening measures that include opening the Chinese banking market to foreign competitors, lowering the number of industries on the FDI negatives list, and joining international stock and bond indexes encouraging inflows into Chinese public capital markets. The underlying rational for all these reforms is to increase capital flows into China. Given that their entire economy is so enormously financially dependent, it makes sense, however, it should not be confused with reforms designed to reduce state control, increase competition, and other concerning behaviors.

What makes this specific aspect notable is that the clear state favoritism to state owned or linked firms became such a hot button topic that it became widely discussed in the Chinese press and business community in Q4 and continuing to a lesser degree this year.  Beijing responded as always by increasing credit to SMEs and our sources tell us of banks knocking repeatedly on the doors of small and medium size businesses offering enormous loans no question asked no collateral required.

We could write an entire post on the recentralization of the Chinese market. However, the primary point is that this is not purely a Trump trade issue, but has been widely recognized by other countries, scholars, thinkers, business people across the spectrum. Not only is the Chinese economy not moving to open up, it is quite clearly going in the opposite direction. There is effectively no evidence there is interest in the type of opening reforms pushed for by the Trump administration.

Assume China did want to make market access and control reforms, are there underlying issues that harmed the ability to make a deal?

Yes. Quite simply, Beijing has lost all credibility on these types of issues.  Over the years, there is wide spread acceptance by people that actually work in China and on China, that China has not abided by its commitments or been a good faith actor.  We know that China has been a continual economic and national security espionage threat for more than a decade. We know that China has engaged in an extensive and wide range of abnormal behaviors covering intellectual property. Subsidies through a variety of channels are common. Then there are the examples of China simply not abiding by what it claims to do.

One study argued that a review of Chinese WTO cases found that China abided by it commitments.  However, this study makes one clear methodological error that manifests itself in different ways which anyone who dealt with China before would catch: observation bias.  The observation bias manifests itself in two different ways. First, if the observation sample is a good representation of the population, it can be used as reliable. However, the observation sample in this case is not representative of the population. There are libraries of stories about countries and firms being intimidated into not bring litigation against Chinese firms, against China, or pushing international trade authorities to bring cases.  Put another way, this is like saying that there have been no complaints filed against the mob, so the mob must be an upstanding business enterprise. Lest this point be disputed, technically, Chinese have freedom of religion, speech, and assembly.  Second, cases examined used times when Chinese law or regulatory practice was amended and brought into technical compliance. However, as anyone who has spent time in China can tell you, what the law says and what it means can be totally different. For every regulatory loophole that is closed down to make someone happy, five new ones spring up.  Typically, with the help of a bureaucrat. This is especially true in financial and economic matters.  There is simply almost no person that knows China and has spent significant time there who would argue otherwise.

The reason all of the background matters is that China has lost credibility and trust to make a deal.  Not only is China, by all reports, refusing to cease things like hacking, sources throughout China still regularly relate tales about new non-tariff barriers being thrown up during the trade opening talks.  One company was informed their import license was being cancelled or delayed, the appropriate administrative agency would let them know, for 1-2 years but that they could continue selling the product if it was made in China with a Chinese producer.  In other words, the bad behavior is continuing currently and I know different trade agencies, chambers of commerce, and governmental agencies are aware of it.

This lack of trust is more than just an existential or theoretical implication but directly impacts the ability to reach a deal, even if we assume that point #1 is wrong and really does want to reach a deal requiring material changes to economic and financial policy. A major sticking point, from a variety of reports on multiple levels, appears to have been the issue of enforcement, verifiability, and or commitment.  For instance, one report indicated the Chinese were pushing for a lowering of all sanctions before they engaged in the required reforms.  Other reports had the Chinese side refusing to make changes to the law.  Other reports recounted problems with verifiability and enforcement issues to ensure a deal was not just reached but executed as agreed.  In other words, the lack of trust proved quite consequential.

Whatever lack of credibility we may assign to the Trump administration, on the China issue, they have actually been generally consistent in what they are looking for across a range of issues.  Furthermore, and it cannot be emphasized enough, there are long and short term reasons that such distrust has built up about Chinese economic negotiators.

One of the issues I wrote about just over a year ago, is why I was willing to go along with Trump, and one key point I made is that no matter who you put in the White House determined to address the Chinese economic relationship, any Presidents likely Presidential Wins Above Replacement is hovering around zero.  As I strongly emphasized, that is not a ringing endorsement or biting criticism of any candidate, rather a clear eyed recognition of who you are sitting across the table from. In fact, I wrote this in April 2018 as the trade war ramped up: “even if you changed the leader and the method, would China alter its behavior? I would not assign a zero change in probability, but I would assign a very low probability to any change.” In other words, do not expect China to change and I think this has held up quite well.

As always, I want to emphasize this is not a pro-Trump piece rather an attempt to look at some of the broader issues at play that are significantly impacting the negotiations that receive so little consideration

I’ve decided to do a couple of pieces this week to answer some of the questions I have been getting. This is the first and basically tries to lay out, regardless of what Trump did, what are some of the framing and backstory issues that are rarely considered that inhibit deal probability.

17 thoughts on “Some Bigger Picture Trade War Stuff Part I

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